Borrowers to set mortgage rates

Strong competition in the Australian mortgage market, coupled with record-low rates, has put downward pressure on lending margins over the past 12 months.

The majors recorded an average net interest margin of 207 basis points, down six basis points on the prior year, according to KPMG.

But now banks are looking for more sophisticated ways of pricing mortgages in an attempt to lift margins and avoid a race to the bottom on rates.

FICO has been working with a number of Canadian lenders, who are seeing an increase in fixed-rate demand much like their Australian counterparts.

Speaking to Mortgage Business, FICO’s chief analytics officer Andrew Jennings said the biggest opportunity for lenders is with refinancing.

As an existing fixed-rate mortgage holder comes up for a renewal, the challenge for banks is negotiating with the borrower to keep their mortgage on the books and trade off a renewal rate by trying to get another seven or eight basis points of margin across that book as it matures, Mr Jennings said.

“You can’t do it by simply advertising the rate in the window,” he said. “What happens is it either becomes very misleading and the authorities come down on you, or it becomes so crude that you get this race to the bottom.

“That is what is happening in Australia, which is competitive pricing, but it can’t last. Everybody’s margins are getting squeezed.”

According to Mr Jennings, in overbanked countries like Canada and Australia, the only way to get margins back up is to be more sophisticated about identifying how price sensitive people are.

“We have been looking at the data for a particular lender and can statistically estimate that a particular customer on a five-year fixed rate is more likely to refinance to a three-year mortgage at a higher rate,” he said. “That is part of a mathematical optimisation”

The analytics considers the lender’s target retention rate, the margin they would like to achieve, and understanding the price sensitivity of all mortgagees in that portfolio.

“Brokers and lenders can therefore identify what offers to make to try and achieve those objectives,” Mr Jennings said.

“You can then set up this process where rates can be re-estimated,” he said.

“You will have this analytic overlay that helps you to be more intelligent to the way you adapt to rising or falling rates.”

FICO has also been able to facilitate commission targets for loan writers based on these rates.

“So a bank says ‘We will give you 15 basis points of discretion, and as you come down your commission will come down, and if you close below this rate you get no commission’,” Mr Jennings said.

“That is all known to the branch staff or broker. So when they are working with the mortgagee, they have much more control over the conversation and they know where the boundaries are,” he said.

“That helps the bank get more control over what’s going on.”

Mr Jennings will be speaking at the Australian Retail Credit Association (ARCA) National Conference on the Gold Coast on 6 November.