MARSDEN There is some fatigue in the borrowing market at the moment but our sense is that the current stage of the interest rate cycle is driving confidence in the new purchase and refinancing markets. Our hardship volumes have increased in the last 3-4 months and we are also witnessing some of the payment buffers that were built during the pandemic period dropping to a quite noticeable, albeit not yet concerning, level.

This aligns with some of the data released by the banks, which reveal that saving reserves are being used to at least some degree particularly as cost-of-living pressures bite. If there are any more rate increases, there may be a tipping point from a serviceability perspective.

The story is somewhat balanced by supporting data from the labour market, which seems to be holding up at the moment – particularly in the public sector. Meanwhile, the outlook for losses on residential portfolios is the best we have ever seen and there is a lot of strength in the housing market in the areas we lend. Specifically, house prices have risen well in metropolitan areas in particular.

RIEDEL We have experienced almost a direct correlation between moves in interest rates and the demand for our residential mortgage portfolio, whereby application flow changes in line with expectations about the interest rate cycle.

For example, in January and February this year there was something of a groundswell of thought that rates might fall in the early part of this year. Consequently, we experienced an uptick in applications in February and March. This quickly changed when the rhetoric of higher-for-longer interest rates became more apparent – and applications dropped as a result.

On the positive side, we have started to see applications slightly increase again since June. The general sense is that we are probably at the height of the rates cycle now, and consumers are conscious of this. Even so, I don’t think demand will demonstrably change until there is clarity about when the first rate cut will come.

TOGNON It also depends on the credit product. From our perspective – in the unsecured consumer lending space – with the economy no longer running interest-free, the long-term value proposition of our card solutions is resonating more strongly with our customers and prospective borrowers. This supported volume growth in H1 2024.

Similarly, engagement from our merchant partners has been re-energised as they view our credit solutions as an important tool to push retail sales. As a result, card volume and receivables have been growing quite steadily in the last 12 months. There has also been solid growth in personal loans in the first six months of 2024.

Demand for larger-sized loans has increased, especially for home renovations – because construction and labour costs are rising – and debt consolidation of more expensive sources of debt into something cheaper.

BELL We have witnessed a change in spending verticals across our consumer portfolios over the past two years. In general terms, there has been less discretionary consumer shopping while the health, hardware and home improvement verticals have picked up.

More recently, spending on travel has also picked up following the pandemic.

At an aggregate portfolio level, these shifts in spending patterns have largely netted out, keeping credit demand reasonably steady where we would have otherwise expected a drop.

RIEDEL It is hard to know precisely but consumer sentiment has been at all-time lows for a while. This is another correlation point to demand. The media, consumer sentiment, the cost of living and increases in interest rates all feed into one another. However, I imagine that, for the typical consumer, how one is feeling probably has greater bearing on behaviour than what is written in the papers.

BARRY System growth has been quite low in recent times, which reflects the current economic environment. Meanwhile, competition has been extremely strong among the banks. Despite this, La Trobe Financial has experienced record volumes. Demand is still strong for borrowers that are more complex in their applications. It really depends on where one plays in the market.

AZZOPARDI Some of the headlines are a bit alarmist. For instance, recently there was a one-month decline in property prices in Melbourne – which was presented as the market going into reverse. I believe consumers see through this and are looking at a 1-3 year horizon. Ultimately, Australian property is still viewed as a good investment.

It is also worth noting that the type of customers nonbanks are trying to serve are generally not first-home buyers – and we are witnessing strong demand in the investor segment. To Martin’s point, volumes are holding up quite well and we are witnessing as much particularly in the investor space.

GUESDE What strikes me is that, compared with the rest of the world, Australia is one of the only real estate markets that is still stable or improving despite higher rates. The fundamentals include the fact that there is a lot of immigration and that 95 per cent of the mortgage market is floating rate. In other words, when rates go down, we can assume – in an environment with structurally high demand – that prices will go up. This puts Australia in a unique situation.

AZZOPARDI Rental yields make such a compelling case to buy an investment property where customers can afford it. It’s unlikely yields will decrease when rates come down and we will likely always have a net inward migration number into this country, holding up underlying security values.

BROWN There is a well-trodden path called ‘rent-vesting’ for those who can’t afford to own and live in a property in the area they want to. This enables them to live in their favoured area, yet get a foothold on the property ladder by buying an investment property to start building some home equity.

There are obviously pockets within the country that are moving at different paces. But, in our experience, investors can reprice their portfolios including charging higher rent at least to some degree. We have witnessed some of this occurring across our portfolio.

