As part of the Banking on Change Seminar, Deloitte’s James Hickey and Westpac’s Sean Carmody offered an in-depth look at the state of today’s mortgage market and how banks consider the complex risks and interactions a mortgage product creates. Peter Sinkis reports.
James Hickey (Partner, Actuaries & Consultants, Deloitte) offered a top-down view of the market, taking the audience on a journey through a record-setting year, expected drivers of growth, and the coming trends.
The records keep coming
James began by giving a detailed overview of the various records that the Australian market broke in 2014–15. These included:
- Highest total outstandings
- Lowest interest rates (discounted variable rate)
- Low defaults and losses
- Strong margins (>220bps for the majors, >150bps for the regionals)
- Lots of competition
Other records that strike a note of caution were also coming thick and fast:
- First home buyers appear to be increasingly crowded out (<15% lending), with low-interest rates and strong price rises limiting growth in deposits
- Investor lending at 40% of settlements, prompting recent action by APRA
- Property price growth vs salary growth rates
- Geographic have and have-nots: market growth increasingly concentrated in Sydney and Melbourne
What are the drivers?
The next stage in the market story was a view of the drivers of the mortgage market. Beginning by defining the potential size, the $1.5trn market remains relatively low compared to the ~$5.7trn of potential stock in the market.
Future drivers of new lending are seen as including:
- Refinancers and Upgraders
- Predominately local, non-SMSF investors making up roughly 5/8ths of the market
- SMSF investors, first home buyers, and foreign investors splitting the rest of the investment market roughly evenly between them
Risks remain in the market, with market participants identifying their big concerns in Dec–14 as:
- Downturn in the economy
- Possibility of macro-prudential limits – some of which have come to pass, albeit limited in nature
The coming trends
James concluded his presentation highlighting a variety of trends Deloitte’s research had revealed in the market. These included:
A growing importance of digital and data – experiences need to be delivered via new digital channels focusing on the customer interaction.
Competitive, but not necessarily the cheapest – taking on a mortgage is a complex and large financial decision, prompting the need for ‘omni-channel’ presences.
The digital opportunity remains to be seized in the market in realising this omni-channel approach – websites, applications, quotes, options, and a human to talk to can all be part of it. There is a definite need to identify how the consumer wants to work through the process and tailoring offerings to their needs.
The greatest challenge amongst the majors remains their legacy systems, and this is seeing them increasingly develop selective relationships with various start-ups in the market. That said, the impact of the cultural mix – scrappy innovator, and complex corporation – on the effectiveness of these relationships remains an open question.
A practitioner’s view
After supporting his organisation’s calls for ‘Death to Powerpoint’ Sean Carmody (General Manager, Risk Analytics & Insights, Westpac) took us through a discussion covering a longer history of the mortgage market, and some of the approaches taken by his bank in considering the risks concerned.
A longer view of the market
Sean began by highlighting the broad range of opinions that remain open on the mortgage market from housing growth is great in supporting the transition from the mining boom, to it’s merely a bubble at the ponzi stage.
Then he began delving further into histories from the late 90’s when new players began joining the market. This lead to margins beginning to decline in the face of increased competition. As the 2000s developed mortgage brokers became key intermediaries in the market, acting as an important origination channel for both new mortgages, and re-financings. The market as a whole was dramatically impacted by the Global Financial Crisis (GFC) with the majors once again taking centre stage, at least for a time. Their strong lift in market share was driven by the challenges arising in securitisation and other financing markets at the time.
Overall the post-GFC world continued showing strong growth in the market, with around 10% compound growth in mortgage debt since 2005. This leads us to today where we are seeing a mining downturn begin to drive delinquency in Western Australia, though there are some positives in that we are not seeing this in response to a tightening interest rate cycle.
Handling the risks
So the key question becomes: what if housing prices do drop? It’s a question that is answered for the banks primarily through stress testing. This acts as a way to get a sense of how plausible scenarios containing events with significant impacts can play out. It acts as an opportunity to highlight risks in the mortgage portfolio, and a framework to think about potential second or higher order effects.
After outlining the context of stress testing, Sean talked through the relevant aspects, including:
- Complexities in 2nd round effects such as losses in time so of falling house prices impacting collateral levels
- An opportunity to understand capital resilience, particularly in relation to both the numerator (capital itself – shares, capital instruments, etc.) and the denominator (generally risk weighted assets)
- This is then linked through to potential actions to ensure that the overall management targets in ‘normal times’ are appropriate starting points
As well as driving thinking around capital, stress testing is used to highlight potential risk concentrations in specific scenarios. This can then be used to guide portfolio settings at a broader level. Although rarely eventuating, working through a scenario remains valuable to inform thinking on such matters.
Sean concluded by noting that although regulatory change will no doubt influence how models are developed and utilised in future, stress testing is a valuable tool that will, without doubt, have a place in the future.
Some questions, some answers
A compelling Q&A discussion followed the remarks of these presenters. The themes included regulatory activity and underwriting standards, stress testing and bank’s responses to crises, where the housing market will move to and relevant comparison points overseas, and lastly potential developments in how initial deposits for homes could be raised by first home buyers in future.
Of particular note was highlighting the different incentives for the various regulators that influence the mortgage market. APRA focused on depositors, RBA focused on the system, and ASIC focused on individual customers. Overall APRA initially flagged focus on detailed mortgage practices, followed by RBA focusing in on investor credit, so it is too clean to say that recent APRA settings of limited investor growth are purely a prudential measure?
In considering appropriate international comparisons, there are challenges. The Australian mortgage market is influenced by full recourse lending, heavy industry concentration, and the rise of dual-income homes allowing an increase in gearing levels. Sean noted that in any comparison there is an implicit assumption of an equilibrium level. In terms of considering the US there are two distinct markets. Many cities have seen limited growth in house prices where they have had ample room to expand, while strong, sustained growth has been seen in US cities such as the bay area of San Francisco that share characteristics of Australian cities such as Sydney, which is somewhat concentrated by geography.
A closing note
A special thanks to Nina Larkin (PwC) who chaired the session and led the discussion. Thank you again to our presenters James Hickey and Sean Carmody, as well as the Actuaries Institute for hosting the event.
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