Survival of the fittest

MPA magazine was privileged to speak to some of the nation's top industry mortgage managers in a roundtable discussion. These players have demonstrated through ingenuity and their ability to adapt quickly to the deteriorating economic climate that it is possible to survive bank dominance and an overall lack of funding.

MPA: What has your company done over the last 12-18 months to survive?

Garry Driscoll, general manager, Mortgage Ezy: We've tried to maintain our business levels, which has been difficult. We have become very aggressive in terms of pricing in an attempt to try and take the majors head-on. Obviously they've got a desire to see the non-bank sector crushed. And they've done a lot to make our lives as hard as they possibly can.
We've increased our sponsorship and advertising spending, as well, to try and get out there. We've re-jigged our products, offering fixed rate products that are extremely competitive, no-frills products, products that have no fees, or no ongoing fees and changed our service offering to make it as personable as we possibly can with our broker clients.

Tanya White, managing director, Australian First Mortgage: We've done much as the same as Mortgage Ezy, but at the same time we've realised we had to cut costs in both staffing numbers and operation expenses. We also have looked at what we can provide to the market and brought on LoanAxis which is a loan servicing business. Smaller managers that were finding it difficult to run their back office have now outsourced that function to us, so that's generated revenue and helped us keep more staff employed.
New business levels have dropped, but we've also refocused our sales staff on reeducating them on how to sell in this environment. We're definitely not writing the volumes that we were writing in 2006 or early 2007, but we're reeducating them on what this market looks like, what the broker looks like, as we're predominately broker-based.

Ken Sayer, managing director, Mortgage House: We've been concentrating on outsourcing and varying our costs, and what it has affected our bottom line. Although the volumes have dropped, we're the same as Mortgage Ezy and AFM, but we've been focusing on the costs. With our sales staff we've gone back to 1980 and all we talk about is service, turnaround times, returning phone calls and spending more time with the client.
We became a bit complacent. At one stage we were so busy we would just post out blank applications and wait for them to come back. We've gone back to basics, do the meet and greet and come back a second time to take an application. We're spending a lot of time on presentation and process and maintaining customer contact and what we've also done is we were lucky in 1998, we bought both buildings that we now occupy, and we're now a quasi landlord and rent out some floors. And the rental income is now higher than interest bill. So we've been focusing on two things: costs and training.

Warren Nicholls, chief operating officer, Firstfolio: We've only been in this business for about 13 months now, but we started with a $1 bn mortgage management book, but we obviously needed some scale so we bought the Lawfund business, which is a smaller aggregator with about a $5 bn book.
And then the downturn in the market happened. But we've done a couple of things. We've continued to grow through acquisitions and organic growth. Volumes are down with existing business. But in late 2007, we bought the the Capital First book. And it was about a $782m acquisition, primarily mortgage management and for that we actually brought the extra volumes for the business, but we only needed to bring on one staff member, so it really helped our cost base.
Obviously the challenge in the market right now is margins are shrinking, as well volumes are down. On the aggregation side of the business - for the first time in January, we paid out more than 90% of the upfront and trails to the brokers. Two years ago, it was more like 85-86%, 15% splits. And that's a worrying trend. You've got the Connectives our there, the AFGs, everyone is very competitive with the larger broker groups. So growth and acquisitions to get some more scale has been really important. Last year in 2008 we purchased the Domain book, which is a mortgage manager out in the Shire in Sydney. We kept their processing centre and it had about a $1 bn book mortgage managed. So that took our mortgage management up to $2.6 bn and that gave us the scale - we brought another three staff on - but that gave us another billion dollars on their book, so the economies of scale and the costs associated with that really improved our bottom line.
Late last year is we bought the eChoice business, which is a b to c Internet-based business and the margins are substantially greater there. So we bought the $2.6 bn book and the distribution of the business, which is 40 home loan lending managers, which gives us the extra volume but also about three times the margins that we have in the aggregation business because it's a direct to customer opportunity rather than through a broker network.
So growth through acquisitions has been really important, as well as minimizing our costs in two restructures with the acquisitions in the last six months.
And we're actively looking at another $5bn in books right now, so we're at about $12 bn and we'd like to be about $15 bn by June and I think the extra scale will assist us with our cost base and the shrinking margins.
We've also diversified a little bit and set up Firstfolio life insurance - a non-advice policy. We've just launched into that with our brokers. Some brokers will take that and run with that. There's quite good incomes there for Firstfolio and the brokers. And also we're building Firstfolio property. Quite a few of our broker groups do a lot of investment properties. We're working closely with PIAA (Property Investor Association of Australia). They'll be rating the properties, there will be a third party rating of the properties and that will also give us some margin. We've got a goal next year to generate more than 10% of our revenue outside of the mortgage space to de-risk the business. I look at the market now and what's happened in the last 18 months and we're quite vulnerable with the bulk of the business going through aggregation. So mortgage management is going to be important, direct to consumer is important for us and earning some additional revenues outside the mortgage space is also a big goal for us.

