What competition?
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11/02/2010 12:00:00 AM
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ACCC chairman Graeme Samuel admitted that as a result of the GFC there is less competition and less competitors in the banking landscape. But what does this mean for brokers? MPA's Andrea Cornish and Tim Neary investigate in this special feature...
Competition - that great engine of capitalism - is up on blocks in Australia's front yard.
In the last two years, the nation's mortgage industry witnessed an incredible breakdown. Like sugar in the gas tank, the global financial crisis has almost completely seized once healthy components such as second-tier lenders and non-banks.
Dependent on securitisation, these entities have been forced to sit out the crisis, while their big bank counterparts continue to lap them in market share.
Former US president Herbert Hoover once stated: "Competition is not only the basis of protection to the consumer, but it is the incentive to progress".
If that's the case, then what does the present situation means for borrowers? And more importantly for our readers, what does it mean to brokers?
Evolution of competition
To analyse the present state of competition, it's important to look at how it's evolved in Australia.
In the 1960s, competition was just a twinkle in the eye. At the time, Australian banks operated under a very protective legal and regulatory regime, which sealed their position in the banking system as core credit providers.
Credit was expensive and the only alternatives to the banks were credit unions and building societies, which were subjected to less stringent regulations, could provide and charge higher interest rates, but were restricted in the range of services they could offer. Most importantly, they were not allowed to call themselves "banks".
Now fast forward to the mid-'80s and there are three things that were true at that stage, says Fujitsu Consulting's managing director Martin North.
One is that the bank margins for mortgages were quite a bit higher than they are today - by almost 4%. Two is that most of the business was written through a small number of major banks and a series of state banks. And three - there were no brokers.
But the situation started to shift in 1983, following the Campbell Inquiry. De-regulation gripped the Australian banking system and a number of mergers took place between the major banks and state banks.
International banks also entered the Australian market and competed with banks not only on price but on product features, says Provident Cashflow Limited's CEO Steve Sampson.
"Eventually because the market was so competitive many of the international banks left the market or their Australian subsidiaries were swallowed up by Australian banks."
At the same time, the world was also awakening to the emergence of global capital markets. Banks that traditionally made loans based on deposits were starting to access other sources of funding through the global capital markets.
It was the birth of a new era. New originators that were accessing these capital markets started to sprout.
Registered Australian Mortgage Securities, better known as RAMS, was originally formed in 1991; however the RAMS Home Loans brand wasn't launched to the retail market until 1995.
Meanwhile, Aussie Home Loans was founded in 1992 as a mortgage originator. Supported by Macquarie Bank, it became one of the first to introduce the securitisation of home loans.
"This was possibly the biggest shake up that the banks ever had," Sampson says. "The mortgage manager emerged rapidly on the back of what Aussie had achieved in the marketplace and by 1995 mortgage managers had a 10% market share of the home loan market."
About this time, the Australian government launched the Wallis Inquiry, also known as the Financial System Inquiry.
The final report, which was released in 1997, was a major review of the Australian financial system that included a stocktake of financial de-regulation, an analysis of the forces driving change and some recommendations on regulatory reform.
In light of the report, the government ended its so-called "six-pillars" policy, which involved a blanket ban on any mergers among the major banks. It also decided that mergers among the four major banks would not be permitted until it was satisfied that competition from new and established participants in the financial industry had sufficiently increased.
According to North, the report suggested that the banking industry needed to unbundle costs and services because borrowers didn't know what they were being charged, as well "they needed to find a way to increase competitive tension in the industry".
As a result of the report, there was more disclosure to consumers, increased de-regulation and Australia started to see more overseas players.
While there was greater consolidation among banks, there were also many new entrants into the marketplace. And with the rise of the non-bank sector came the dawning of new profession - mortgage broking.
In the mad grab for volume, both banks and non-banks looked to mortgage brokers to provide greater distribution of their products.
