US private equity giants muscle in on Australia's home loan market

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US private equity giants muscle in on Australia's home loan market

By Emily Cadman

US private equity giants are muscling in on Australia's lucrative home loan business, shrugging off the risks of a falling market to seize an opportunity created by the retreat of the big local banks.

KKR, Blackstone Group and Cerberus Capital Management have all snapped up small local home loan lenders in the past 14 months, providing the heavyweight backing that has made non-bank lenders the fastest-growing source of new home loans this year.

The private equity giants are seeking to take advantage of the banks' tighter lending standards.

The private equity giants are seeking to take advantage of the banks' tighter lending standards.Credit: Rob Homer

With the non-banks unable to take deposits, much of their foray into home lending is being funded via the capital markets. While total issuance of residential mortgage-backed securities (RMBS) has fallen this year, the smaller lenders have been responsible for well over half of the market.

"The non-bank sector is changing," said Andrew Papageorgiou, investment manager at Melbourne fund manager Realm Investment House. He reckons the backing of KKR and others will enhance access to the deeper European, UK and US funding markets: "Having a private equity backer of significance changes the nature of the conversation with your senior bank funder and probably opens up a great number of options," Papageorgiou said.

After KKR agreed to buy non-bank lender Pepper Group in August 2017, Blackstone snapped up an 80 per cent stake in La Trobe Financial Services at the end of the year, and Cerberus Capital Management agreed to purchase Bluestone in February.

The share of home loans from non-bank lenders is rising.

The share of home loans from non-bank lenders is rising.Credit: Bloomberg

Under pressure from regulators, the large banks which dominate home loans have pulled in their horns.

Westpac  and its peers have curbed interest-only and investment lending, stopped loans to foreign buyers and introduced stricter verification of income and expenditure. The tighter standards have allowed non-banks to pick up a slice of the near-prime market, said Taosha Wang, a credit analyst at Pacific Investment Management in Hong Kong.

Cushioning the downturn

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A Moody's Investors Service analysis of the mortgages contained within the debt issued by non-bank lenders shows the proportion of loans issued to property investors rising to about 35 per cent at the end of 2017, from around 15 per cent in 2014.

While riskier than traditional owner-occupier loans, "such mortgages are less risky than the non-conforming or alternative documentation loans that most non-bank lenders have traditionally focused on,'' Moody's said in a June report.

The shift has helped cushion some of the effects of reduced bank credit on the property market, where prices have fallen for 12 straight months.

"The rate of decline in Australian house prices would certainly be more without non-bank mortgages,'' said Jonathan Reeves, a lecturer in financial economics at the University of New South Wales Business School.

At the margins

However, the effect is at the margins because the growth in non-bank lending is happening from a very low base. That explains why regulators remain relaxed about the trend.

Compared to the entrenched market dominance of the big four, the new entrants still have a small part of the market.

Compared to the entrenched market dominance of the big four, the new entrants still have a small part of the market.Credit: Bloomberg

"Lending by non-prudentially regulated lenders has picked up, but they must still comply with responsible lending laws and are too small to fully offset the tightening from other lenders," the Reserve Bank of Australia said in its latest financial stability report.

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Despite the end of the long housing boom, which saw Sydney prices rise 74 per cent between 2012 and the middle of last year, there's little sign of stress in the RMBS market. The proportion of non-bank loans included in RMBS that are subject to arrears has ticked up in recent months, but remains low in absolute terms.

As long as the arrears don't escalate, the non-bank lenders and their private equity backers can continue to nibble away at what has traditionally been a lucrative market for Australia's big banks, which have about 60 per cent of their loan books in residential lending.

For the banks, it's a simple dynamic -- their profits have been sustained by the comfortable spread between the average mortgage rate and the rate on money they can borrow in the wholesale market.

Bloomberg 

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