Credit Squeeze and Non-Bank Lenders

The subprime mortgage crisis has created a credit squeeze. The credit crisis has led to increased costs of debt and the lack of investor interest to refinance existing debts, which lead to the collapse of RAMS home loans and also the recent end for packaged mortgages (also called securitisation). Higher interest rates are expected as non-bank lenders cannot offer home loans as a result of the credit crisis. Since non-bank lenders are out of the picture, the lack of competition means higher interest rates.

Virgin Money, a non-bank lender who previously gave cheap mortgages now has this statement on their website: "The cost of money is currently so high that we're unable to bring you the great value home loan we're synonymous with." Virgin Money is no longer offering new home loans as it cannot secure credit at a low rate. Australia's largest home loan lender, Commonwealth Bank's chief executive, Ralph Norris, said this month: "Over time, interest rates being charged will increase unless we see significant drops in rates both internationally and locally." Another non-bank lender, Wizard is also confronting the same problem. Their owner, GE Money can’t seem to make money from the business model and is looking to sell. Previous owner of Wizard, Mark Bouris, sold the business to GE for $500 million in 2004 is looking at buying back the business.

Packaged mortgages (securitisation) were the main method which these alternative non-bank lenders financed their loans to compete with the big banks. Packaged mortgages raised $45 billion in the six months leading to June 30 last year. The next six months saw financing crash to only $6 billion as investors pulled their capital. Lenders which have found their supply of credit dry up include: Challenger, Adelaide bank, Bluestone, Pepper and Liberty. GE Money's Australian chief executive, Mike Cutter says: "We fund the book 100 per cent through wholesale funding, we don't use securitisation." But even this is not enough. "Since the credit crisis, the price of wholesale funds has increased higher than the cash rate in Australia."

Global confidence in the debt markets have crashed with the cost of borrowing for banks have risen dramatically: with the cost starting from 0.3 percentage points rising to 1.3 percentage points above the benchmark interest rate. Non-bank lenders have contributed to the reduction of the lending rate by 2 percentage points as a result of strong competition against the big banks. There is no more competition and the market is there for the taking by the big banks. The big banks are beginning to bargain down the commissions that mortgage brokers receive.

However, there are long term solutions to this problem. The packaged mortgage market can be restructures using a Canadian model which could cut 1.5 percentage points off the lending rate which requires industry support while another alternative will need Federal Government support which could see government supported lending models similar to US based lenders Fannie Mae and Freddie Mac.

There have been a few packaged home loans sold to the market recently: but at a higher price – hence the increased pressure of rising interest rates. Investment bank Citi sold a $500 million package of Australian mortgages to investors which they will receive 1.45 percentage points above the benchmark rate, where previously before the credit crisis they obtained 0.16 percentage points. Another institution, GMAC sold their securitised product at 3 percentage points above benchmark rates.