Beware Sting In The Tail In Mortgage Managers' Home Loans
The Age
Tuesday February 13, 1996
The big four banks would carve more than $1 billion off their profits if they matched the 8.9 per cent home-loan deal offered by the leading mortgage manager Aussie Home Loans.
Some would argue this would be no great hardship given that the four chalked up profits totalling $4.8 billion with their latest full-year results, but either way it highlights the sort of pressure banks face to maintain profitability.
When the Treasurer, Mr Willis, last week used AHL's interest- rate reduction of 0.35 per cent to turn the thumb screws on the banks, there was more than an element of political opportunism in the statement.
AHL's move resulted from a renegotiated deal with Macquarie Bank's mortgage funding arm, Puma Management, which provides AHL's funds, and not lower interest rates in the wider market.
Mr Willis's assertion that the banks' home-loan rates were ``defying gravity" was pure bunkum based on the realisation that official interest rates were not going to fall in the near future.
For the banks, it's not as easy as cutting rates to compete with the mortgage managers. A conservative analysis concludes that providing a widespread branch network adds 100 basis points to a bank's variable rate. Some would argue that the figure would be nearer 200 basis points.
Macquarie Equities' banking analyst, Mr Graeme Maloney, last year measured the sensitivity of bank profits to a change in home-lending rates.
The analysis assumes that other factors, including cost of funds, are constants.
Mr Maloney concluded that National Australia Bank has the lowest sensitivity, with every 1 per cent change in home-lending rates resulting in a 7 per cent move in bottom-line profit.
Based on NAB's $1.97 billion profit for the September year, a 1 per cent drop in home-lending rates would have carved almost $138 million off its profit. To match AHL's rate would cost it $221 million.
The biggest loser would be Commonwealth Bank, which would see $245 million - 25 per cent - disappear off its bottom line for every 1 per cent reduction in home-lending rates.
CBA's cost to match AHL would be $392 million.
To match AHL's 8.9 per cent, the big four banks would sacrifice $1.08 billion in profits.
The most vulnerable banks are the former building societies, St George Bank, Bank of Melbourne, Advance Bank and Metway Bank. All four have ``sensitivities" of more than 40 per cent.
But that's not the end of the banks' troubles. The mortgage managers, with AHL leading the pack, are using their price advantage to tear into the bank's share of the market. At last count they were grabbing 10 per cent of new business.
With most of the banks offering a 10.5 per cent variable- rate mortgage, there are no prizes for guessing why four of every 10 mortgages written by mortgage managers refinance business the banks have lost. Based on an average mortgage of about $135,000, savings of more than $40 a month are on offer for a move from one of the banks to AHL.
Borrowers, however, need to tread cautiously. The economic cycle at present suits mortgage securitisation, but this will not always be the case.
Mortgage managers source their funds from a securitiser such as Puma, which in turn taps into institutional investors by paying a margin over the 90-day bill rate. Credit risk is insured by either the securitiser or the end borrower, depending on the loan-to-valuation ratio. The loan is administered by the mortgage manager, who also markets the product.
The package allows the mortgage managers to undercut the traditional lenders, but there is a sting in the tail.
When 90-day bill interest rates go up there is no real scope for mortgage managers to absorb the increase. For example, when 90-day rates notched 18.7 per cent during 1989, banks held home-loan rates some 2 to 3 per cent lower. The mortgage managers would have been forced to increase their rate to around 20 per cent because their cost of funds was inherently tied to the bill rate.
Similarly, when interest rates are falling, often the best deals on offer are fixed-rate mortgages, a format that doesn't sit well with securitised loans because somebody other than the borrower must carry the risk of interest-rate changes.
So far, the mortgage managers have not had to deal with an economic downturn and the consequential arrears problems.
Several industry analysts have questioned the administrative backbone of the mortgage managers to adequately handle these situations.
All of this means that a securitised mortgage may be less of a bargain than it at first appears, but the massive price advantage the mortgage managers hold over the banks should ensure a continual flow of new customers.
There is nothing to stop banks entering the securitisation market, but to do so would risk cannibalising their own home- lending book, so most are taking their time to come up with an appropriate strategy.
Some of the regionals have gone interstate with securitised products, and Citibank has made an early entrance to the market.
The big four banks have yet to declare their hand, but there is an expectation in banking circles that the wait will not be a long one.
THE COST OF COMPETING
. Latest Effect on profit Effect on profit
. profit of 1% fall in if matching
. mortgage rate Aussie's 8.6% rate
NAB $1.97b $138m lost $221m lost
Commonwealth $983m $245m lost $392m lost
ANZ $972m $126m lost $202m lost
Westpac $897m $170m lost $272m lost
* Bottom-line profit after preference-share dividends:
falls in profit assume no change in banks' cost funds
Source: Macquarie Equities
© 1996 The Age