MPA: What have you done to diversify your business?

White: We've always had a commercial division, and we've put more emphasis into that during 2008. But then, of course, we did have issues with funders in the leasing space. In saying that we still operate a leasing and commercial division and they're still generating additional revenue that we didn't have prior to that. Unfortunately, the availability of funds from lenders is shrinking also.

Sayer: We've actually embarked on a total reversal. We're walking away from anything that isn't our core business and specializing in funding. We stopped becoming a mortgage manager in February 2007, we're now a funder in our own right. I think Warren is very clever, his timing is immaculate. It's perfect to aggregate pools and diversification. We started with those models as far as real estate and insurance a long time ago. And with the shrinking market we've decided to apply 100% of our focus on one thing and that's just funding. Just about all the non-bank funders have pulled back or stopped and we're not diversifying, we're more determined to stay in the one spot. So it might work for us, it might not.

Driscoll: We've adopted a similar strategy. We believe that we have an excellent business here in mortgage management and we're trying to improve that all the time. We've had a commercial division for five or six years, and it was very successful. But in the last 12 months, there's been a lack of funding for commercial and I don't really think that's really hit the market hard yet. Here in Queensland there have been a number of large developers that have gone to the wall. That's certainly not the last of it, either. As people's loans are due to be rolled over they're going to find it increasingly difficult to get any type of commercial finance at all.

MPA: Do you expect further consolidation?

Driscoll: I don't think there's any doubt that there's going to be some mortgage managers who are around today that won't be around tomorrow. Whether through mergers or they just decide to get out of the business entirely. Firstfolio has been fairly active in that area. I believe that there will be less managers but those managers that are left will certainly be a lot stronger and leaner and no doubt a lot smarter. From our perspective if there was potential for us to acquire somebody we'd look at that, but our main focus is on ensuring that we continue to write good volumes of business.

White: I believe the market will continue to contract. It has, and those who are left standing will be standing strong and there won't be as many. We've done a few acquisitions of a few small portfolios, swallowed those brands. But it was actually out of a lot of acquisition discussion that LoanAxis came out. We actually said to potential vendors, 'you're not realistic in what you see your business being worth, we're not willing to pay top dollar for it, but here's an alternative for you. You hang onto the asset, we'll take the pain away from you and do your servicing and credit processing. That's where we saw the opportunity in this merger and acquisition market and LoanAxis was born.

Sayer: We're just knuckling down. If an acquisition turned up on our doorstep we'd be foolish not to consider. But our plan is steady as she goes.

Nicholls: ING were talking about cutting the funding to about 10 managers Australia-wide. Origin has a similar goal. I've heard that Adelaide bank as well. I heard a prediction from ING from a very high level that they think there's going to be less than 20 mortgage managers in the industry in 18 months time and there's probably hundreds right now.
But I was talking to a fellow the other day, he's got a $750 m book on the Gold Coast, two funders and it costs him about half a million dollars a year in wages - two credit people, processor, basically he's not doing much new business, just sort of managing. If I was to take that business, I could probably take one of his people. And that would save $500 k out of cost of that business and that just goes straight to the bottom line.
We're looking at two mortgage management books right now, that one and another one and they're actually about the same size. And we're actually meeting an aggregator today about a $3 bn book, because for us it's all about economies of scale. Either keep cutting costs, or increase your income by acquisitions. We're growing at about $3 bn a year organically. I just think the consolidation in this space is going to get more fast and furious. If you've got less than a half a billion dollar mortgage book, they will just get rolled up. And ING have been very active in introducing us to people who have small books. So consolidation is coming from three angles - the seller, the buyer and also the funders.
I don't think the industry will look as it looks now in 18 months time. I've only been in the industry for three years and it's changed a hell of a lot in that time.

MPA: How will the mortgage management sector look in 18 months time?

Sayer: At best it's an educated guess. The world won't look positive before the second half of 2010.

Nicholls: The first or second quarter of next year - that would be great.

White: I agree too, we've got at least another year of this to ride.
 