"The mortgage manager was a driving force of competition for the banks and eventually the bank spreads on home loans reduced from up to 5% pa to 1.5% pa - now that's competition working," Sampson says, adding that banks where forced to close branches and retrench staff to hold up their profits.
Consumer choice was at its height: some 2,300 home loan products were available in Australia.
The increase in product diversity and loan providers fuelled the acceptance of the mortgage broker in Australia and banks embraced the third party channel to hold up their market share. At the time, about 80% of loans written by mortgage brokers went to major banks.
According to Sampson, the banks recognised this success and started putting their own 'mobile lenders' on the road.
By 2004-05, brokers were a firmly entrenched part of the mortgage business - writing between 30-40% of loans and by 2007 mortgage managers wrote about 20% of home loans in the market place.
It was the broking world's equivalent to The Age of Aquarius.
Cue sinister music
But nothing good lasts forever, right? The turmoil in the global credit markets severely hampered non-banks and regional lenders' ability to raise the cash needed to stay competitive in the lending game.
The first to falter was RAMS, which showed signs of struggle in September 2007 when it failed to refinance $6.1bn in short-term debt during the height of the credit freeze. Westpac swept in to take over the group's brand and franchise network in October.
On top of the funding crisis, non-banks had to deal with the flight to perceived brand quality. Resi's head of consumer advocacy Lisa Montgomery publicly admonished banks for "scaremongering".
"At the time major banks delivered a barrage of negative comments informing consumers that non-bank lenders would be more adversely affected (than banks) by the increased cost of funding, which would be reflected in significantly higher interest rates.
"In doing so they gave consumers the false impression that all non-bank lenders will cost them more to borrow - which is simply not true."
Montgomery also says banks led borrowers to believe the US sub-prime crisis was primarily a non-bank issue.
Damage was further done to the non-bank and mortgage manager sector by actions such as GE Money, which failed to pass on rate cuts to borrowers and then pulled out of the market completely by ceasing to offer home loans through third parties.
Bendigo and Adelaide Bank, which provided wholesale funds to a number of mortgage managers, also had to close ranks - a move that Damian Percy, general manager of third-party mortgages, says meant a lot of "difficult conversations, particularly with white label partners".
And formally strong specialist non-banks such as Pepper, Liberty and Bluestone entered a period of hibernation, creating cost efficiencies through job cuts and diversifying their services into other areas in an effort to survive.
According to figures provided by CANSTAR Cannex, since November 2007 42 lenders and 562 products have dropped off their database, either because the lenders have left the industry, or removed their information.
Undeniably the GFC left its mark on competition. Mortgage Choice chief executive Michael Russell remarked to The World Today: "I'm terribly concerned that it has regressed, and I don't think it's anybody's intended actions that have caused that. I think it really is an unintended consequence of the global financial crisis, but I think we're operating in a market place now where the four major banks certainly have a fairly significant stranglehold on the market, and I don't think that's healthy for anybody, short or long-term," he said.
His comments were echoed in an interview ACCC chairman Graeme Samuel gave to the ABC: "Anyone would say that as a result of the trauma, the shock of the global financial crisis, we've got a whole different banking and finance market in this country to what we had before," he said. "There is less competition, there are less competitors."
Between big banks
In addition to the black eyes that the GFC gave non-banks, we've seen incredible consolidation. This has resulted in some seismic shifts in competition.
According to Sampson, "The GFC has allowed the Big Four to reduce competition, buying smaller banks at red spot special prices and dominate the home loan market at 82% (67% pre GFC)".
Twelve percent of that growth came from acquisitions, he said.
The mergers between CBA and Bankwest and Westpac and St.George have helped those banks pull away from its main competitors within the banking sector, NAB and ANZ.
Statistics released in December from the Australian Prudential Regulation Authority revealed that CBA and Westpac garnered 80% of system credit growth over the six months to October 2009. The merged Westpac/St.George entity dominates the housing market with 23% share - just slightly ahead of CBA/Bankwest which had 22.1% of the mortgage pie.
