Mortgage banking Australian style

Housing Finance International, Jun 1999 by Pruett, Robert, Johnson, Wayne

In 1994 a visionary team of executives from Westpac Banking Corporation (WBC) and the technology and management consulting groups of Electronic Data Systems (EDS) discussed various strategic and operational concepts intended to revolutionize the Australian home lending market. The challenge involved transcending virtually every aspect of product development, origination, settlement and servicing to accommodate the need of a national uniform commercial credit code (UCCC), decreasing origination and servicing costs and providing securitization opportunities. The mortgage project would impact Westpac in several aspects:

Home loan origination and support staff for 2,000 retail branch offices;

Regional credit approval centers;

State loan processing and servicing centers;

Create the first national mortgage processing center (MPC) in Australia;

Recruit and train (internal and external) initially 450 staff for the new operation, ultimately growing to over 2,000;

All new mortgage processes and procedures;

Implement USA-style technology systems to support mortgage origination, servicing and securitization;

New technology must incorporate Australian loan product features and culture;

New systems and processes must be integrated into the banks' existing infrastructure.

The challenges continue, as the project must be flexible enough to deal with the UCCC, which had not been finalized or published, and an enactment date that would change several times between 1994 and 1996. The final challenge was to complete phase 1 of the project (including opening of the national MPC) within 12 to 18 months. This article will address the development of Australian home lending, how the Westpac project evolved and what the future may bring to mortgage banking in Australia.

AUSTRALIA HOME LENDING

Australia has 18 million people in a country slightly smaller than the United States, 60% of whom live in five capital cities. The Australian Bureau of Statistics estimates that 70% of households live in a dwelling they own or are purchasing. Homeownership is a very important and social aspect of Australian life.

Historically the Australian government was quite active in promoting homeownership, including enacting controls that capped home loan interest rates at 13.5%. Customers normally got their home loans from the four major banks (Westpac, NAB, ANZ or Commonwealth), regional banks or building societies. This approach worked well until April 1986 when the government eliminated the 13.5% interest rate cap. (See Figure 1.)

The new unrestricted flow of home loan funds and increased competition was supposed to lower home lending rates. However, as the housing rate chart depicts, the free market approach would take time before competition was able to reposition its investment portfolio and for new lending sources to enter the market. This transition period (1986-89) resulted in increased lending rates that peaked at 17% by 1989.

The mortgage product of choice had always been variable rate, but with interest deregulation and the resulting rate increases, many hardships developed. Fixed-rate loans were then introduced as a way of hedging a homeowner's risk; but as rates continued to fall this strategy caused relationship problems between the banks and their customers. When the customer had a variablerate loan, interest rates went up; when they switched to a fixed-rate loan, rates went down. The customer lost and the banks won in both interest rate swings (from the customer's perspective). This point of discontent in the early '90s created an opportunity for non-bank lending sources such as the mortgage manager (similar to a mortgage banker in the USA) and insurance companies to enter the market.

In the mid-90s, this group of non-bank loan originators started to take market share away from the four major banks, with projections that they would control 38% (Bain Securities Research) of the mortgage market by the year 2000. With interest rates steadily declining from 1990 though 1998, competition for the customer's business became intense. The mortgage managers, whose funding source is securitization rather than deposits, created basic loan products (minimal features) with low rates and fees, and a promise for quick approval and funding.

The banks' margin on home loans was traditionally very high (4% from 1992-94 vs. the UK, NZ or Canadian margins of less than 2%); but in order to compete with the mortgage managers, they needed to decrease loan rates. The banks challenged the mortgage managers with creative product features, low loan rates and fees, and bundled services; but continued to see their market share decrease slightly. During the process of competition with the mortgage managers, the banks saw their housing margins decrease to less than 2% by 1997. (See Figure 2.)

Products and Features

The home lending culture in Australia focused on flexibility and relationships, which ran counter to the new philosophy of standard loan products that could be securitized. Additionally, refinance fees were minimal ($300 to $600) and often discounted or entirely waived in light of the intense competition. Teaser rates (discounted rates in the early years) came into play, and new products were created in a feverish attempt to retain or gain market share. The combining factors of new non-bank lenders, falling home loan rates and minimal refinance fees erased any barriers to refinance so that customers routinely rotated loans from lender to lender.