J AUSTIN Serviceability and whether Australia is slowly changing to an investor market is an interesting point. It is very hard for the average first-home buyer to buy property unless they have financial support from their parents.

Looking at the numbers, it is quite difficult to justify house prices based on a conventional multiple of income or even of dual income. This means it is increasingly becoming an investor market over the long term. This is probably already the case in some of the biggest cities overseas. With this, unfortunately, the dream of everyone owning their own home is slipping away.

FISCHER This chimes with performance in our book – our investor customers are performing, on average, better than our owner-occupiers. This is across the portfolio, not just limited to Perth and Adelaide. As investors search for returns we expect there to be opportunities for investor mortgages to continue to perform well.

GUESDE SMSF [self-managed superannuation fund] lending is going through the roof. Five years ago, it was a new category and no-one was writing it.

J AUSTIN Unfortunately so! When we started originating SMSF loans they had about a 400 basis point margin. Even though there is still no competition from the banks this is now down to about 270 basis points, which is only 20-30 basis points above the standard investor market. The remainder has all been competed away purely by nonbanks, which demonstrates the benefit of competitive market conditions that nonbanks foster.

J AUSTIN Yes, at one point we were running at around the low 30s per cent and it is now around 22-23 per cent. It is not back to the pre-COVID-19 level but it’s getting there.

TOGNON Our consumer lending products are very different, of course. Through the cycle, personal loans have a prepayment rate of about 50 per cent and credit cards fluctuate in the
80-100 per cent range. We have to work harder on volume compared with a mortgage lender to put a dollar of receivables on the balance sheet.

J AUSTIN We are relatively new to the auto space but it surprised me just how much CPR there is in autos, considering payments are on a fixed schedule.

FISCHER Last year in mortgages, especially prime, there were a lot of cash-back offers and it was very competitive. Pepper Money is a diversified business and we could allocate capital to other areas of the business where returns made more sense. It is a more even playing field now and volumes are increasing, albeit slowly. CPR has reduced from the height it was at this time last year, which is positive for a more even playing field. Volume in the nonconforming space has been quite steady.

Asset finance is still very competitive. NIMs [net interest margins] have reduced due to competition and as there are more players in the space. Macquarie Bank withdrawing has opened opportunities but there have also been new entrants to the market.

RIEDEL Asset finance has been the most competitive. Westpac Institutional Bank research revealed that there are about 20 issuers in the space. This identifies the fact that the exit of Macquarie and Westpac Banking Corporation from consumer lending – and Macquarie from commercial – has been followed by a lot of nonbanks seeking to diversify their businesses and access different customers.
There has been a significant increase in competition in this space. We are cognisant of this and are ensuring that we continue to earn the right level of return for stakeholders.

TOGNON We have experienced the same trend on the auto side. In fact, we have allocated more capital into personal loans and cards origination in part because of the margin compression in motors – and we don’t think this is likely to go away anytime soon.

On the unsecured consumer credit side, it feels like the sector is now being more disciplined on risk pricing and upfront loan profitability rather than banking on potential loan add-ons or refinancings to make the return part work over time. While the environment clearly remains competitive, the mentality of chasing growth for growth’s sake seems largely to have left the segment.

J AUSTIN An important demonstration of the competition nonbanks bring is in SMSF and auto lending. These are predominantly nonbank markets now, yet they are incredibly competitive and margins are being eaten away. For example, if a nonbank prices autos 10 basis points out, volume disappears – that’s how sensitive it is.

AZZOPARDI Overall, I believe opportunities have significantly increased since last year. The market is more buoyant and the structural disadvantages associated with the TFF [term funding facility] have reduced. Nonbanks will always have a structural disadvantage to deposit takers, but overall it feels like a more level playing field.

But I also agree that competition between nonbanks is relevant. Nonbanks need to have a really competitive product, service the consumer really well and have a robust distribution team that resonates well in the market. This is all possible – but the trouble is we are all doing it. Still, I feel very positive about the outlook for origination opportunities. I’m pleased with how things have played out so far this year and believe it will continue as rates come down. Nonbanks get hurt as rates rise, but there is greater opportunity on the way down.

BARRY Some investors have asked us about the runway for growth: with all the issuance the sector has been doing, they want to know if there are enough assets for everybody. I echo all the comments that have been made about competition but add that the mortgage sector in Australia turns over A$2.8 trillion (US$1.9 trillion) every four years. In our segment, this is about A$150 billion per annum of eligible loans we would consider.