Andrew Inwood, principal of research at Brandmanagement says competition hasn't "died" - it was given away.
"Westpac, which has really survived through the Bradbury effect has now found itself in a relatively luxurious position, and CBA is effectively out-competing everybody else," he told MPA.
In another interview with ABC, Inwood maintained that there's still competition between the two majors and they're still fighting hard to get share.
"There will be a drive by National Australia Bank and I would just say ANZ to re-enter the market and start to claim their share back as well."
We may be witnessing that at the moment. NAB's decision to match the RBA's December rate rise was a clear challenge to Westpac which had doubled the rate rise to 45 bps. NAB group executive of Personal Banking Lisa Gray said "we are sending a message to customers at Westpac, and the other banks, that NAB can offer them a better deal".
But it's clear from 2009 figures that NAB has its work cut out if it wishes to catch up with CBA and Westpac.
Analysis done by Inwood found that in the first three months of last year CBA and Westpac accounted for $23bn worth of new residential lending out of a total for that period of $25bn - more than 90%.
Australia appeared to be moving in 2009 from a four-pillar policy to a "two-pillars, two-stumps policy", as ANZ CEO Mike Smith noted, however he is not onside with comments made by Samuel which suggest the ACCC would be looking at any mergers involving one of the big four banks "very rigorously indeed".
Smith has argued that there is still genuine rivalry in the banking sector. He told the ABC, "I think this whole issue of "are banks being competitive?" is crazy. I mean, people have a choice."
It's a sentiment shared by Huw Bough, Westpac's head of broker sales, who says competition is alive and well within the banking system, as well as between the Westpac brands.
"This has been due to the competitive positioning of our products as well as the backing and strong support for our broker partners and our customers.
"There has also been a significant customer flight to quality and the security of mainstream banks. However second-tier lenders and non-banks still have a viable proposition for a cross section of borrowers," he adds.
The majors' willingness to write home loans at a reduced margin is proof of the fierce competition within the sector, says Advantedge CEO Drew Hall, who took over his present position after NAB purchased Challenger's mortgage management business.
"There are a number of lenders and certainly a multitude of brands in the marketplace. And I think you're evidencing some extremely strong competition and the best evidence of that is you've actually seen businesses writing loans and you've seen the margins stay down and contracting in many cases. If there wasn't the competition that is evident in the marketplace you would see those margins expanding much further than they are outside of the RBA cycle."
But Firstmac's managing director Kim Cannon has a different take on the situation. According to Cannon, the major banks are performing a classic Pincer manoeuvre - writing cheap homes at the expense of business lending, in an effort to drive non-banks into non-existence.
"It's quite obvious that with the GFC the banks have held down the interest rates on home loans to build up market share and wipe out the second tier and the person that's paying for it at the moment is business and small business. You didn't see rate cuts to those guys. You see bigger lending margins now under the guise of credit. You see bigger fees in that area. They're all subsidizing home loan rates to keep everyone happy, but to the detriment of the consumer."
Did the ACCC act prudently in allowing these mergers? Graeme Samuel, chair of the ACCC told Lateline Business that "the advice that we had at the time from both APRA and the Reserve Bank, I think, gave us absolutely no choice. We had to approve that merger." However, he admitted in a later interview with ABC that had the merger not taken place during the GFC, it's questionable whether it still would have been approved.
North says he believes the ACCC had no choice but to approve the consolidation between banks and mergers between banks and non-banks given the circumstances.
"I think they've done a very good job - you've got to remember the state of play at the time ... There were good reasons why those mergers should have gone ahead - at the stage where we were in the GFC some of those banks needed to be propped up. The second thing is none of those players were effectively leading the market in terms of price or product. So effectively it wasn't like you were taking out a really innovative player that was leading the market. Which is why I think it was perfectly ok for them to do what they did. Now, the next big deal will be AMP or Suncorp - that could be a lot harder because essentially that could change the complexion of the market more dramatically, but I actually think they've done a pretty good job in quite a difficult situation."
