Finance Market Update - 15 February 19
In this update we discuss how the market power of the big banks could change following the Royal Commission, recent trends in credit and decision-making processes at banks.
Moving the goal posts When we talk about a credit crunch, we are talking about it being harder to get a loan.
There are various reasons that might make it harder but ultimately it all comes down to the decision-making criteria of the lender. Each lender has a ‘credit policy’ which dictates what standards/numbers/criteria applicants must meet to get a loan approved.
Once the criteria changes, so does their decision making and number of loans that get approved, so you might have been approved based on the old criteria but get declined on the new criteria. Changes in credit policy and decision making has been happening at an alarming rate within banks and the number of loans being approved is down because of it.
Changing credit criteria is like moving the goal posts half way through the game.
The big 4 banks (CBA, NAB, Westpac & ANZ) have made notable changes to the way they assess mortgage applications since the Royal Commission started including how living expenses are assessed, which can impact the likelihood of an application being approved.
The banks did not know where the recommendations from the Royal Commission would land so they self-regulated by declining more loan applications and assessing them in much more detail. This has been to show the government and population that they are ‘responsible lenders’ and don’t need more oversight.
None of the recommendations from the Royal Commission state that the banks loan approval process or decision-making criteria needs to change, so it will remain their choice.
They do not even need to change their use of the semi-controversial “HEM” benchmarking of living expenses which was a clear factor in the banks lending more than they should in the past, some have said by as much as 30% more. ASIC announced they are looking to changing benchmark uses.
The big banks will continue to move the goal post (i.e. change the credit criteria) to a place that suits them, and if more and more people go direct to banks, which could be a very real outcome if the broking industry is dismantled because it becomes unviable to operate a profitable broking business from changes in commission payments based on the recommendations from the Royal Commission, then those goal posts will continue to move in the banks favour, potentially making it harder for people to get loans.
On top of that the big banks, who operate as an oligopoly and command 80% of all home loans, will be in a more powerful position to dictate interest rates. They will get pricing power over the market if there is less competition, like from smaller lenders who rely in some cases solely on brokers for product distribution.
In this scenario, it means the big banks get the market power to dictate interest rates and move in sync to manipulate the market, like a rising tide rates will go up. The ACCC has said in the past there is evidence that rate rises are synchronised by big banks.
Recent trends in lending This chart from CBA depicts the changes in credit growth, which is to say how much banks are lending. You can see that both trend lines peak around 2016, right around the time the property boom hit its peak.
The easy access to low repayment loan options and historically low rates for wealthy baby-boomers who could leverage the equity in their main home or other investment properties meant there were many more investors out in the market.
The sharp decline of the investor line in 2016 is when APRA introduced the cap on banks lending ‘Interest Only’ loans. This stopped investor activity. Before then, investors were almost exclusively taking out ‘IO’ loans given rates were low and the favourable tax breaks.
This next chart covers all residential property lending in the country and shows the dollar value of both owner-occupier loans (family homes) and investor loans, which you can see the total has been gradually declining since early 2018. We wrote about this trend back in July 2018. The investor loan number is the lowest since November 2011, and we do not see it growing back to those levels anytime soon. Owner-occupier loans are the lowest since May 2015.
This next chart shows the approval rate dropped sharply in 2018, coinciding with the reduced dollar value of loans, and the start in the run down in property valuations.
This is only representative of CBA approvals, but the amount of loans declined by banks all round follows a similar pattern. At last count there were 108 lending institutions in Australia. This includes banks, non-bank lenders, credit unions and building societies. There has been a shift in borrow sentiment towards non-bank lenders as banks decline more loans.
This trend will likely continue till after the federal election and the government clarifies its view on the responsible lending laws and their actions on the recommendations from the Royal Commissions final report.
A comment on the final report from the Royal Commission Contrary to many other brokers who have gone up in arms over the recommendations made in the final report we believe it will ultimately be a positive change for the industry and our clients. We see change as a fundamentally positive step in the evolution for the broking, banking and wider financial services industry, a step towards being customer focused and delivering real value.
Note this is all for mortgage broking and home loans, but Skyward Financial provides commercial and business loans which are unaffected.
The 2 key changes are banning trail commission and eventually moving the industry to a customer pays model.
We agree with the banning of trail commission as it was originally implemented by banks in the 90’s who wanted to draw out the commission paid to brokers over a longer time horizon and never helped the client/borrower. Basically, it is an on-going fee paid for no service. It is likely the upfront commission amount in the medium term will rise to offset this change when it is implemented in July 2020.
The other is that eventually there should be no commission paid by the lender at all and the customer/borrower should pay the broker a fee for their service. This might be hard for people to understand as traditionally a mortgage brokers service has been ‘free’ for them, but it makes sense given the Royal Commission clearly wants brokers to act for the customer and for there to be no misunderstanding of who’s interest they are acting.
Currently this is not so clear, as banks pay brokers for bringing them the deals, but in the future, borrowers would pay brokers for searching and finding the best deal. Almost controversially compared to other brokers we see this model as a viable option for the future of the industry. The reason we take this view is that we fundamentally believe there is value in an independent expert helping find the right options and providing valuable advice, which is what a good broker should be doing anyway, and this is a service people should be willing to pay for.
Commissioner Hayne says that the fee could be capitalised on the loan so the customer would pay it over a 30-year term and would be an inconsequential amount compared to the loan value itself, which should be acceptable to borrowers if they see value in using a broker.
The final point to touch on is that the final report suggests that brokers should have a ‘best interest duty’ placed on them. This might sound strange to people who might think brokers are obligated to act in their best interest, but this is not legally true. Brokers technically only need to find a loan option that “is not unsuitable” rather then one that is “in the best interest of the borrower”. Skyward Financial has always and will always act in the best interest of clients, we are an independent and modern broker are not tied down to old ways of doing business like other brokers.
Both sides of government have said they will implement this as we welcome being client centric to become an official way of doing business across the industry. It is likely that under this regulation (mortgage) brokers in the future will look and act a lot more like financial advisers.
This includes being subjected to higher standards of education, licensing, and advice standards, which will likely see many brokers who either can’t or won’t operate in this higher capacity leave the industry and see a rise in the quality of service and outcomes delivered to clients.