Despite the competition, there is more than enough for us all to do a great job providing niche products and genuine alternative solutions. In short, competition is healthy and there are more than enough assets to go around.

GUESDE Nonbanks’ market share was about 15 per cent prior to the financial crisis. It is now about 7 per cent. I’m not sure it will go back to 15 per cent but there is still room to grow. Just normalising CPRs would naturally support growth.

It is also significant that we have not seen a lot of companies exiting the market. Most of the players, at least all the main ones, are still here because they are providing a service and competing. Nonbanks have been able to show brokers that they bring something different to the market – and this is quite unique.

BARRY Meanwhile, it seems the banks are still focused on automation and lowering costs. Capital rules for the banks direct them to the very prime, low LVR [loan-to-value ratio], automated loan products. There has been talk about whether banks should be relaxing lending standards, but I don’t think the regulator is keen to entertain this. It has said as much on serviceability buffers and the like.

MARSDEN The capacity of funding markets will always govern the size of the nonbank sector. I remember Martin said at one of the first of these roundtables some time ago that A$20 billion was likely to be the limit for a single issuer, and this has very much transpired.

BARRY It’s true – but the rise of private credit and retail funds definitely helps. Many whole-loan investors are also interested in developing this funding tool in Australia.

J AUSTIN If two large nonbanks were to merge right now and go through A$20 billion, it would cause a serious funding problem.

BARRY Consolidation is a key factor here: one plus one doesn’t equal two, and nonbanks therefore have to look at alternative funding – be it asset managers, institutional capital, retail, whole-loan or via different currencies. We have learned that it is possible to be a bit larger than we thought we would be a couple of years ago – but it definitely requires more lateral thinking.

GUESDE With a large, merged entity, banks will consider concentration of risk and type of funding. If a nonbank is entirely reliant on public markets for its funding, it will be vulnerable to an extent. As such, we believe it is important to diversify funding sources either by having an asset manager or access to alternative funding sources.

For instance, if two nonbanks were to merge they would potentially lose a few warehouses due to concentration limits. Whole loans are a way to diversify and limit the risk of funding constraints. Other options are to look for private placements or tap international markets.

O AUSTIN It is something we have been aiming to develop. We have been having conversations on the Australian market specifically with European investors for the last 3-4 years. To your question, we are unsure of how large the whole-loan market is, but there is certainly interest and our sense is that there is capacity to grow.

There are large pools of private credit already in Australia.There are also many large insurance mandates and asset managers globally that are hunting for assets. This is evident in the funding market this year: we have witnessed how oversubscribed mezzanine tranches have been, with a lot of new participants coming into the market. We see an opportunity to work with specific investor segments to provide access to larger pools of assets on a whole-loan basis. It doesn’t even necessarily need to be whole of loan for institutional capital. It could also be a wholesale-retail approach – which a number of asset managers have successfully championed for a long time.

Natixis CIB is a big believer in this being the next area for nonbanks that want to expand above the A$15 billion threshold in securitisation. We view it as a natural evolution and one that has taken place in international markets.

RIEDEL I don’t think whole-loan sales are a good development for our space. Since the financial crisis, we have collectively been demonstrating to investors that Australian nonbanks are not an origination-to-securitisation model and that alignment of interests is critical to success. Whole-loan sales risks this proposition as there is no retained skin in the game. If our industry starts to originate assets to give away to someone else, it would not be a good development in my view.

AZZOPARDI I agree with Peter: it is a poor development because it undermines a conventional nonbank business model.

RIEDEL We have received reverse enquiry about a forward-flow arrangement. I’m not sure if anyone is doing it, but as far as I understand forward-flow is a bit different from whole loans in the sense that the asset isn’t completely sold and the originator retains an interest in the performance of the receivables.
If forward-flow provides more certainty of liquidity for the nonbank – and providing alignment of interest is retained – it may have a place if nonbank market share grows.

GUESDE Forward-flow does not use existing loans. Rather, it requires the nonbank to originate a volume the investor wants – and this is what we have in mind.

O AUSTIN Absolutely. This is fundamental to the idea of building this funding source as a long-term model. We are not focused on one-off portfolio sales but on working with pools of capital that have long-term asset origination requirements and marrying these up with asset originators. For this to be successful, economic interest must align and originators are required to maintain skin in the game.