Nicholls: Agreed. My biggest fear is what are the banks going to do with the commissions they pay. The complexities around the new structure with regards to quality and the fee splits depending on submission - it just makes it so much more difficult to manage and maximize your commission rates. And I've got a fear that they're going to have another go at cutting commissions and that would be a real negative for the industry.
I don't think there's any doubt that they're going to commissions.

Sayer: Trailers will be gone for sure.

Driscoll: I believe that the way they're setting it up by putting in all that different criteria is just a way to set them up for a sucker punch and you've seen that with Suncorp and the way they've changed their commissions. And if you look at the New Zealand situation - it's almost word for word. And I think any broker who believes their commissions are going to remain the same for this year, they're going to need to take a bit of a reality check because it's not going to happen.

White: That's right - they need to burst that bubble don't they?

Driscoll: That's why they really need to support this sector. Most of the non-bank sector was built on the broker model. Obviously there are some people who go direct, but the majority of mortgage managers are dealing with brokers. And the banks are setting up brokers to cut their commissions.

MPA: So do you foresee brokers returning to the mortgage management space once this happens?

White: [Brokers] are still using managers, however, our biggest threat is what happens to our funding sources. That probably keeps me up at night, more so than what the banks are doing. We are reliant on the Adelaide banks, ING's and the Challengers to have deep enough pockets to keep funding us. Whilst the brokers might be willing to come back to us and we offer a slightly higher incentive for their business, we need to be here in 12 months with our funders. So that's a threat and a concern to me.

MPA: Are mortgage managers starting to feel trickle down effect from AOFM's investment into the RMBS market?

Driscoll: We've seen a very positive impact from that. We offer the FirstMac product and that's given a lot of traction for us. And I see now that Resimac are coming out with a very competitive product as well that will stack up against the majors propacks. Bendigo and Adelaide bank have received an allocation as well, and historically they've always been big supporters of mortgage managers, they know the market extremely well. I see that as being a very positive step. The main issue there is that the funds of the bank actually go towards new borrowing, as opposed to just topping up a warehouse. And I think that's been made fairly clear by the government.

Nicholls: It's a good sign. I was talking to CBA the other day and just to put it into perspective, Commonwealth Bank is taking $15 bn worth of applications a month. If you take a look at the top four they're probably doing $60bn a month in applications. So $8bn is a great start and a vote of confidence, but it needs to be really scaled up to keep the other guys honest.

Sayer: It's a stimulus, but we need more.

Nicholls: Absolutely.

Homeloans Ltd.
Tony Carn, general manager of Homeloans Ltd. was unable to make the tele-conference, but spoke with MPA in a separate interview.

MPA: What has your company done to survive over the last 12-18 months?

Carn: We've had to bring our level of resourcing down, at the same time we've done a lot of expansion through acquisition. We're very lucky to be a public company with considerable cash reserves. We've used the downturn in market to expand through acquisition. Not everyone can do that, not everyone is that fortunate. What we've really focused on is getting better customer service initiatives. Increasing our levels of customer satisfaction. And we've had to make our margins slimmer in order to compete with what the large banks are still offering.

MPA: Diversification strategies?

Carn: We don't really see it's appropriate to be expanding into other product lines which are non-residential mortgage. Where we've been starting to focus more is back into our retail. Like a lot of mortgage managers in the early days we had our own sales force and we always have, getting into the broker market is obviously of critical importance to us, but yeah, we have had to focus on our retail business.

MPA: What have you done to maintain the relationship with brokers?

Carn: For us it's been business as usual. We're still out there communicating - we've got 14 BDMs nationally, so they're still very active. We continue to talk with aggregators and partners.
But the significant flight to brand quality for brokers and consumers alike - that's a fact of life. What do we do different? We've had commission promotions, we've had product promotions and pricing promotions. But realistically now we're at a time where a lot of brokers are having to realize that need to operate as a business, not as a individual broker. So where we focus on our relationships with brokers is being like a credit coach to them - helping them to understand exactly how to get deals approved.
If you look at the most competitive products in the market it's probably pro packs with very low rates now around low 5% - so we've ensured that we have products with the same functionality and the same pricing.

MPA: Do you foresee banks cutting broker commissions?

