Home Loan Star Ratings - September 2008
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RELATIONSHIP RIFT: LENDERS CUT BROKERS ADRIFTAs the global credit crisis deepens, lenders have seen their profit margins squeezed to such an extent they have been forced to take drastic action. Lending practices have been thoroughly scrutinised resulting in many cases of broker relationships being reviewed or overhauled. Lenders who once enjoyed a close relationship with brokers have now decided to spend “time apart” during these extenuating financial circumstances.Earlier in the year a number of Credit Unions, such as CUA, Savings & Loans, and Police & Nurses, stopped or reduced their broker-sourced home loan offerings. Although the credit union market is small, these three lenders account for around 40% of the $25 billion credit union mortgage market. Savings & Loans had previously sourced around 20% of its mortgage sales through brokers. This “temporary separation” was, in most cases, more about the credit unions controlling the number of loan applications they were receiving in an environment where many mortgage managers and banks such as Macquarie were leaving the broker market. Meanwhile, in a separate move which has created waves among mortgage brokers, several major banks cut their upfront broker commissions. Commonwealth Bank introduced a tiered commission structure, encouraging brokers to lodge applications online and with the correct information in order to minimize expensive follow-up. This followed comments by a senior bank representative that the Australian mortgage industry’s efficiency levels are ripe for improvement in regards to transfer of information between lenders and brokers. The other major banks also applied similar changes to their broker commission and trail fee structures, with a view to incentivising brokers to encourage borrowers to hold a loan for longer periods, as opposed to the previous structure which rewarded brokers primarily for selling a product irrespective of how long the borrower then remained with the lender. BankWest took a slightly different approach, removing a large number of brokers from its approved list, culling those whose submissions had required greater follow-up work by the bank. In addition, the bank’s flagship Rate Tracker mortgage was pulled out of the broker channel entirely. MONEY MARKET HEADACHES: WE ALL SUFFERDespite increasing their margins relative to the Reserve Bank (RBA) cash rates since the turn of the year, lenders are again feeling the squeeze as wholesale borrowing costs rise at an even faster pace.In July 2007, just prior to the onset of the credit crunch, the major banks’ average standard variable rates were 1.68% above the RBA cash rate. This had increased to 1.82% by the start of 2008, and has recently widened further to a 2.36% margin. Funding costs on the wholesale markets along with the increasing difficulty in obtaining those funds is proving a headache for our financial institutions which are busy trying to reduce the debt burden on their balance sheets. Most lenders claim to be absorbing some of the increased lending costs. The whole aim is to not lose potential new customers in the short-term then retain them longer-term once the credit crunch is over.  The above chart illustrates how volatile the relationship between the RBA cash rate, 90-day swap rates, and variable mortgage rates has become during recent months as the credit crunch has tightened its grip on the economy. Lenders tend to use the 90-day swap rates as a guideline on mortgage pricing, as this measure reflects the cost of funding for them. Around February / March, the 90-day rate indicated that market expectations were for the RBA cash rate to continue increasing. These expectations reversed sharply around July-August, with 90-day rates showing expected decreases in the cash rate. We can also see from this chart that earlier on in the year, the margin between mortgage rates and the 90-day swap rate was much smaller than during previous recent history, suggesting that lenders were having to absorb some of this increased funding cost themselves – subsequent months saw lenders increase their rates in order to restore their long-term margins. While mortgage rates may have been somewhat reined in compared with lenders’ funding costs, some of these higher funding costs have been passed on to borrowers in the form of higher monthly service fees, and the introduction of new fees, such as legal, administrative, or loan servicing fees. Lenders are now seeking to focus on profit margins in order to maintain the viability of their lending operations, whereas as recently as this time last year the focus tended to be far more on increasing market share. Back in April, Australian Central CU’s managing director Peter Evers summed the situation up when he said that his credit union would from that point be looking to manage profitability rather than growth: “We made a decision in Sept 2007 to reduce volumes of home loans based on the pricing mismatch, because the cost of money was going through the roof.” Further highlighting the issue, ANZ recorded a profit decline in mortgages despite increasing its book by 13% in the 12 months to the end of the first quarter of this year, due to tighter margins caused by the credit crunch. Virgin Money stopped marketing mortgages to new customers in May, again citing high funding costs as the reason. A further rate cut or two by the RBA is widely predicted to happen before the year is out but at this stage, banks are reluctant to commit to passing the rate cuts on to customers. For them, it is a constant juggling act between dwindling money supplies, higher costs and competition for that money between internal lending divisions. It is tempting to criticise the big financial institutions for maximising their profit margins at the customer’s expense but the alternative is far less palatable – withdrawing from lending altogether. TOP OF THE LADDERAccording to APRA July data, a merged Westpac / St George would have Australia’s largest residential owner-occupied mortgage book at $118bn (24.3% of the $486bn market). Including residential investment properties, however, Commonwealth Bank would remain the leader in terms of market share, with 24.5% of the $722 billion market, aggregating both owner-occupied and investment residential property mortgages.RATES IN REVERSE – TIME TO FIX?On September 2nd, the RBA cut its cash rate for the first time in seven years. After a long period of money tightening to rein in excessive growth caused by the commodities boom, signs were that borrowing and spending had peaked, meaning that the numerous recent rate rises had taken the effect desired by the RBA. Many financial analysts believe that interest rates have peaked