GUESDE To be clear, this is exactly what we have done in Europe. The nonbank asks what the investor wants – which could be risky and well-priced assets, or super safe ones. The nonbank then puts up a shelf for this investor and originates to these specifications. This provides certainty of funding for the nonbank to then start producing. It is not about getting rid of the stock.

GUESDE Yes. It’s what we call ‘DTO’ – ‘distribute to originate’ – and I believe this is a way we can attract capital. The ability to buy a portfolio that is structured to suit one’s needs is attractive especially for big investors, such as life insurance firms, that are able to do multiple types of investments.

There is a lot of frustration for investors participating in the public market as 10 accounts might be bidding for the same notes. At some point, there comes a bit of fatigue for investors, especially if they are getting 15 per cent allocations, for example. What investors need is certainty upfront.

MARSDEN I don’t believe nonbank business models are mature enough to have long-term, sustainable whole-loan programmes, particularly in the prime mortgage space – which is where I’m assuming the bulk of asset volume would need to come from. If there was huge demand for that asset class it could have negative implications for credit quality or yield, given the concentration of the banks in the origination space for prime mortgages.

O AUSTIN It is not necessarily just about solving for prime assets. A lot of the capital that is considering whole loans is quite sophisticated. It is a capital subset that perhaps just doesn’t have boots on the ground in Australia, although it would consider working in long-term partnerships with originators here.
This is a terminology issue. Our goal is to establish long- term relationships. This type of arrangement could provide nonbanks certainty of funding on assets that wouldn’t otherwise fit into a general funding programme. From our conversations with investors, we believe there is a space for this.

There is potentially interest in forward-flow for straight prime but it is a more vexed conversation, especially if it has the potential to cannibalise an issuers’ securitisation market funding.

TOGNON Perhaps there is a middle ground. Rather than using whole-loan sales for the bread and butter of one’s business, they might work better for the more exotic assets – for example, products that are at the early innings of development – or to support assets for which funding markets are weaker.

FISCHER There is greater demand for different types of structures where alignment is shared, which is in the form of different types of whole-loan sales. There are structured whole- loan sales and full sales onto a balance sheet.

We have been doing the latter for years, and it is a good part of our funding structure because it gives us additional diversification. However, this is not an easy process to go through. It involves significant amounts of due diligence every time we do one of these deals.

Structured whole-loan sales are bit different. The investors are similar to those that participate in public securitisation deals. But often these investors want to get part of the equity piece as well. Meanwhile, it is a good way for the investor to get meaningful bond allocations.

Mortgages have the added complexity of differing views on CPRs, which drives much of the economics. Some of the other asset classes we originate can be capital-intensive and require us to have more diversification across the business.

J AUSTIN Probably not. The problem is it hasn’t been economic for a long time.

MARSDEN We’ve found the US 144A market for Australian paper to be fairly deep and reliable. However, pricing is the main issue.

FISCHER We securitised A$5.4 billion in the public market domesticlly only last year and this year we have completed a lot more private deals. We were considering returning to the US market last year with a securitisation deal – but the economics did not stack up. On the other hand, when the US economics of a securitisation deal work, it can unlock a significant amount of liquidity.

BELL The US market is very deep and mature. To date, the 144A market hasn’t been a primary consideration within Zip Co’s funding strategy but may be more of a consideration as the business scales. Interestingly, we receive more reverse enquiry from the US than we do domestically.

GUESDE It’s a bit of both. What we’ve seen this year is that there is an arbitrage play and, on a relative-value basis, Australian securitisation has looked more attractive. But while investors are active in Australia currently, it doesn’t mean they are here to stay. At the moment other markets are going down. But as soon as they pick up, we have to acknowledge that money could go elsewhere.

RIEDEL I’m glass half full on this. A decade ago, ABS [asset- backed securities] issuance was A$30-40 billion per year. It’s double that now, and the share of nonbank issuance has also increased to 70-80 per cent from 20-30 per cent. Our product has become valuable to global investors.

I feel optimistic that the market will look very different in another 10 years’ time. The allocation to Australian fixed income, which has a growing pool of investable capital, will continue to increase. We have every right to be optimistic that ABS total issuance can well exceed A$100 billion in the medium term. This is not to say we shouldn’t be looking at other opportunities, but let’s be optimistic – we have proved our capacity and that we’re able to grow.

O AUSTIN Many new investors are coming into the market because of the depth and liquidity Australia is perceived to have, as well as asset quality and performance. We view some of the interest as opportunistic but investors are doing the work to understand the market and individual programmes. Once this work is done for the first time, it becomes much easier for accounts to participate on an ongoing basis.

