Rise of the non-banks

The year 2018 was a tumultuous one for the finance industry. Borrower sentiment towards the banking sector waned, the scandals that emerged from the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry hit borrower confidence, while the banks themselves began to reduce their risk appetite and “simplify” their offers. All in all, the environment was one that created an opportunity for non-banks to take a bigger bite of market share, which they did in droves.

Recent ANZ Bank data showed that new mortgage issuance by non-bank lenders has risen by approximately 13 per cent over the year in the 2017–18 financial year, taking the non-banks’ share of total housing debt from 6.6 per cent to 7.7 per cent.

It was a rise that did not go unnoticed. The uptick in market share for the non-bank sector caught the attention of those in the finance industry as well as economists, researchers and government officials.

In fact, near the end of the year, four separate analysis pieces from each of the “big four” accountancy and business consultancy firms – Deloitte, EY, KPMG and PwC – highlighted how the annual results from the four major banks demonstrate that the big banks face “pressure” for the foreseeable future as a result of remediation-related cost increases and slower income growth.

Initiatives aimed at increasing innovation and competition, particularly from non-bank lenders, were starting to “chip away” at the “entrenched position” of the major banks, the reports suggested.

Each of the accountancy firms noted challenging conditions, including the impact of ongoing regulatory reform, scrutiny from the ongoing financial services royal commission, competition from non-major banks and non-bank lenders, conduct challenges, customer remediation and the upcoming open banking regime.

Shifting market share

The analyses from the big four firms show that headline cash earnings of Australia and New Zealand Banking Group (ANZ), the Commonwealth Bank of Australia (CBA), National Australia Bank (NAB) and Westpac Banking Group (Westpac) dropped by 5.5 per cent year-on-year, from $31.2 billion to $29.5 billion in the full year 2018. Likewise, lending grew at just 3.1 per cent in FY18, the lowest growth rate in a decade.

PwC’s 2018 Major Banks Analysis suggested that lending growth had been subdued “in part because system growth has slowed, and in part because the majors have lost share to smaller bank and non-bank players”.

Speaking after the release of the report, Colin Heath, PwC Australia’s banking and capital markets leader, added: “The major banks’ share of credit is starting to decline, with non-banks in particular seeing a notable lift in lending, reaching 27 per cent on an annualised basis for the third quarter of this calendar year.”

Analysis of the big four banks’ 2018 full-year results from EY also observed that the competitive landscape for Australian banks was undergoing “rapid change”.

Policy initiatives aimed at increasing innovation and competition are starting to “chip away” at the entrenched position of the major banks, EY said, echoing the sentiment that the evidence suggests that non-bank lending has been growing off the back of the major banks’ tighter lending standards and from macroprudential constraints on investor and interest-only loans.

Several lenders have already noted that their growth is being affected by increased flows to the non-bank sector. La Trobe Financial chief lending officer Cory Bannister told The Adviser: “Whilst the value proposition of non-bank lenders has long been recognised as being customer and solution-focused businesses, the historical challenge has been to overcome consumers’ insistence on using a major bank.

“The current environment, where change and complexity are as common as the daily news headlines, has seen a marked shift in consumer sentiment (away from the major banks) and a strong willingness to seek non-bank alternatives to provide financial solutions for what are now underserved markets.”

Likewise, Bluestone announced in August last year that it had seen a 96 per cent increase in applications and 153 per cent rise in settlements, doubling its monthly application and settlement volumes less than six months after its renewed push into the near-prime lending space.

Royden D’Vaz, Bluestone’s national head of sales and marketing, said: “The non-bank proposition has become increasingly attractive to many borrowers recently, as our individual approach to credit assessment means we can facilitate loans that don’t fit into the cookie-cutter approach of the big banks with their credit scorecards.

“Most of these borrowers don’t pose any more risk than your average vanilla deal. They just need a little bit of personal attention to fully understand their situation. Non-banks like Bluestone provide that.”

Similarly, non-bank lender Liberty Financial reported a net profit after tax (NPAT) of $64 million, up by 10 per cent from FY17. The non-bank’s profit growth was spurred by a 15 per cent rise in new loan originations, increasing the value of its total assets under management by 35 per cent to $10.2 billion.

“What we’ve seen over recent periods is that banks have an appetite that has been curtailed [by] prudential requirements that we’re not subject to,” said Liberty Financial CEO James Boyle, who also noted that Liberty offers loans that banks no longer provide, making reference to decisions by some banks to withdraw from self-managed super fund (SMSF) lending.