for the foreseeable future, and that there are likely to be further cuts over the coming months.The cost of fixed rate mortgages has been on the decline since August in anticipation of RBA rate cuts. More attractive fixed interest rate loans are now appearing on the market to tempt customers who are concerned about the interest rate outlook and want the security this loan type offers. As at all stages of any economic cycle, a huge decision for any home loan borrower rests in deciding whether to fix your mortgage or take your chances with a variable interest rate. The answer depends solely on your individual circumstances and what you feel comfortable with. Are you comfortable taking the gamble of seeing your repayments rise and fall in line with interest rates? If you strongly believe that rates won’t go up in the near future, then you may consider a variable loan – as long as your finances allow you to make higher repayments should interest rates trend upwards again. If, instead, you are not inclined to take the gamble, or – just as importantly – your finances dictate that you must be certain what you will be paying every month, then fixing remains your best option. There is a third way of course, which is to take a split product, which allows you to fix part of the loan and keep the rest on a variable rate.  HOW SECURE IS MY LENDER?With financial institutions in the US and UK finding themselves in trouble and some smaller ones here in Australia getting out of the home loan market, should we be worried about our own mortgage provider?Let's take a look at what happens if a lender strikes serious trouble. In this case, the impact on the borrower is fairly minimal, at least in theory. Your lender (or their administrator) will sell your loan to another bank and you will continue to make loan repayments as before but simply to someone different. A good example of this are the clients of Rams Home Loans last year, who are now effectively clients of Westpac. There is, however, potential for the borrower to encounter problems while this lending difficulty plays out. The lender is probably in trouble because it is not able to get medium-term funding and having to pay high, short-term money market rates. It is also possible that many of the lender’s customers are beginning to default on their home loan repayments. The troubled lender needs to find someone to buy their book of loans. Whilst doing this they may increase interest rates to figures higher than their competitors. If this happens, hopefully you can refinance and move to another lender. However, if you have only been with the troubled lender for a few years you may have to pay high exit fees to refinance with another lender. Worse still, with the property market slowdown, you may owe more than the value of your house. This will make it a difficult proposition for any new lender and you may have no option left but to pay the higher interest rates. So how do you find out if your lender is secure?Checking the institution’s credit ratings is a great place to start. Ratings agencies such as Standard & Poor’s, Fitch, and Moody’s all offer guidelines as to the security of a lender’s credit rating. Be warned though that ratings agencies sometimes get it wrong. Not all companies have credit ratings either. Some smaller building societies and credit unions may have strong balance sheets but because they are not actively trying to raise funds in the debt markets (funding loans from their deposit books instead), they may have decided not to apply for a credit rating from Standard & Poor’s or Moody’s.Is your institution accepting new loans?This question is a good indicator of a company’s financial health. Institutions in trouble are focused on refinancing their existing loans and are not looking for new business. Simply ask a lender about their financial position. The topic is front of mind for most institutions at the moment so the ones who are in a strong position will be keen to explain it.At the end of the day however, the best defence is to try and make sure you have a buffer in case your interest rate does begin to rise again. TOUGH TIME FOR HOUSING FINANCEWith high interest rates and property prices added to increasing difficulties in obtaining finance since the onset of the credit crunch, mortgage arrears continue to rise. Recent data issued by Standard & Poor’s showed that monthly mortgage arrears (defined as mortgage payments being more than 30 days late) increased for the sixth successive month in May, the longest such run since this data series was commenced in the 1990s. This figure is almost 50% up on the second quarter of 2007 arrears figure of 1.02%, covering the three months immediately prior to the credit crunch outbreak in July 2007. Further data showed that in April low-doc loan arrears stood at around 2.59% compared with 1.3% for full doc, highlighting the larger risk to those lenders offering low-doc mortgages.According to data supplied by the Australian Bureau of Statistics, housing finance fell by 6.1% from April to May, seasonally adjusted. The fall was most pronounced in new-build finance, which will worry many builders, traders and suppliers. Such data suggests that potential home-buyers are holding off climbing onto the property ladder. Reasons for this are likely to include high repayment costs caused by current interest rate levels, and high property prices, currently at a multiple of around seven times the average wage* – higher than almost any other developed country in the world. NEW PRODUCTS - NEW OPTIONSNAB launched the Clear Banking Home Loan in July, responding to the government’s recent calls to allow borrowers to move more easily between mortgages without incurring penalty fees. Once the $600 application fee has been paid, the rest of it is plain sailing, with no early exit, discharge, settlement, or ongoing fees applicable. The interest rate is set to match the standard variable rate, which sits at 9.36% at the time of writing.Another interesting new product on the market is BankWest’s Rate Tracker home loan. This product offers an eye-catching 1% rate discount compared with the 4 major banks’ average standard variable rate, for the first two years of holding the loan. It should be remembered that when compared to the big banks’ basic variable rates, this discount is closer to around 0.4%, which is nevertheless a significant discount to buyers facing high initial costs associated with moving into a new property. * Based on income data from Australian Bureau of Statistics, February 2008 – national average gross income ~$57,000 per annum; assuming national average residential property price of approximately $400,000. Download Home Loan Star Ratings (PDF)Home Loans ... |
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