CBA plays an ace

Ralph Norris at the Commonwealth Bank may have difficulty with continuous disclosure obligations but he has certainly got the wood on many of his competitors when it comes to formulating and executing a domestic retail banking strategy.

Norris and his team at CBA have capped a great year for acquisitions with the purchase of half the $8 billion book of home loans originated by Wizard Home Loans. CBA also helped its affiliate, Aussie Home Loans, to acquire the Wizard branch network.

CBA owns 33 per cent of Aussie, so the transaction is effectively a way for Norris to gain access to a much larger network of branches for distributing home loans funded by CBA.

The Wizard deal comes just two weeks after the Australian Competition and Consumer Commission rubber stamped the CBA acquisition of BankWest.

The BankWest deal was a pearler in terms of the price paid. It was the lowest price to book ratio for a banking acquisition in Australia for the past 16 years. It was less than half the average price to book for the 10 most recent transactions and it was third of the price to book paid by Westpac for St George.

CBA is in the box seat to acquire Suncorp's banking business which remains up for sale. A CBA acquisition of Suncorp's banking arm would run a good chance of getting the approval of the ACCC using its counterfactual competition analysis. This analysis examines the impact an acquisition would have on competition and compares that with the likely future state of competition if the acquisition did not proceed.

This analysis was used by the ACCC to justify CBA buying BankWest which delivered CBA 47 per cent of transaction accounts in WA, 25 per cent of branches in WA, 38 per cent of ATMs in WA and lifted its national share of home loans to 21.6 per cent.

Transaction accounts are the crucial component in any banking relationship. They are the source from which many other financial relationships fan out. CBA's retention of all those BankWest transaction accounts will be a test of Norris' customer service mantra.

The Wizard deal has the potential to further entrench CBA's leading position in home mortgages. At the moment CBA is neck and neck with Westpac which has 21 per cent market share of home loans.

The big banks' share of the market has been rising thanks to the demise of the securitisation market. Prior to the financial crisis the Big Four banks accounted for about 80 per cent of all new home loans with the remainder spread among regional banks and non-bank lenders.

Now, the Big Four account for about 90 per cent of new home loans written and the remainder is spread among the regionals and non-bank lenders.

The non-bank lenders were able to win large market share because of their ability to source funding at attractive rates from wholesale markets. The wholesale funding from securitisation meant non-bank lenders could offer rates that undercut the Big Four.

It is not clear at this stage whether the securitisation market will return as a competitive factor in the home loan market.

Federal government efforts to kick start the securitised mortgage market have had some success but the pricing of issues backed by the Australian Office of Financial Management have been well above the levels necessary to give non-bank lenders a clear competitive edge over the big banks. Investors are returning to the market, but only tentatively.

One factor that worked in favour of non-bank lenders such as Wizard and Aussie Home Loans was the fact that people don't like banks. The non-banks were able to present a friendlier face and cash in on the distrust of banks.

Aussie founder John Symond has been a master at presenting himself as a friend of the borrower and a mutual enemy of the big banks – as did Wizard founder Mark Bouris, who will remain an advisor to Aussie.

However, a check of the latest basic home loan packages compiled by Infochoice shows Aussie is not that much better than the Big Four. The Aussie basic home loan package is 6.19 per cent compared with CBA's 6.23 per cent.

Wizard is currently one of the cheapest providers of basic home loan packages with a variable interest rate of 5.43 per cent. That rate may have been artificially low to drive sales ahead of the transaction. Either way, whether that rate survives the Aussie takeover will be a test of competitive forces.

The Wizard deal will make Aussie the largest non-bank provider of mortgages in Australia. Its branch network will increase by 160 outlets and it will pick up more than 300 mortgage advisers. It will now have about 360 outlets and 500 mortgage advisors.
The ACCC says branches are not a key determinant of competition in home loans but judging from recent comments made by Symond, branches and people on the street are critical to building a successful business with high customer satisfaction.

It is estimated that a new bank branch costs $800,000 to establish, according to the ACCC. On that basis alone the Wizard deal at a price of reportedly less than $30 million is outstanding value.

Aussie's strategy is similar to that pursued by St George. Through the careful use of advertising and marketing, St George was able to build a brand that gave the impression of price leadership against the big banks. In fact, the ACCC found that it rarely showed price leadership.

Symond has built a brand that stresses independence from the big banks. Looking at his website you have to search hard for the CBA connection.

CBA gets three major benefits from the Wizard deal.

Its affiliate in the non-bank lending space significantly increases its capacity to sell home loans which can be funded either directly from the CBA balance sheet or from the securitisation market.

It has its foot on a business that provides strategic leverage to the revival of the securitisation market as a competitive force in Australian home lending. A revival of securitisation will help CBA with off-balance sheet loan growth.

As well, CBA acquires up to $4 billion worth of Wizard-originated home loans. The typical home loan takes three to four years to become profitable because of the costs of acquisition. The Wizard loans are of a vintage that should deliver profits to CBA in the first year.

Norris at CBA was in danger of having a forgettable end to the 2009 year because of the debacle over disclosure of bad loans. But the Wizard deal meant he was able to salvage his reputation as the Big Four banker most focused on dominating the domestic market.