Westpac’s Safe Mortgage House May Teeter in Australian Light

(Bloomberg) -- As Australia's housing market goes, so goes Westpac Banking Corp.

The company tends to duke it out with Commonwealth Bank of Australia at the top of the country's mortgage market, with about 24 percent of the owner-occupied loan book and 27 percent of investment mortgages among bank lenders. 

What's more, while its big three competitors — including National Australia Bank Ltd. and Australia & New Zealand Banking Group Ltd. — have reduced their market share over the past year, Westpac has been expanding aggressively. Its share of new loans jumped 9.7 percent from a year earlier in the 12 months through February, according to mortgage broker and data company AFG:

That makes its performance in first-half results announced Monday impressive. Despite a housing market where prices have been gently drifting down for almost the entire six-month period, it managed to beat analyst expectations with a 6 percent increase in cash profits to A$4.25 billion ($3.2 billion). 

The “orderly slowdown” that Chief Executive Officer Brian Hartzer sees happening in the market “shouldn't be confused with a reduction,” he said in a video on the bank's website. Almost 70 percent of customers are ahead on their repayments, giving them a cushion should the environment grow tougher.

There are two reasons to question whether this performance can go on in the long term.

The first is how recent much of Westpac's mortgage lending has been. Fully 54 percent of the book was originated since the end of 2014. The bank sees this as a badge of honor, given how much lending standards have tightened in recent years — but older loans tend to fare better in a soft market than those written closer to the peak of the boom.

The other comes from looking not at Westpac's results, but the rest of the market. Remarkably, the bank has increased market share without being able to count on cheap pricing to draw in new customers. Indeed, its standard mortgage lending rates are among the most costly:

That's where it's worth looking for direction from the Royal Commission that's currently scrutinizing bad practices in Australia's banking sector.

The ability of higher-priced products to dominate cheaper rivals seems to go against Economics 101, but it's not so surprising when you consider the sales-driven culture within the financial system and the paucity of good information about interest rates available to borrowers.

With most new loans offered at an undisclosed discount to the published rate and strong incentives available to bank staff and third-party brokers who win new customers, it's little surprise that so many borrowers are driven toward the few lenders with the largest branch networks and deepest incentive pockets.

This is a recognized problem in the industry. The Australian Banking Association and Australian Securities & Investments Commission both published reports last year calling for a crackdown, with the former's plan already in the process of being implemented. Westpac, to its credit, has been trying to base more of its incentives on customer satisfaction rather than sales alone, but anyone who's ever filled in an online feedback form knows how such metrics can be gamed.

In addition, the central plank of those reforms centers on stamping out activities that directly harm the consumer through putting them on unsuitable loans. The indirect harm caused by reducing competition in the mortgage market is reduced to a side issue.

The risk of the chicanery being uncovered by the current inquiry is that Commissioner Kenneth Hayne comes to a broader conclusion: that Australia's financial sector will keep finding new ways to treat its customers badly as long as opaque practices can be used to disguise the real level of competition. Should that happen, the status quo that has served Westpac so well will start looking rather threadbare.

To contact the author of this story: David Fickling at dfickling@bloomberg.net.

To contact the editor responsible for this story: Matthew Brooker at mbrooker1@bloomberg.net.

1. Most Australian banks quote a "standard variable rate" or SVR and a "comparison rate" the former is their standard non-fixed mortgage rate and the latter factors in the impact of fees and charges on the SVR. We've looked at comparison rates on SVR-like products as detailed in the chart footnote. "Basic" loans which don't include near-standard facilities such as offset accounts haven't been included.

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