THE PERFECT STORM OF CIRCUMSTANCES FOR NON-BANK LENDING GROWTH

Non-bank residential mortgage lending is estimated to have grown by roughly 15 per cent per annum over recent years, well above growth in lending by banks. [1]

We think the cause of this push of volume towards non-bank lenders is due to:

1. Major banks repricing of investor and interest-only (IO) loans which are on average 50 basis points above owner-occupied and principal and interest loans (P&I)
2. Significant tightening of credit across 2018 and 2019 as a result of the Financial Services Royal Commission.
3. Record low interest rates, investors are chasing yields giving rise to fertile funding conditions in mortgage securitisation. Residential mortgage-backed securities (RMBS) issuance over 2017-2018 was $30b+, more than double what it was over the prior 2 years (2015-2016).

Non-bank lending to property developers has also grown at a fast pace, through funding from private high net worth individuals (sophisticated investors) and institutional investors.

Non-bank lenders have enjoyed very favourable circumstances over the past 2-3 years, however with signs of a recovery in Australia’s residential property market and the Bank’s gradually getting over their Royal Commission pains, it will be interesting to see if non-bank lenders can hold onto the beach-head they have established into the heavily bank-dominated home loan market.

The things lenders compete on are:

1. Credit availability: this has been a significant driver of growth in share-of-wallet but this advantage will be short lived and also comes with the price tag if higher credit risk.
2. Price: non-banks typically charge higher interest rates but have opportunities to do more on this front, given they have lower operating, compliance and service costs.
3. Customer Experience:  It could be perceived that it’s easier to get a loan at a non-bank lender, given there’s less red-tape in smaller organisations, however given the lack of digital infrastructure at most non-bank lenders, this isn’t a strong point of most non-bank lenders. (I share my personal experience below)
4. Service Quality: Make one mistake and your customers are gone! (Mature organisations such as the big banks are generally better at this)

Everyone complains about their banks, but my experience with a non-bank lender (vendor financier) was like this:

• There is no call centre to call for support
• There is no online portal to view my statement
• I get a statement in the mail once a quarter(?) not even sure but it arrives when it does

In short the experience I receive from this particular lender was pretty terrible (although I’ve heard there are some good ones out there). For example, the application user interface of TicToc seems pretty nifty, although that’s the extent of my experience.

OUR EXPERIENCE AND OBSERVATIONS

We’ve worked with a number of clients over the past 2 years in the non-bank lending space, advising them on their customer experience, business / operating models, software selection and infrastructure. The key observations we would like to share with non-bank lenders are as follows…

• Lenders with established FUM/AUM (funds or assets under management) are what we call FIN’s. Established financial services firms with little or no-tech hence have no clear differentiators for growth when compared to emerging FinTechs in this space. Add a little bit of relevant technology and it change your story. People in the industry understand this, but are afraid of what this means.
• Owners / managers of non-bank lending organisations struggle to manage IT projects so typically vie for out-of-the box lending solutions. We’ve worked with clients who have had no experience in software project management or even writing requirements and hence find their lending platform acquisitions between a rock and a hard place. The client didn’t specify what they want and the vendor wasn’t delivering it.
• Out of the box lending solutions are limited in their functional reach, some systems only do origination and don’t handle loan servicing or recoveries.
• Lending software is a mature space and most lending origination & servicing platforms are built on out of date technologies. We’ve seen a number of desktop applications with poor consumer online portals or no mobile capability. Web technologies are outdated and unresponsive such as ASP.net. Integration using web services are highly couple and point-to-point meaning a low degree of platform flexibility and high maintenance cost.
• Enterprise Architecture is a challenge; some organisations have existing CRM platforms but then need to contemplate migrating that to one that comes bundled with the lending platform. Integration into broader platforms such as user management, email, the general ledger is also a challenge. We’ve seen instances where loans have been written straight to the general ledger instead of being written to a product sub-ledger that then sweeps repayments, interest and fees that come from bank feeds into relevant GL accounts.
• Lending is still a risk-discrimination game. With the retreat of the major banks in lending across 2018/2019 non-bank lenders have had access to higher credit quality borrowers, but as banks refocus on residential lending there is an expectation that credit risk in the non-bank lending sector will increase. Non-bank lenders suffer from small portfolio sizes  and a lack of quantitative historical delinquency / default data.

SOFTWARE SELECTION

Our experience with lending software selection shows that there are 3 tiers (cost tiers).

• Software platforms such as Sandstone, IRess, BakerHill are some of high-end platforms in use within Australia’s major banks. Don’t get out of bed unless you are willing to spend a couple of million dollars on licencing and implementation. (Go speak to them directly on price if you are interested)
• Then there are more cost effective platforms that are in the hundreds of thousands to get up and running and charge monthly for licensing in the 10-20k range. These platforms all have integration into credit bureau’s, KYC services, ATO, Bank feeds out of the box. (come on it’s 2020 after all, 3rd party integration isn’t a selling point anymore, it’s expected)
  
  We’ve run platform selection and implementation projects in this space with a number of mature but value-driven lending platforms. (Speak to us if you are interested in knowing more about software options in this space)
  
• There are few FinTechs out there building platforms and seeking clients. They promise the world, say they are using the best of breed of everything, may incorporate block-chain but have no real differentiators when compared to existing mature software that is in essence very cheap.

SO WHAT’S OUR RECOMMENDATION

• Don’t rush into a platform choice, spend time defining a solution architecture that aligns to your business model and can cater for growth.
• Negotiate a contract with your vendor that can be stepped in terms of scaling cost with the growth of your loan book.
• Do not get cornered into a walled garden software ecosystem you can’t get out of.
• Consider data portability, migration and disaster recovery, in case you run into issues with your vendor.
• Ensure you can access the data efficiently to enhance capabilities that you must own to differentiate yourself. (e.g. Data / analytics that drives credit risk assessment and capital management)

IN CLOSING

Non-bank lenders have established a small beach head in the Australian residential lending market with a share-of-wallet of around 5%. With banks coming back strongly non-bank lenders will need to consolidate their gains and transition from competing on credit availability to competing on experience.

Established non-bank lenders need to bridge the gap between Banks and P2P lending FinTechs and offer a robust and delightful customer experience while understanding the financial needs of retail mortgage and construction lenders.

Our team has been involved in lending process automation and platform development since the early-mid 2000’s. Speak to us if you are a “Fin” looking to get some “Tech” to help anchor your loan book growth or build new capabilities such as securitisation.

References:

1. https://www.rba.gov.au/publications/fsr/2019/apr/box-d.html
2. https://www.abs.gov.au/ausstats/abs@.nsf/exnote/5671.0
3. https://www.afr.com/companies/financial-services/anz-s-market-share-slide-is-unprecedented-20190830-p52mcz

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