Carn: It's hard to actually make these comments without sounding like your throwing rocks on scaremongering. But I think the market has to realize where it's at. So we say there's a flight to brand quality - I think that's an interesting term 'brand quality'. I think broker perception and consumer perception is understandable, but it's still very misguided. I look at the market and see that there's a lot of concern expressed over whether a lender or a balance sheet or a non-balance sheet lender. And if the government is standing behind a major bank they're seen as safer as well with their guarantees. I think that the reality is that organizations such as ourselves and other mortgage managers - we're deriving our funds from both sources - securitized funders and balance sheet funders. So process and service-wise I think we're very superior to banks at the moment and what the market doesn't understand is we are product and pricing wise as well - not superior, but we're on par with most bank products out there. I think with mortgage managers and non-banks, they're very dedicated to the market and they're the ones that have led commission cuts, in some cases have had to keep products competitive following the banks. But I think the introduction of commission hurdles has been a big factor that the market needs to realize too.
On perception of brand quality - I think it's a matter of getting out and about. I'm confident that brokers and consumers will realize that it's still a level playing field out there, but that takes time. I see real signals that that's starting to emerge at the moment. I'm seeing brokers saying I need to see you because I think the banks' service and the banks' attitude is appalling. Our market is going through a cycle and banks have had a wonderful leg-up in recent times through that perception and also through government guarantees and international people pulling out of the market. I think they've played it really well - hats off to them. But they'll always turn around and drop the ball on service, which we're seeing every day. We're seeing a lot of channel conflict through dual pricing and dual servicing.
Brokers need to ask themselves some serious questions. If our distribution channel, the broker market, is supporting banks to the tune of 95% of their business flows and they're doing it after commissions have been cut 30-40%, you've got to question how banks see them going into the future. Once you have an oligopoly established in the market, which we're pretty close to having, it takes a lot of competition out of the market and less competitive markets don't have a need for multiple distribution channels.
I think we can learn a lot from other industries. I look at travel agents, for example. They've had their commissions cut on domestic flights from 5% to zero, because you've got an oligopoly. Quantas and one or two others - they just cut those. The internet has played a big part of that.
I think the computing industry is an interesting one too. You've got players like Dell, who only sell direct to the public, so they won't deal with a Harvey Norman or anyone else.
So I think these are good examples of other industries that have faced these challenges, but they thrived through them regardless. But if you look at what it comes back to is they have started to rely less on their product and more on their customer service to thrive. And I think that's where the answer is for brokers going forward as well. Do I think banks will cut commissions more? What I think and what I hope are two completely different things. I hope they don't, but the direction of the market would have to indicate that it's likely.
I spoke to a broker yesterday, and they said why am I dealing with suppliers who take weeks to process a loan, they can never contact them, yet if my customer walks into a branch they will do it in a day and they've just cut my commission 30-40%? And he said, we've had the epiphany and we've just picked up the phone and called you and asked you to come see us, because we've had to make the move back to non-banks. I love it because I think our industry has been devolving competition-wise, but we're now starting to see that the market knows what's going on and a balance is on the way.

MPA: Has the AOFM's investment made a positive impact on your business?

Carn: That's a difficult one. You can ask yourself the question - is it enough money that the government has put in there? I'm not sure that it is. I think that there are other alternatives out there. But I think the kids at school that sat closer to the front of the classroom are better equipped to answer that question than me.
But there's a lot of money in superannuation out there, and I ask if some was required to be invested in the area of mortgage backed securities, it would probably make a bigger impact. But there are probably 50 reasons why those kids who sat closer to the front of the classroom would say that's a silly idea. But I think there are other alternatives out there that could have a bigger impact.
It's a great initiative that the government has done, but time will tell whether it's enough.

MPA: How does 2009 look for you?

Carn: I'm pretty optimistic about the year ahead. I think the critical thing for any business is to have a sound business plan, which we have. We know the direction we're going on and we're in a cycle. I get buoyed by the fact that in the mortgage origination sector there's been a lot of people competing in the past, for ourselves as a publicly listed company in a good financial position, we are going to see less and less players, but we know it's going to be us and a few select other players - it makes our market a little bit easier as the competition pendulum swings.

MPA: Will the mortgage management sector look quite different in 18 months?

Carn: I think it will look different because there will be a lot less players. A number of mortgage managers in the past didn't have the right infrastructure, service, finance, credit capabilities - and these are all areas where we've been very strong.

Loan Services Australia
Gus Mendez, director of Loan Services Australia, gives his thoughts on the mortgage management sector:

MPA: Describe the last 12 months and what your company has done to survive?

Mendez: The last 12 months have definitely presented challenges, however we have not really had to do anything significant otherwise in the current environment it would be difficult to survive if a significant change to business strategy or model was needed. Our business strategy and model which is focused on a core mainstream product with diversified distribution channels has enabled us to reallocate resources to those channels which currently still add value. For businesses that relied on niche products with limited distribution channels are finding it difficult to re-structure and therefore survive, luckily we are not in that position.