Sampson also agrees, although somewhat more begrudgingly.
"Look I think it was the economic circumstances. Much to the annoyance to the Australian public, but necessary."
Between banks and non-banks
Not only has there been consolidation between banks, but Australia has witnessed increasing bank involvement in the non-bank space.
Westpac took over RAMS in October 2007, CBA took out a 33% stake in Aussie (which bought Wizard from GE) in August 2008, and NAB purchased Challenger's aggregation and mortgage management business in October 2009.
But what does this mean for competition? Is this the mortgage industry's version of grocery store home brands?
"Does it blur the line?" Inwood says, "Yeah, I guess it does and probably quite intentionally."
But Hall maintains the difference between banks and non-banks has never been black and white.
"The line between bank and non-bank has always been blurry," Hall says, adding that there are several classic examples of bank involvement in non-bank entities. For instance, Macquarie bank was the funder and the operator of the PUMA program which funded businesses like Aussie Home Loans, as well there's Adelaide bank which ran a wholesale lending bank and funded a number of mortgage managers.
"So in some ways "bank/non-bank" is a bit of a state of mind. It's the way that the people who operate those businesses interact with their customers. And the service proposition and the way you go about doing things differently from all the more established brands that may have a set way of doing things from the branch network."
Hall adds that he thinks genuine competition is borne out of having these brands (such as RAMS) stay in existence even though they might have some common ownership.
"And speaking from my own point of view with Advantedge, we are very much motivated - our key performance indicators are not about how many loans NAB writes, it's about how we grow our business. My mandate is to grow the business and make it as successful as it can be."
Bough says Westpac's multi-brand strategy is about offering choices for customers, "and maintaining multiple brands is the most effective way to meet their needs.
"Ultimately, I believe that the customer will largely dictate how much room there is for competition and this will ensure that every lender, however they are aligned, will have to offer competitive products."
Cannon says bank ownership of non-banks gives consumers the illusion of choice. He adds, however, that eventually banks will try and turn the non-bank entity into a mini-version of itself.
"Non-banks have a different culture and mentality to banks. The first thing a bank does when it acquires a non-bank is try and turn it into a bank. You're seeing that at the moment. The variation may be someone like Aussie, who's only sold 30% to the banks," he says.
At the time of CBA's investment in Aussie, the bank maintained it would continue to keep Aussie "strongly independent".
Aussie stated that CBA's 33% stake in the business would give it "the financial muscle to seize opportunities in the non-bank sector" and investigate acquisition opportunities, focusing on smaller home loan brokers suffering from the credit crunch.
NAB's purchase of Challenger's mortgage management business was met with similar enthusiasm from mortgage managers who talked about the "oxygen" it would deliver to the sector.
Mortgage Ezy CEO Garry Driscoll stated that the purchase signalled a return to competition.
"The real wildcard is the NAB and their purchase of Challenger (now Advantedge) which could stir up some real competition. The opportunity for mortgage managers to gain access to funding via such a strong balance sheet has huge positive implication for the competitiveness of this sector. There is no doubt that mortgage managers provide a far superior level of service to brokers at the loan assessment and approval stage and more personalised service to borrowers post settlement and once armed with a competitive suite of products they will be able to challenge the recent bank monopoly of the home loan market," he said.
Late founder of McDonald's Ray Kroc on competition:
"If any of my competitors were drowning, I'd stick a hose in their mouth."
The role of competition in capitalism
In a capitalist economy, the prices of goods and services are controlled through two factors: supply and demand and competition.
Competition results when several producers of a similar product sell to the same buyers. In capitalist economies it is the catalyst to innovation and reasonable prices as companies jockey for buyers. And without its presence, you risk the creation of a monopoly or cartel.
