The story of the world economy at this time is one of consolidation and economies are operating against the backdrop of a huge volume of merger and acquisition (M&A) activity. This partly explains why stock market valuations have been driven sharply higher over the past 12 months. According to research published last December by consultants Deloitte, 700 banks will be acquired over the next four years, leading to the creation of a handful of Pan-European global champions by 2010. Looking across the past two years, eight of the 12 big European M&A deals have been cross-border retail banking deals. Not only has the last year witnessed some large takeovers of British, Italian and German banks by non-domestic acquirers, but we have also seen strong evidence that consumers are increasingly receptive to doing their banking with ‘foreign’ banks.
This transformation will mean customers enjoying keener pricing and more choice through traditional as well as online channels. The relentless search for operational efficiency will force banks to consider innovative offshoring and customer service propositions such as Sunday openings – something many estate agents already do and some intermediaries may have to consider if they are to compete post-Home Information Packs (HIPs).
Consultantcy Accenture expects that only four or five ‘mega lenders’ will survive this shake out process, with many mid-tier lenders losing market share and smaller companies assuming niche roles or sinking out of sight completely. The mortgage bank Northern Rock, agrees with this assessment and it too expects the number of large mortgage lenders in Britain to halve within five years to five or six big players. Competition will be the driver and banks will continue to look at acquisitions pitched at the right price. Today the top five lenders control almost half of all home mortgage loans. If, as most commentators suspect, within three to five years a handful of megabanks will dominate the industry, innovative smaller companies – the ones undergoing the most rapid growth – will be snapping up niche markets and leaving the remaining firms scrambling to compete. However, competition will come from new entrants like Tesco, which is considering moving into mortgages. Of course, Tesco Personal Finance was launched as a joint venture with the Royal Bank of Scotland (RBS) a decade ago, when supermarkets moved into banking and insurance, offering no-nonsense, cheap, off-the-shelf deals for its customers.
Visibility
Consolidation has been most recognisable recently in the life assurance market – particularly in closed funds business, where new insurer Resolution has just agreed to buy the life business of Abbey bank for £3.6 billion in a deal that will double its size and propel it into the FTSE 100 blue-chip share index. Abbey itself was taken over by the Spanish banking giant Santander Central Hispano for £9bn.
In the prime mortgage market, lenders with large branch networks will challenge intermediary dominance in order to reclaim a greater share of distribution margin going forward.
These lenders will attempt to increase branch productivity by streamlining sales processes through simplified key facts illustrations (KFIs), implementing more effective valuation technology and offering free HIPs. However the ambitions of the lenders will be curtailed by the slow progress in developing a Common Trading Platform (CTP).
Intermediary sector
The overall picture for the mortgage market remains rosy and the market share for intermediary sector looks set to grow in the future. However, compliance will cause some contraction in the sector. The Financial Services Authority (FSA) will adopt a more rigorous regulatory stance that will cause numbers of firms with inadequate compliance performance to merge or exit the market. However there will be a positive trade off with an increased demand for advice the numbers of advisers in firms with robust compliance performance will remain stable. KPMG predicts that a growth in non-conforming business will counteract the increased costs of compliance for many firms.
Most large intermediary businesses will remain unattractive consolidation targets. That is because networks are, by and large, under-capitalised and there is a much greater compliance burden levied on networks compared to directly authorised (DA) firms and it may be that those with appointed representative (AR) status could decide to move to directly authorised status, further reducing the revenues of networks.
The number of one-man band firms is expected to reduce, although they won’t disappear altogether and will remain an important outlet. Intermediaries naturally prefer not to merge as they can leverage buying power via clubs and networks.
However, KPMG expects the whole of market brokers will decline in number, believing it to be a costly and risky process to implement, but expects to see a rise in multi-ties as in the IFA sector, in which firms negotiate higher commission terms with small panels, the benefits of which are shared with customers in better rates. There could also be a growth in tied distribution, in niche areas like debt restructuring, where the existing lender is in a strong position.
Super brokers – similar to those that exist in the US – will emerge in the UK mortgage market, developing their own products that would be distributed through a massive broker workforce, with loans passed onto lender balance sheets once they have been originated.
Non-conforming
During the last six months, the non-conforming mortgage market has attracted much interest from more traditional lending institutions and, in particular, major investment banks.
Morgan Stanley moved into the market at the end of 2005 after acquiring Advantage Home Loans. Merrill Lynch has also entered the market via acquisition, while Deutsche Bank has launched its own lending arm, db mortgages. This is a very interesting development and could lead to further consolidation of the sector since these institutions also have the ability to access capital more cheaply than many of the traditional buy-to-let and non-conforming lenders. That means they have the power to sustain a period of loss lending that would undercut their competitors, eventually turning them into a takeover target.
It is too early to assess how quickly the market will react to these changes and the pace at which the investment banks will move. Whatever tactics they choose to employ, they are sure to make waves in the non-conforming and buy-to-let mortgage markets.
One spin-off of their appearance will see intermediary margins for non-conforming business grow steadily, as a result of the influx of international entrants who lack direct distribution and need a high-street presence. This will increase intermediary bargaining power leading them to negotiate volume deals with lenders which will lead to a progressive decline in average panel size. Panel size is already decreasing, leading to an increase in commission for intermediaries and, likewise, procuration fees will creep up as intermediaries take on an increasing amount of the new business administration.
Home Information Packs
KPMG expects that the introduction of HIPs in June 2007 will offer a big opportunity for intermediaries that should give a significant boost to their business. However, their introduction could also provide an opportunity for big estate agents to make inroads to the mortgage intermediary market since those intermediaries best positioned to benefit from HIPs will be those who are either owned by estate agents or with whom already have close ties.
According to KPMG, the current estimates of the proportion of estate agent customers that are converted into mortgage customers run to about 27 per cent. This, it predicts, could rise to 45-50 per cent, following the introduction of HIPs. One consequence for intermediaries could see homebuyers seeking less financial advice, which will lead to an element of consolidation within the intermediary sector.
Strong and sustained competition in the mortgage sector has resulted in significant improvements for the borrower's benefit – and has led to a number of casualties among lenders. We are entering a new period of consolidation that may see some of the medium-sized lenders, especially in the non-conforming sector, being taken over by the more established companies or investment banks, which are awash with cash following the recent upswing in M&A activity. The intermediary market will continue to flourish, but there may well be a shake-out in the number of networks as ARs switch to those firms that have robust compliance tools in place or choose to become DAs. People with debt problems will continue to use debt consolidation programmes secured on their property and this will drive further grown and acquisition among lenders offering secured loans to people with credit problems. It will certainly not be boring.
