Lenders must address the mortgage retention challenge if they are to aim for a sustainable future
Damian Young
January 13, 2016: Despite the Bank of England’s most recent vote against a rise in interest rates, many financial analysts remain confident that we will see a rate rise over the early stages of 2016. This confidence is primarily drawn from the recent surge of the UK economy, which saw a 0.7% rise in GDP in Q2 2015, a figure that is expected to grow to 2.6% over 2016. This surge is inspiring some much needed regeneration in many sectors across the UK, including mortgage and of late, remortgage segments.
Historically speaking, economic upturns tend to create a set of pricing conditions that encourage mortgage customers to re-engage with the market in search of a better deal. This gush of customers on the move inevitably leads to an intense surge of competition between lenders, and this time, it is no different. Customers are seeing exceptional value as banks scrap aggressively in the market for borrowers looking for a change.
At face value, these lending strategies appear to have been successful in their immediate goal of driving new business volumes; fixed-rate products have increased to 90% in 2014, up from 50% in 2010, creating a new dynamic for ongoing re-offers to existing mortgage customers. However, our analysis reveals a worrying truth that lurks behind this perceived growth. The data shows that new mortgage pricing has actually reduced profitability for most banks. In the myopic pursuit of new mortgage lending volumes, lenders seem to have lost sight of existing customers.
The extreme prioritisation of acquisition over retention has resulted in many lenders having to lend even more just to stand still, never mind achieve net lending growth. Therein lies the paradox, as retaining an existing customer base is far more cost-efficient and, with the right tools, easier to plan for than customer acquisition.
In 2007, at the mortgage-lending peak, to grow total net lending by £100 required lenders to advance £350. In 2014, banks would have needed at least £850 of new lending to achieve the same net lending growth.
Overlooked by the mainstream media, this trend represents a significant misjudgement of the fundamental principles of market lending. The combined factors that brought about such an unbalanced approach from lenders are complex but in short: new regulation, increased competition for the most credit-worthy customers, a historically low bank base rate, and relatively low levels of new customers entering the market have all created this environment.
The unavoidable reality is that lenders are running hard to effectively stand still. Figures show that of the £300 billion written in the 18 months to June 2015, net lending was just £35 billion (12%).
Net lending totals have long been a problem, but mismanagement of back books – and of existing customers in particular – is now no longer a viable option for lenders concerned with future sustainability. The current tendency to rely on customer apathy or information asymmetry is under threat from concerned regulatory authorities and disillusioned customers that may start moving in their thousands.
Incumbent mortgage lenders must be wary of these threats. The ‘unloved’ individuals that make up their existing customer base may be closer to the edge than expected. A broadening market choice, courtesy new entrants to the UK mortgage market, will only exacerbate the issue. Although the top six players continue to control over 70% of the market, we are seeing new sizeable competition from brands such as Tesco Bank and Virgin Money. The regulatory authorities, that are looking to establish fair pricing, open lines of communication and timely availability of relevant information, will only want to perpetuate these developments in market competition.
If it is not the traditional high street banks that will attract customers away, then perhaps they will turn to the ever-more-trusted alternative finance providers. These providers’ expanding growth figures are testament to growing levels of consumer trust and general availability to more people. Clearly, the message to take away from these developments is that lenders must either protect their mortgage assets or prepare for a future without them.
Of course, this is not a real choice. The only feasible option for lenders is to recognise the mortgage-book retention challenge for what it is and mitigate its potential effects. The key to success here is redefining ‘what good looks like’ for existing customers. This will require advances in payments strategies that incorporate more sophisticated technologies that consider customer segmentation, behavioural-based pricing analytics and regulatory commitments.
Lenders must ask themselves three key questions:
• Can you profitably grow your book and offset falls in net interest margin if you need to lend £850 for every £100 of net book growth?
• With 90% of new customers on fixed-rate mortgages, how do you plan to retain these customers in a rising interest-rate environment, and can you handle the operational peaks?
• As intermediary lending continues to grow and as the remortgaging market returns, how do you plan to deepen relationships with customer?
The first, and possibly most crucial, step is to better understand the customers and what they are looking for from their bank. This allows for the most appropriate offers to be made based on a real understanding of needs. This is the principal means by which mortgage lenders drive retention, book size and ultimately their return on assets. Lenders must provide the motivation for loyalty.
This steady building of customer loyalty requires a precise, scientific approach to lending. If the technique is perfected, then banks can expect to see drawn-out periods of stability and growth. There will, of course, always be healthy competition for new customers, and we are now suggesting that banks give up this critical goal. But over-investing in acquisition at the expense of retention is not efficient. With the right strategy, it is possible for banks to have their cake and eat it.
Thorough consultation of the data held within an organisation, using data analytics, allows lenders to collate and segment customers based on preferences to determine the optimum price for any given customer. This is key to offering customers a fair deal, which will in turn, lead to a virtuous circle where by loyalty is established and returns are made.
Incumbent mortgage lenders are in serious danger handing over existing loan books and stock market shares to competitors, both from outside and within the traditional lending space. In the hasty pursuit of new business, lenders must be careful not to neglect the fruitful opportunities that already exist within the institution.
Damian Young is Managing Director of Nomis Solutions, EMEA
The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions, position or policy of Nomis Solutions (Europe) Ltd., Berkeley Research Group, LLC or its other employees and affiliates.