Major bank mergers:
CBA
1989 -Acquired 75% of ASB Bank in New Zealand
1991 -Acquired the failing Victorian government-owned State Bank of Victoria
1994 -Sold its shares in National Bank of Solomon Islands
-Took a 50% share in PT Bank International Indonesia
2000 -Commonwealth Bank and Colonial Limited announce merger, included Colonial's stake in Colonial National Bank, the former National Bank of Fiji.
-Also acquired remaining 25% of ASB Bank
-Acquired full ownership of PT Bank International Indonesia
2006 -Acquired remaining 49% in Colonial National Bank
2008 -Acquired Bankwest
-Purchased 33% stake in Aussie, which had recently acquired Wizard Home Loans
NAB
1981 -Merged with The Commercial Banking Company of Sydney
1987 -Bought Clydesdale Bank (Scotland) and Northern Bank (Ireland)
1990 -Bought Yorkshire Bank (England and Wales)
1992 -Acquired the Bank of New Zealand
1995 -Purchased the Michigan National Bank
1997 -Bought HomeSide Lending
2000 -It's acquisition of MLC Limited for $4.56bn marked one of the biggest mergers in Australian corporate history
2009 -Purchased Aviva's Australian wealth management business Navigator
2009 -NAB purchases Challenger's aggregation and mortgage management business for $385m
ANZ
1970 -In what was then the largest merger in Australian banking history, ANZ merged with the English, Scottish and Australian Bank Limited to form the present organisation, Australia and New Zealand Banking Group Limited
1979 -Acquired the Bank of Adelaide
1984 -Purchased Grindlays Bank
1985 -Acquired Barclays' operations in Fiji and Vanuatu
1989 -Purchased PostBank from New Zealand Government
1990 -Acquired National Mutual Royal Bank Limited
-Acquired Lloyds' operations in Papua New Guinea
-Acquired Bank of New Zealand's operations in Fiji
-Acquired Town and Country Building Society in Western Australia
1991 -Acquired 75 per cent of Bank of Western Samoa
-Sold Canadian operations to HSBC Bank Canada
1998 -Acquired stake in PT Panin Bank, Indonesia
1999 -Purchased Amerika Samoa Bank
2000 -ANZ sells its Grindlays businesses in the Middle East and South Asia, and associated Grindlays Private Banking business, to Standard Chartered
2001 -Acquires 75% of Bank of Kiribati
2003 -Acquires National Bank of New Zealand
2007 -ANZ acquires Citizen Securities Bank (Guam)
2009 -Signed an agreement to acquire Royal Bank of Scotland's Asian operations. The deal includes RBS's retail, wealth and commercial businesses in Indonesia, Taiwan, Singapore and Hong Kong, and its institutional banking businesses in Taiwan, the Philippines and Vietnam.
Westpac
1982 -BNSW merged with the Commecial Bank of Australia to create Westpac Banking Corporation
1984 -WBC and the government of Kiribati formed Bank of Kiribati as a 51%-49% joint venture
1985 - Replaced Barclays Bank in the National Bank of Tuvalu (est. 1981) in Tuvalu (ex-Ellice Islands), taking 40% of the shares as well as a 10-year management contract.
1988 -Acquired the European Pacific Banking Corporation in the Cook Islands and a HSBC subsidiary, the Solomon Islands Banking Corporation
-Also acquired HSBC's operations in Fiji and the New Hebrides
1990 -Bank of New Zealand sold half its shares in Bank of Tonga to WBC and half to Bank of Hawaii, giving each of them 30%
-Bought Banque Indosuez's operations in New Caledonia and Tahiti.
1995 -Sold its shares in National Bank of Tuvalu to that country's government, which now wholly owns the bank.
1995 -Acquired Challenge Bank in Western Australia.
