Second tier lenders - Beginning to bloom

It has been a very different story for their somewhat smaller second-tier peers.

One of the biggest challenges for second tier lenders over the last two years has been their ability to access competitively priced funds.

While second tier lenders have continued to lend, they have also had to pare back their lending volumes to conserve funds and ensure they remain viable.

Before the GFC, second tier lenders had been steadily increasing their market share by an average of 0.2 per cent each year, but this has been reversed.

As the financial crisis bit deep, the market share they had worked so hard for started to ebb away, thanks to the worsening domestic and global funding environment.

According to the prudential regulator APRA, second tier lenders’ market share slid from 17.28 per cent in December 2008 to 16.86 per cent in December 2009 - representing a 2 per cent drop in overall market share.

And despite the Federal government’s best efforts to reinvigorate the mortgage backed securities market with a $16 billion injection of funding, second tier lenders have generally found themselves doing it tough.

GFC DICTATES

The tight market conditions have dictated how second tier lenders have approached the mortgage lending market.

Like the majors, smaller lenders have reviewed their distribution channels and in most cases reduced the number of groups they choose to work with. In some instances lenders have exited the market altogether.

In a major blow to brokers, Macquarie Bank pulled the pin on the third party channel in 2008 after securitisation ground to a halt.

While the bank only accounted for a relatively small share of overall third party volumes it was a popular lender and its departure rocked the industry.

And only this January RAMS announced its intentions to exit the broker market, blaming a slump in activity.

It’s no surprise then that brokers are concerned about the threat of further departures from the second tier lending market and the potential impact on competition.

UNFAIR ADVANTAGE?

Over the last 18 months, second tier lenders have stood by and watched as the majors continued to grow their share of the mortgage market - which, according to APRA, now sits at around 90 per cent of all new home loans written.

Of course, second tier lenders have not had the access to funding that the majors have - or the benefit of various government initiatives including the wholesale funding guarantee, which comes to an end on 31 March.

The original driver of the guarantee was to promote financial system stability and ensure the continued flow of credit throughout the economy at a time of heightened turbulence in international capital markets.

It also aimed to provide a buffer for the banks, to ensure they were not placed at a commercial disadvantage compared to their international competitors.

Bank of Queensland chief executive David Liddy is concerned that without a staged withdrawal of the guarantee second tier banks - already unfairly disadvantaged - will be penalised.

“I think we have been put in an uncompetitive position right throughout this period. I think it was unintended initially but the point I want to make is that we are an alternative to the major banks,” Mr Liddy says.

“We have continued to lend throughout this period but at the end of the day, we’ve come back on our share.”

But being competitive comes at a price.

“We’ve absorbed [funding costs] for the last 12 months,” says Mr Liddy, “you’ve got to try and balance shareholder needs and customer needs at the same time and sometimes it is a difficult juggling act. I do say we will continue to be competitive but it does come at a cost to the overall bank.”

But not all of the non-majors are concerned about the Government’s decision to withdraw the guarantee.

Bendigo and Adelaide Bank’s general manager third party mortgages Damian Percy says it will have no material effect on the bank’s balance sheet.

“The way the guarantee was structured was such that it was prohibitive to some of us smaller lenders,”

Mr Percy says, adding: “We never used it. We always wanted to stand on our own two feet and we have managed to do just that quite successfully.”

ING DIRECT is another lender that has stood tall throughout the global financial crisis.

The second tier lender’s executive director of mortgages Lisa Claes says the bank, which has a large deposit portfolio, will manage quite comfortably without the guarantee and that its withdrawal may in fact mean greater competition in the market.

“The guarantee could have been said to favour the majors and its removal could see second tier lenders improve their competitive position,” she says.

READY, SET, SECOND TIER

Ms Claes says ING DIRECT has plans to grow its mortgage book over the coming year by increasing growth from 2009 and to reclaim market share from the majors.

She says despite having endured a rough 18 months, the second tier lenders are set to stage a comeback, reigniting competition in the market.

“The market is crying out for more competition. Nowhere else in the world do four institutions command more than 90 per cent market share. Where it makes sense to take a bit more risk for reward, we will,” Ms Claes says.

