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Rise of mortgage brokers transforms the profit banks once made on home loans

A fork in the road? Or are our banks facing the prospect of a U-turn? 

Amongst the reams of data, analysis and information released by three of the nation's biggest banks in the past fortnight, there was a surprising consistency in the underlying tale of where they've come from and where each are headed.

And for once, that wasn't down to accusations of collusion.

Day after day, the story was the same.

All three lenders – National Australia Bank, Westpac and ANZ – reported serious downturns in earnings and each doled out unexpectedly large wads of cash to shareholders, either to distract from the performance or to diminish the pain and keep the share prices elevated.

But there was something even more startling when it came to real estate. Mortgages over housing continue to dominate the activity and loan books of our major banks. But the profit stream is rapidly diminishing. In some cases, the earnings drop has been alarming.

The shadow of Macquarie Group, which is determined to gain a foothold in the housing market, has loomed large over the sector for the past two years, as it aggressively prices out its rivals.

But that's not the full story. The rise of mortgage brokers has also played a significant role, and unlike the emergence of a hungry new interloper, their influence is likely to be permanent.

Around 75 per cent of new home loans now are negotiated through mortgage brokers. It's a development that has broken the traditional link between client and institution, that has helped put borrowers into the power seat.

It explains why our big banks have been slower than in previous cycles to pass on rate hikes, sometimes taking months to put through higher repayments.

Where once loyalty, or maybe even apathy, made borrowers hesitant in moving their business across the street, price (the interest rate) now dominates how buyers choose a lender.

Banks can no longer rely on a captured clientele and have been forced to battle, not just against each other, but a range of upstart, online operators and aggregators that publish the competing rates from all lenders on your phone screen.

Home loans increasingly have become a commodity that can be switched on a whim. Brand no longer matters.

End of an era?

Home loans have always been the bread and butter of our big banks. But two big events helped turbocharge their involvement in real estate.

The first was financial deregulation in 1983 that eliminated interest rate controls. And the second was the stock market crash of 1987.

As the once towering business empires of Christopher Skase, Alan Bond, John Spalvins and John Elliott crumbled, defaulting on billions in unpaid loans that were secured against depreciating asset values, shock waves rumbled through our financial system.

Westpac was the hardest hit and only barely managed to avoid a total collapse. ANZ wasn't too far behind. It was a defining moment for our economy.

One by one, the Big Four switched focus as the boards and management collectively realised an age-old truth. Home loans may not be glamorous. But home owners will do almost anything to avoid default and keep a roof over their families' heads.

As interest rates fell from the late 1990s on, rising real estate values fuelled a bank earnings bonanza that has continued until now.

The more they lent, the more prices rose. The more prices rose, the more they lent. Australian banks became some of the world's most profitable and Australians among the world's most indebted.

The only serious threat to the earnings stream emerged in the early part of the new millennium when non-bank players like Aussie Home Loans and Wizard, realising the enormous margins the major banks were enjoying on mortgages, began accessing cheap funding from wholesale money markets offshore.

They undercut the banks, sparking a price war and forcing a reduction in home loan rates.

The global financial crisis cut that short and brought the new players to their knees. Those that survived were mopped up by the banking establishment.

That cemented the marriage between our Big Four banks and the Australian obsession with real estate. Incredibly, both the Commonwealth Bank and Westpac still overwhelmingly rely upon mortgages as their main source of business, accounting for more than 60 per cent of their total loan books.

From conflict of interest to interest rate conflict

Kenneth Hayne's royal commission into banking misconduct was supposed to sound the death knell for mortgage brokers.

A key recommendation was that banks should sever the relationship with brokers and that commissions should be banned. He argued customers should be paying brokers to get them the best deal instead of payments from the suppliers.

Treasurer Josh Frydenberg agreed but later backflipped after a concerted lobbying campaign by the brokers.

While many feared the potential conflict of interest would see a re-run of the shocking revelations exposed in the financial planning and insurance industries, it hasn't come to pass.

The banks initially saw mortgage brokers as a means to cut operational costs, as they needed fewer staff in-house to sell home loans. But that has come back to bite them.

The brokers helped unleash a wave of competition that has smashed bank earnings from their biggest business line. Westpac's retail bank earnings dropped 32 per cent in the first half of this financial year. ANZ's division was down 25 per cent and NAB felt the pain as well.

"I think brokers are here to stay," Frank Mirenzi from Moody's Investor Services told The Business.

Banks now have to fork out up-front and trailing commissions to brokers. And given brokers now account for three quarters of all new mortgages, bank profit margins have been whittled back through a spike in costs.

Add into that, the intense competition that has slashed what can be charged, and the banks are under fire at both ends. "Bankers need to factor that into their costs and how they think about mortgage profitability going forward," Mr Mirenzi said.

But who's going to pull the trigger? CBA, which accounts for a quarter of all Australian mortgages, last year decided it wasn't worth writing new business on such skinny margins. That resulted in market share losses month after month.

It's now plunged back in, determined not to be outplayed.

For now, the big banks are glumly watching re-runs of Back To The Future. For the first time in more than 30 years, the profits from business lending are outstripping mortgages, even at Westpac. And, not surprisingly, they're all looking at expanding in that area.

What could possibly go wrong?


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