1996 -Merged with TrustBanks
1997 -Acquired Bank of Melbourne in Victoria
1998 -WBC sold its operations in New Caledonia and Tahiti to Soci‚t‚ G‚n‚rale
2001 -The government of Kiribati sought to reduce Westpac's share in Bank of Kiribati from 51 to 49%, leading WBC to sell its shares back to the government.
-Bank of Hawaii sold its interest in Pacific Commercial Bank (42.7%) to Westpac, which held an equal portion.
-WBC offered Samoan investors, who held the remaining shares, the same price it had paid Bank of Hawaii. WBC now owns 93.5% of Westpac Bank Samoa and Samoan companies and individuals own 6.5%.
-In Tonga, Bank of Hawaii sold its shares in Bank of Tonga to Westpac, giving WBC 60% ownership of what is now Westpac Bank of Tonga.
2002 -WBC acquired BT Financial Group
2008 -Westpac merged with St.George Bank
-Acquired BankSA (continues to be a division of St.George Bank)
-Acquired RAMS home loans
Longtime witness
FBAA president Peter White has 30 years invested in the banking and mortgage broking industry.
He had his first mortgage broking company in the late 1980s, however, at the time mortgage broking was not quite the industry it is today. He initially focused on consumer car finance, business lending and commercial. He says there were no commissions paid - he worked entirely on a fee-for-service basis.
"So you had to negotiate your agreements with your clients. It was hard and there had been some issues with brokers doing the wrong thing," he says.
White did that for three years, and then moved to Sydney to work with Advance Bank, which was later acquired by St.George. He was only there for eight months before he joined RAMS to set up their network.
"The '90s was when we saw the real growth," he recalls. "The consumer drove the non-banking sector - they wanted it. They wanted the service, they wanted the pricing and they wanted the product opportunities."
White later became involved with Wizard - working as its chief executive officer. He founded Avanti Commercial in 2002 and has been an active participant in the FBAA since 2003.
Despite the GFC's crushing effect on non-banks, White says he's not worried about the present state of competition.
"Like anything when you over blow the balloon, there are going to be some that pop out the end of it and you come back to what is probably a more solid core. So the competition as we go forward will probably be a more solid group and the fringe element disappears."
But he's doubtful that the return of securitisation markets will result in a return to the days of pre-GFC in Australia.
"No I don't think anything is going to look like it did pre-GFC. A lot of securitisation vehicles were doing things outside of the box. And we need to come back within the box.," he says.
Brokers and competition
The mortgage broking profession really grew in lock-step with the rise of non-banks. And when competition was at its height, brokers were the prettiest girls at the dance. But now that there's been a significant reduction in competition it seems the balance of power has shifted to lenders.
The commission cuts in 2008 could be seen as evidence of the changing dynamic. At the time, brokers talked about "voting with their feet" but the ultimate loan choice comes down to the borrower and when a "flight to brand quality" mentality exists, there really isn't much brokers can do to steer business elsewhere.
The cuts were coupled with higher demands from banks for brokers to lift their game - metrics were introduced around conversion and electronic submission for instance.
"I think the banks are in such dominant positions at the moment that they are going to determine who they use as providers," commented Principal of research at Brandmanagement Andrew Inwood.
Fujitsu Consulting's managing director Martin North looks at the lack of competition and its effect on brokers slightly differently. He says that when there was a dizzying array of products available, consumers had a greater need to use brokers to help them navigate the complexities of a home loan.
"The fact is there are a smaller number of originators now and the products are much more similar. So to an extent the broker proposition is less relevant."
However he adds, "I think today the broker proposition is different - it's more about taking the complexity out of the process, so in other words the banks pass on some of their inefficiency and the brokers deal with all the difficult issues - they make a consumer's life easier. And the second point is - I think there's more emphasis now on slightly broader advice."
North argues the broking industry may have to re-invent itself and brokers could be faced with a decision to offer whole of market advice for a fee or work for a small number of lenders for a commission.
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