Ms Claes says while access to competitively priced funds remains a challenge for second tier lenders, there are signs the securitisation markets are beginning to thaw.

On 22 January, AMP almost doubled its residential mortgage-backed securities portfolio to $1 billion with Australia’s first sale of bonds for the year.

AMP had initially planned to sell $543.5 million of bonds, but investor demand forced it to price a main class of $920 million in notes to yield 130 basis points over the bank bill swap rate.

AMP’s banking managing director Michael Lawrence describes the deal as a testament to the resilience of the investor market. He says although the market has been closed for the past few years, it is starting to show signs of life - good news for second tier lenders.

“The market has, to a degree, managed to bounce back from the economic perils it faced in early 2008. I couldn’t say we will see second tier lenders ramp up their position overnight, but I can say things should start to

improve for this market sector,” Mr Lawrence says.

The Federal government recently committed $250 million in RMBS investment to AMP, to be used in three different tranches (AMP currently has three deals in the pipeline). Mr Lawrence says the Government’s RMBS initiative has been a great boost to smaller lenders.

“This direct investment in the RMBS market has been critical to preserving the infrastructure of this important market and is fostering a recovery in private investor confidence,” Mr Lawrence says.

THIS YEAR, RECOVERY; 2011 - GAME ON

The ability of second tier lenders to access competitively priced funds will be a major factor in their ability to compete head on with the majors over the next 12-18 months.

While access to funding is becoming easier, head of distribution and marketing of Citibank mortgages, Peter Hayward says it is still an issue and will remain so for some time.

In the interim, Citibank plans to focus on its existing relationships “so that when the time is right we can push forward and make our mark on the industry”.

Like many second tier lenders, Citibank’s primary distribution channel is brokers.

Mr Hayward says the lender is using this time to explore opportunities with its broker channel, which currently accounts for 95 per cent of its distribution.

“2010 is not the year of growth, but rather the year of recovery,” he says. “Funding is tight, lending criteria will remain strict, so we want to use this down time we have to work on our brand recognition.

“For us, it is not about putting our pedal to the floor, it is about strengthening the relationships we already have.”

Bankwest’s head of retail sales Mark Reid says the market can expect at least another year of uncertainty.

He says Bankwest has no intention to withdraw from the market, but says lending will remain at fairly low levels while capital remains scarce.

“This is not a year for growth,” he says.

“I would be surprised to see any new entrants enter the market. We have already seen two lenders pull back from their broker distribution channel, so it is obvious that times are still tough.”

Mr Reid says Bankwest will continue to operate hand in hand with the broker channel and is currently working on strengthening its relationships with its

high- performing brokers.

Although funding is tight, Mr Reid says Bankwest

will continue to deal with the brokers that have given the lender the greatest support over the last few years.

“We are not strictly introducing minimum volume requirements, but I can say we will be focusing on quality rather than quantity moving forward.”

“The broker channel is integral to our growth and there will always be a place for them in the mortgage broking sphere. As such, we will continue to work alongside our broker partners to help them grow their business and support them in any way possible.”

BROKER SUPPORT

Market conditions may still be tough but there is little doubt that brokers view the second tier as central to the long-term prosperity of the third party distribution channel.

Tandem Uehling’s principal Greg Uehling says he is an avid supporter of second tier lenders because they bring competition to the market and help keep the majors honest.

“Unfortunately there is not too much serious competition at the moment, because of the challenges in funding,” he says. “While access to funds may not improve this year, it will improve, and when that happens I think we should start to see other brokers moving away from the majors.”

Mr Uehling says once securitised lending comes back to the fore, brokers will be in a prime position to take business away from the majors.

“If I were the majors, I would make sure I supported the broker channel,” Mr Uehling says.

“What they [the majors] are doing right now in implementing volume requirements will only see more brokers let their accreditations lapse and focus on moving all that onto the next tier lenders,” he says.

Ultimately, he says, it’s consumers who will dictate which lenders thrive.

“Brokers will be here ready to support those that support them and of course the client. Let’s not forget the client. They’re not moving because of a flight to quality. They just want a good rate.”