MPA: What diversification strategies have you employed?

Mendez: None, I have the view that diversification strategies are 'evolutionary' rather that 'revolutionary'.  If diversification is the only strategy for survival then it would be very difficult to survive, you are simply starting up again. Diversification strategies, when well executed, work well when a core business works and continues to add or at least sustain value.

MPA: What will be the keys to surviving and thriving in the next 12 months?

Mendez: Be adverse to unnecessary risk, focus on core business and look for new opportunities. For those that can see beyond the credit crunch clouds there is a silver lining. There have been significant changes to credit appetite and therefore policy, re-structuring processes and systems to accommodate these changes is key to keeping a tap on manufacturing costs which can further squeeze ever shrinking margins.

MPA: Where will the mortgage management sector finish up once the credit crisis has blown over?

Mendez: Different!

Better Mortgage Management
Murray Cowan, managing director of Better Mortgage Management, also shared his thoughts in a separate interview:

MPA: Describe the last 12 months and what your company has done to survive?

Cowan: One aspect that BMM has focussed on cost management over the past 12 months to ensure all facets of the business are running at optimal cost efficiency. 

MPA: What diversification strategies have you employed?

Cowan: Although still retaining a focus on residential mortgages and not diversifying in a big way, BMM has developed a commercial lending division over the past 12 months and has established partnerships with other lenders which has delivered revenue from referral fees.  After heavily promoting our Lo Doc range of products in recent years, BMM has also launched new Full Doc products such as our Freedom Recovery product in December aimed at capturing higher volumes in the Full Doc market. BMM has also written more non-conforming loans in the past 12 months as credit policies from major lenders continue to tighten.

MPA: There's been a significant flight to brand quality from consumers and brokers alike - what are you doing to win both groups back?

Cowan: BMM has been concentrating on maintaining high service levels as this is remains the fundamental difference between dealing with banks and non-banks for both customers and brokers.  We have also been constantly reviewing out product offering and its pricing to ensure we are offering both parties the most competitive solution possible as compared to the major lenders.  The AOFM investment in the RMBS market has also helped give the non-bank sector more credibility and is helping us attract new brokers.

MPA: How do you feel the flight to brand quality will affect brokers in the long run?

Cowan: Brokers will need to be cautious that they are not depending entirely on banks for their ongoing income because the risk is always there that banks will continue to alter their commission levels, particularly given their high market share at the moment.  Brokers should be looking to diversify their earnings between banks or non-banks to ensure a lower future earnings risk profile, particularly as many commentators believe it is only a matter of time before there are further commission cuts by banks.
The government recently published a report in November on competition between the banking and non-banking sectors. In it, they made several recommendations and endorsements. One such endorsement was that of the AOFM's $8 bn investment into the RMBS market. Do you feel this is enough to restore competition?
Will this money benefit the smaller mortgage managers?
Have you heard evidence of that yet?
There is no doubt that the AOFM's investment into the RMBS market has delivered more competitively priced products into the non-bank sector, with BMM in a position to deliver new products such as our Freedom Recovery in December and Premium Power Pack in February which are priced better than most bank products and are full featured.  Already these products have proven popular with our brokers and we anticipate that as further investments are made by the AOFM that more competitive products will be released in coming months.

MPA: How do you think 2009 will shape up for your company?

Cowan: BMM has already seen an increase in both the level of enquiry and applications during the early part of 2009 on the back of our newly launched products and we anticipate that this trend will continue.  We also anticipate higher revenue from the referral partnerships with other lenders that we established in late 2008 to eventuate during 2009.  There has also been a surge in applications for accreditation with BMM over the past 2 months indicating brokers are looking for alternatives, and we anticipate these brokers will start to produce additional volumes in the medium term.

MPA: What will be the keys to surviving and thriving in the next 12 months?

Cowan: Delivering quality service and taking advantage of market opportunities as they develop, while at the same time closely managing costs, will be the key to thriving and surviving during the next 12 months.

MPA: Where will the mortgage management sector finish up once the credit crisis has blown over?

Cowan: Smaller mortgage managers will be squeezed out of the market through a combination of competitive pressures and selective culling by funders and mortgage insurers, leaving the stronger and better managed mortgage managers to prosper in the marketplace.  So while the numbers of manager will be reduced, those that remain will still play an important role in the lending market by giving brokers a clear alternative to the banks.

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