No-frills Home Mortgages - Why Lenders Wear The Risks
Sydney Morning Herald
Tuesday April 25, 1995
IT'S clear the no-frills mortgage managers are continuing to grab an ever bigger slice of the lucrative home mortgage market, despite a levelling-off overall in new home loan approvals in recent months.
The mortgage managers - also called mortgage originators - offer cheaper home loans than the banks by running shopfront operations, writing most of their business in customer's premises, undercutting the banks and their costly branch networks, and passing the savings on to borrowers.
In some cases they may act as agents for regional or merchant banks, selling the mortgages in territories where the bank does not have a presence. More commonly, they access funds from other financial institutions such as pension or super funds and life offices via securitisation - issuing securities on the capital markets, backed by the mortgages.
The market leader is Aussie Home Loans. Other prominent players are FAI First Mortgage, RAMS Mortgage, BMC Mortgage and Austral Mortgage. Their discount rate, which may be more than 1 percentage point lower than the major retail banks' normal product, plus the fact that their products are virtually indistinguishable from those of the banks in many other respects, has allowed them to acquire a significant slice of the market.
The growing activities of the mortgage providers are yet to emerge in the official figures on overall home lending, which perhaps reflects a statistical anomaly. However, according to research by Bain Securities, the newcomers command a healthy 7 per cent of all new home loans and are growing rapidly; some industry estimates put the new-loan figure at close to 10 per cent.
Bains forecasts that mortgage managers will be writing a quarter of new home loans within three years and possibly half by 2000.
The mortgage managers are not without their detractors. The banks have been keen to marginalise them by branding them the Johnny-come-latelies of the mortgage market - new, unknown, untested.
Adding to this perception has been the financial background of some of the newcomers. For instance, as was first disclosed in these pages, Aussie Home Loans chalked up sizable losses in its first two years of operation and earned an auditor's query regarding its viability, though it now claims to have well and truly turned the corner on profits.
ASC records also showed some of the mortgage managers began with very modest capital bases, which was not very reassuring for borrowers contemplating a commitment as large and long-term as a home loan.
Elsewhere, it emerged that a predecessor company of Aussie Home Loans, Mortgage Acceptance Corp, virtually went out of business.
Now the influential consumer magazine Choice has turned the spotlight on the mortgage managers in its March issue. The magazine raises concerns about what it claims is a lack of prudential supervision, suggesting there may be a risk to borrowers should a mortgage manager experience financial difficulties.
So just how safe are the mortgage managers?
One hundred per cent, says the industry. The mortgage managers vehemently deny their product is less regulated or less safe than that of any bank.
The managing director of Aussie Home Loans, Mr John Symond, says securitisation is a well-established means of financing mortgages, accounting for 60 per cent of the home loan market in the US.
Nevertheless, market apprehension in Australia, based on lack of consumer awareness about securitisation, has been a significant hurdle, he says.
Most people remain unaware that the mortgages are held not by the manager but by a trustee, he says, with the trustee lending out as mortgages the funds obtained by the securitiser from the wholesale market.
The trustee is there to assure borrowers and investors that the process is properly and legally supervised. "The mortgage manager acts as an agent, finding the customer, administering day-to-day queries and checking repayments are made," Mr Symond says. "The manager doesn't touch the money." The mortgage account itself is held in the trustee's name.
Ratings agencies monitor the transactions and require that 99 per cent of the loans are insured with a mortgage insurer before they will issue a rating.
According to Mr Stephen Paterson, national president of the Mortgage Industry Association of Australia (MIAA), the capital markets and the borrowing public demand this sort of arm's length prudential supervision.
"Otherwise the rating companies won't put the AAA rating on the deal and without the rating the market won't buy the securities that fund the mortgages," he says.
Mr Paterson says that if a mortgage manager experienced financial difficulties and went out of business, the trustee would simply appoint another manager to fill its place. The terms and conditions of the loan could not change, he says.
While variable rates could possibly change with a new manager, this could only happen in consultation with the securitiser, and such action would run the risk of the borrower deserting and refinancing elsewhere.
Nor is it true that the mortgage managers are under-supervised, he says. In fact, they are subject to regulation by the Department of Consumer Affairs and the Commercial Tribunal. "Failure to abide by their requirements can mean a mortgage manager could lose their credit and finance broker's licence," he says.
Most mortgage managers are members of the MIAA (like banks, building societies and credit unions) and are obliged to abide by its code of ethics. The MIAA has a panel of experts who can mediate in the event of a dispute between a borrower and a manager, Mr Patterson says.
Mortgage managers do not not hold deposits, so Reserve Bank supervision is not necessary, he says.
Stricter loan criteria set by a mortgage manager means that in many ways a borrower is more secure than borrowing from a bank. Unlike the banks, each loan application to a mortgage manager iss reviewed not just by the manager but also by the mortgage insurer and the securitiser. A bank has a high proportion of risky loans, he says, and has to factor risk into its margins.
According to Mr Paterson, the idea of risk in a home mortgage is a common misconception. In any loan, the lender wears the risk, not the borrower.