Japan is a whole other story – there is a massive amount of capital there. It takes a long time to onboard but, once an issuer makes appropriate efforts, these have proven to be long- term investors that want to put scale into this market through the cycle.

TOGNON While investors might initially be lured by relative value, they are also spending time analysing issuers and transactions. In our experience, a first investment usually translates into long-term engagement.

GUESDE Issuers have done an amazing job explaining the market. Nonbanks are now fully connected to the rest of the ABS world. For instance, Japanese investors used to only look at bank ABS. They are now increasingly looking at nonbanks. It’s not their bread and butter but they do buy these deals.

The next challenge for us will be getting this buyer base to buy more collateral types. It is important to have global reach, whether it be through foreign currencies or other methods.

In 5-10 years from now, this is where we need to be for sector progress to be sustainable.

BROWN Japanese investors have always been large buyers of CLOs [collateralised loan obligations] and there are very similar dynamics in that market. Spreads are working right now for Australian RMBS [residential mortgage-backed securities] but the asset class is also a diversification play. Investors have done the credit work so they might still appreciate the diversification even if spreads have less relative value.

GUESDE Good point. All ABS margins have come down, so Australia is paying a better return in relative terms. But investors will find better alternatives at some time or other. The asset class has to be able to sustain more volatility in the market.

J AUSTIN Green mortgages are a constant evolution. The first iterations were based on the building code in certain locations, but in this case the lender is not doing anything to influence the borrower or the climate outcome. The finance is not changing carbon emissions, it is simply building to code – and was built anyway regardless.

More recently, our transaction this year relied on the Climate Bond Initiative solar proxy. We offer a loan that takes an existing property and – based on its size, location, number of bedrooms, and whether there is a pool or gas connection – installs a solar panel system of a certain size to reduce emissions. Once the system is installed, the mortgage qualifies for our green home loan pool and discount.

This product has been very successful: we are writing A$100 million or more per month. The key difference is that the finance influences change that lowers emissions. I think this will be a space that continues to evolve in future iterations.

J AUSTIN We don’t fund the solar as security, it’s just part of the mortgage. We give a discount on these loans, which is what attracts the borrowers.

From this, you could ask, ‘but there’s no greenium on funding, why do you bother?’ There is a lot of hunger for these assets from investors, so the way we have gone about it is to discuss that it is a ‘two for one deal’: if an investor wants a green asset, we would like them to fund our nongreen RMBS also.

J AUSTIN Yes, and particularly when we are writing A$100 million per month – it is now a sizeable green asset, and therefore leads to quite a bit of extra volume. Many investors – ethical funds – just want to buy the green asset. But we tell them they need to buy both, because otherwise we don’t get the price benefit we need to pass onto customers.

O AUSTIN We have certainly noticed that green assets are attracting investors – particularly from Japan and Europe.

Having a green programme is a hook for investors to come in, do the credit work and onboard an issuer they might not have previously looked at. It doesn’t need to be purely green assets: it just needs to be a portion, as investors want to see that a lender is working toward growing the pool over time. It is a journey, and investors recognise it as such.

GUESDE We have tested this in private placements. If there is a green tranche, investors move the transaction to the top of the list – which is meaningful when they have multiple investment options.

O AUSTIN A lot of offshore investors, particularly European, have regulatory obligations and these add extra incentive for them to look for green assets.

On the other hand, there is still a long way to go with some European accounts. Some portfolio managers are focused on ESG [environmental, social and governance] assets, then there are also separate securitisation teams. These are coming together more and more, but progress is still needed.

Some European investors are exploring the Australian market and mainly focusing on issuers with a clear sustainability programme. This is for triple-A for the moment, but there is capacity for a lot of these accounts to look across the stack.

BROWN Some European investors are required to report on financed emissions, so we have experienced an uptick in the conversations we are having about CO2 emissions. To try to map star ratings to emissions without data is incredibly difficult so it will be good to see development here.

J AUSTIN I lost interest with the CSIRO work. We tried to do a freedom of information request, but the data we got out of it wasn’t helpful.

MARSDEN One of the banks has a methodology whereby it has been able to more accurately pinpoint household level emissions based on CSIRO data.

I believe our sector will be caught up in needing to report on portfolio and corporate-level emissions, particularly as the major domestic banks seek to include third-party exposures as part of their Net Zero Banking Alliance reporting – which they are already compliant with for their own portfolios. I suspect this is only a couple of years away.