By Tony Moroney, Managing Director International Financial Services of Berkley Research Group
The UK economy is in growth, with GDP reported to be up 0.7% in the second quarter of 2015. This figure, which looks set rise to 2.6% over 2016, is causing many to predict a rise in interest rates within a short time frame. Growth and confidence have also initiated an apparent return of growth to the UK mortgage market and, of late, the remortgage segment. 
Mortgage lenders and mortgage brokers are set to further benefit from an increase in customers remortgaging and, for some time, have been aggressively competing to attract new customers. Customers are seeing exceptional value as the pricing differential with existing customers continues to broaden.
While lending strategies, at face value, 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. Furthermore, our analysis of the data shows that new mortgage pricing has actually reduced profitability for most banks. Critically, in the myopic pursuit of new mortgage lending volumes, lenders seem to have lost sight of existing customers.
While an aggressive acquisition strategy enables banks and building societies to report larger mortgage lending volumes (and perhaps market share), in the absence of effective retention strategies, it results in 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.
Experience suggests that this is an unsustainable misjudgement of fundamentals of the lending market, yet it is currently underreported in the mainstream media. The combined factors that brought about such an unbalanced approach from lenders are complex but in short include 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.
The unskewed 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 also on the radar of the regulatory authorities which are looking for fair pricing, open lines of communication and timely availability of relevant information. A reliance on customer apathy or information asymmetry is no longer acceptable.
Incumbent mortgage lenders must be wary of ‘unloved’ existing customers defecting to competitors, including new entrants in the UK mortgage market. Although the top six players continue to control over 70% of the market, we are seeing competition from brands such as Tesco Bank and Virgin Money. Apart from new banks and financial institutions attracting customers away, customers will and are turning to the ever-more-trusted alternative finance providers. These primarily online alternatives are growing in size, availability and levels of consumer trust. The challenge is clear: ‘protect your mortgage assets or lose them’.
In reality, against a backdrop of increasing rates and intensified competition, mortgage lenders have no choice but to face the mortgage-book retention challenge head on. To address these trends, boards will need to redefine ‘what good looks like’ for existing customers. This will require more sophisticated retention strategies, including customer segmentation, behavioural-based pricing analytics and due regard to regulatory obligations to treat customers fairly.
As per our recent blog published in partnership with Nomis Solutions, we advise lenders to 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 step is to better understand what is important to your customers so that appropriate offers can be made based on a real understanding of needs. Only by doing this can mortgage lenders drive retention, book size and ultimately their return on assets. Why else should lenders expect customers to stay with them?
Building customer loyalty creates an extremely valuable asset for banks which necessitates being much more scientific to preserve and cultivate. Of course, there will always be healthy competition for new customers, but investing in acquisition alone at the expense of retention is not efficient; yet neither need be at the cost of the other.
Analysing the data held within an organisation allows lenders to collate and segment customers based on preferences to determine the optimum price for any given customer. This is key to building loyalty, realising planned return on assets and treating customers fairly.
Incumbent mortgage lenders need to respond now or risk damage to existing loan books and loss of stock-market share to competitors, both from outside and within the traditional lending space. In the current climate of new mortgage opportunities, lenders must be careful not to neglect the opportunities and advantages they already have within their existing mortgage customer base.
The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions, position or policy of Berkeley Research Group, LLC or its other employees and affiliates or Nomis Solutions (Europe) Ltd.
About the Author: Tony Moroney is a managing director and has 34 years of experience in the financial services industry, of which 28 have been in mortgages. His extensive experience uniquely combines business advisory and executive management of mortgage divisions and mortgage banks spanning origination, servicing, arrears management, balance sheet management and governance.
Mr. Moroney has been a leading advisor on mortgages in both the UK and Ireland and has undertaken significant advisory engagements including strategy, pricing, market-entry strategies, service diagnostic and target operating models for both mortgage lenders and servicers. He has also spoken at industry conferences on topics ranging from ‘risks inherent in the UK buy-to-let sector’ to ‘management of credit and conduct risk in the UK mortgage market’.