“[What’s] different about us is we’re able to help customers that banks no longer choose to,” Mr Boyle said.

“It’s our commitment to providing ongoing broad solutions that has allowed us to grow faster than we’ve seen in other parts of the market,” he said.

The agility of non-bank lenders to fill a void is a major calling card. While borrowers and brokers are increasingly turning to them for finance solutions, investors are also seeing the attraction of the sector.

In the past year or so, several mergers and acquisitions have taken place in the non-bank sector. In December 2017, New York-based global asset management firm Blackstone acquired 80 per cent of La Trobe Financial. In February 2018, private investment firm Cerberus Capital Management acquired specialist lender Bluestone Mortgages Asia Pacific (Aus and NZ). And in December, SME Capital Investments III (a subsidiary of Affinity Equity Partners) acquired business lender Scottish Pacific.

Non-bank growth rate could catch the eye of the regulators

The rise of non-bank lenders has also caught the eye of the regulators, however, with APRA now having been given the ability to invoke a reserve power to impose regulations on non-bank lenders should any systemic risks to stability be identified.

PwC’s 2018 Major Banks Analysis suggested that while non-bank lending had grown and increased competition, it was “too early to call a trend”.

However, Mr Heath warned that should non-banks continue to grow at this rate, “regulators will need to keep a close eye on the implications for the system.”

Likewise, in October last year, the Reserve Bank of Australia’s (RBA) Financial Stability Review noted: “The tighter lending conditions have encouraged some borrowers to obtain finance from non-ADI lenders, in particular prospective borrowers who were offered smaller maximum loan sizes or unable to obtain finance from ADIs."

“Given that non-ADIs are subject to less regulatory oversight, this could increase financial stability risks.”

However, the RBA said that it believes non-ADI lending is “unlikely to lead to systemic risks at its current level”. It added that the Australian Prudential Regulation Authority (APRA) would consider further regulation if non-banks pose a greater threat to stability in the future.

“If non-ADI lenders were at some future time to pose a material risk to financial stability, APRA now has the ability to invoke its reserve power to impose regulations on these lenders in order to manage these risks,” the RBA said.

Many non-banks have hit out at the suggestion that their standards are less stringent than banks due to the fact that they are unregulated, with several non-ADIs banding together recently to develop a new Fintech Code of Lending Practice.

Developed with support from the Australian Finance Industry Association (AFIA), the Australian Small Business and Family Enterprise Ombudsman (ASBFEO), thebankdoctor.org and FinTech Australia, the code pulls together the obligations of online small business lenders to promote high industry standards of service, provide a benchmark with respect to the disclosure of comparable financial information to borrowers and support compliance with legal and industry obligations.

According to the group, the code is needed given the fact that the regulatory landscape is “changing rapidly” and the current legal and compliance commitments facing online small business lenders have been labelled as being “fragmented”.

Modelled on best practice examples and feedback from the more mature fintech markets in the US and UK, the code has therefore been brought forward as part of a “proactive move to pull the obligations of online small business lenders together into one document” and make it easier for both participants and borrowers to understand their obligations.

The six signatories to the code so far are Capify, GetCapital, Moula, OnDeck, Prospa and Spotcap.

Looking to the future, many expect 2019 to be the year of the non-banks, with continued volumes going to this sector as the fallout from the royal commission continues and banks look to simplify their offering.

As La Trobe Financial’s chief lending officer predicts: “We expect to see continued growth in non-bank volumes over the coming year and beyond. The current economic and regulatory conditions are expediting the shift in the immediate term and, in our view, this is likely to be the catalyst for longer term growth in the sector.”

Mr Bannister said that this would manifest in terms of consumer sentiment “as future generations choose performance over historical allegiance” and also product availability as banks continue to “simplify” their product offerings and adjust to the need for “more detailed, and often manual, credit assessment techniques that many non-banks already adopt”.

He concluded: “As a non-bank, we rely almost exclusively on brokers for loan originations. This puts brokers at the top of our tree in terms of importance and value. We have great relationships with brokers and feel that there are great synergies between brokers and non-banks in the current environment – both are focused on solutions, customer service and choice, and now more than ever, they are relied upon by consumers for assistance. In our opinion, brokers and non-banks are a great fit.”