Major banks contacted by the Herald would not be drawn on any of the concerns raised by Choice magazine, preferring to point out another commonly perceived potential disadvantage of the mortgage-manager loans - the fact that most securitised loans are tied to the volatile bank bill rate.
According to Ms Lyndell Deves, of the Commonwealth Bank, which (with a quarter of the market) is the largest home mortgage lender in Australia, banks have an advantage over mortgage managers because they can keep rates low even when money market rates are high. (They do this by passing on savings from their low-cost base of depositors' funds.)
If you have a loan linked to a bank bill, the argument goes, you are vulnerable to a rapid rate increase. "You would have to go into it with your eyes open," Ms Deves says.
However, according to Mr Tony Gill, a director of PUMA Management (a Macquarie Bank subsidiary and the largest of the securitisers), the danger of a loan linked to a bill rate is overstated. While bank bill-linked rates may exceed the banks' rates, if this happens the borrower can simply refinance.
Furthermore, the banks themselves are subject to the same money market rate fluctuations, he says. "About 85 per cent of banks' funding is in the capital markets, according to recent Reserve Bank statistics, so if there is a rise in rates in the capital markets there would be the same pressure on the banks' margins."
Mr Gill says borrowers are at an advantage if the manager has an agreement that includes a mechanism to hedge or switch out of bill rates should they get too high. PUMA has such an arrangement with Aussie, enabling it to offer the lower of the bill rate and a bank-style variable rate at any particular time.
Mr Gill concedes that banks can offer the borrower a greater range of services, including cheque accounts, credit cards and other facilities. But an increasing number of borrowers just want a good mortgage with a good rate, he says.
Mr Gill says that while people might be put off by the complexities of securitisation, "borrowers can reassure themselves that the advanced financial engineering behind it has been thoroughly investigated by investors, rating agencies, and structurers."
Permanent Trustee Co Ltd and Perpetual Trustees Australia Ltd are both active in securitisation. According to Mr Lawrie Brunello, assistant general manager for securitisation trusts at Permanent Trustee, borrowers should be reassured by the fact that the mortgage is held by a trustee at arm's length from the other parties in the securitisation process.
"If the trustee as an independent party physically holds the underlying security, in this case the mortgage document, and that party is also the legal mortgagee, it makes it difficult for any other party to improperly deal with the asset," he says.
The bottom line is this: if you don't want the bells and whistles of a nine-to-five bank branch service, with cheque accounts, credit cards and other depositor's facilities, a loan through an established mortgage manager will save you money and is safe.
However, you should ensure you understand the loan conditions, including the rate, before you sign any agreement.
As Mr Stephen Paterson, of the Mortgage Industry Association, says: "Use a commonsense approach. Make sure the players are reputable. Make sure there are appropriate ratings in place, and that you understand the loan rate.
"The message to the consumer is read and understand the loan contract, as in any financial transaction."
MORTGAGE ORIGINATORS: WHAT THEY OFFER OWNER OCCUPIERS
Standard Special 1-yr 2-yr
% Variable Variable Fxd/Cap Fixed
AIDC 9.55 - - 10.60
Aussie Home Loans 9.40 - - 10.95
AMP Blue Ribbon 9.75 - - -
Austral Mortgage 9.95 9.45 - 10.95
BMC Mortgage 9.50 - 10.45 10.65
FAI First Mort. 9.75 - - -
Finance Lease & M 9.75 - - -
First Pacific 9.75 - - 11.40
Macquarie Resid. 10.30 8.90 11.30 11.50
Morgan Brooks HL 9.80 8.95 8.95 11.45
National Mortgage 9.75 - 10.70 -
RAMS Mortgage 9.75 8.75 - -
Super Members HL 8.70 8.70 - -
3-yr Init fees Init fees
% Fixed Variable Fxd/Cap
AIDC 10.80 $750 $1250
Aussie Home Loans 10.95 $500 $500
AMP Blue Ribbon - $580 -
Austral Mortgage 11.25 $500 $990
BMC Mortgage 10.65 $750 $750
FAI First Mort. 10.75 $125 $125
Finance Lease & M - $750 -
First Pacific 11.70 $690 $1690
Macquarie Resid. 11.65 $300 $300
Morgan Brooks HL - $945 $945
National Mortgage 11.10 $775 $775
RAMS Mortgage - $500 -
Super Members HL - $500 -
% M'gage
ins ratio*
AIDC 75
Aussie Home Loans 76
AMP Blue Ribbon All
Austral Mortgage 75
BMC Mortgage 75
FAI First Mort. All
Finance Lease & M 76
First Pacific All
Macquarie Resid. 76
Morgan Brooks HL 76
National Mortgage 80
RAMS Mortgage 76
Super Members HL 80
* Loan to valuation ratio at which cost of mortgage insurance is passed on to
borrowers. Mortgage insurance is a one-off cost normally amounting to between
0.1 and 0.4 % of amount borrowed.
© 1995 Sydney Morning Herald