David Ellis: Now, Jim, I was wondering if we can turn to a different subject, a different topic. You've done a lot of work in the US on the US card companies, so Visa, Amex, American Express and related to that is the work you've done on the payment systems and particularly, focusing on the digital or potential digital disruption and new companies the big tech giants like the Apples of the world and Googles of the world and a lot of smaller upstarts as well. How do you see that playing out? What do you see the impacts of the – not of course just in the US but around the world because it's very topical to Australia as well. How do you see that playing out and what impact do you see on the big incumbents like the big banks?
Jim Sinegal: Yes, I think the last 12 months have been especially good for the existing payment networks and the reason is because a lot of new upstarts have faced bigger hurdles than people expected and it's a function of our viewing those companies, the existing payment companies as wide moat companies, why we are confident in maintaining our opinion over this amount of time.
Some of the problems they faced are, first of all, the chicken and egg problem of developing widespread cardholder acceptance among merchants and widespread cardholder usage. Visa, MasterCard, China UnionPay, each of them have billions of cardholders. To get that sort of user base for a new and existing upstart player is very difficult. The same thing merchant acceptance. Visa and MasterCard are accepted at 40 million merchants. Even the big new upstarts, the tech players, it's very hard to achieve that level of acceptance.
The second obstacle is that it's very hard to provide something of value to all of the players within the payment space. Merchants want lower prices, but it's very hard to cut prices to merchants without cutting the benefits for cardholders. So, that's been an issue and a big fight has been over data. Merchants don't want to give up their data to companies like Google. Consumers are more wary of giving up their data to third parties. That's been a big battleground and a big reason it's been tough for these new players to gain a foothold in the payments space.
So, what we've seen is the initial success of Apple Pay has been predicated on a coopting of the existing payment space. Apple is using Visa and MasterCard; they are keeping those brands, the card issuer brands front and center. Apple agreed not to gather any data. It was a big sticking point for other payment players and they are using existing network technology for security and other purposes. Because Apple is so focused on a smooth user experience, they didn't face as many challenges as some of the other new upstarts and we think that's been very good for Visa and MasterCard.
Ellis: Thank you. Jim, just finalizing and circling back to our bank coverage. We get a lot of questions about the Australian property market and obviously how high house prices are, particularly in Sydney and in Melbourne. Would you mind provide a little bit of background on what do you see as the key differences that are leading into the financial crisis in the US in 2008? How do you see the key differences between – or what was the situation in the U.S. with the mortgage industry and obviously, I'm more than happy to contrast that to the Australian situation, but can you please provide a bit of background on that?
Sinegal: Yes, I think we've had some great discussions along those lines this week. I think what happened in the US was really a concentration of the very highest level of mortgage risk at the big banks in combination with very low capital levels. On a tangible basis, the big US banks are levered in some cases up to 50 to 1 and they were taking the highest level of risks, subprime mortgages, very high loan to value loans, concentrating them in securitizations and adding those to the balance sheets. Something you've pointed out is the Australian banks now partly through strong regulation, partly through tighter underwriting standards have seen that example. They are not taking nearly as much risk on the mortgage side, not concentrating risk on their balance sheet and they are maintaining higher capitals. So it might be helpful for you to expand on that.
Ellis: Yeah, the point you made about the Australian banks not holding as much risk on their balance sheet what that means is that most mortgages in Australia that have got a loan to valuation ratio higher than 80 per cent are mortgage insured and those mortgage insurers also are regulated by the same regulator as the banks, so that's APRA (Australian Prudential Regulation Authority) and they are required to hold appropriate levels of capital to meet 1 in a 100 year crisis.
So, other reasons that – other buffers that the Australian banks have that often are not focused on that the overall loan to valuation ratios for the mortgages in the Australian bank, in the major banks, is round about 50 per cent. So, there is considerable equity buffer on average across the loan book. Also, in Australia, most Australian home loans are variable rate interest and most Australian home loans because of the very low interest rate environment we're in and a reasonably solid economic conditions we've seen a large degree of prepayment of payment obligations. So, Commonwealth Bank, for example, it quotes a figure of approximately 70 per cent of its mortgage book in Australia is in prepayment and approximately 7 months or so in the prepayment. So, these are large buffers in that respect and of course, in Australia, all mortgages in Australia are full recourse. So, the banks have the legal right to recover any assets that the borrower has in the case of default.
Looking at the underwriting standards, they are certainly getting tighter. There has been some recent macroprudential changes announced by APRA limiting the growth in investor residential mortgages to not more than 10 per cent and the banks themselves have been lifting the benchmark interest rate they apply for a home loan application. So, there is at least 200 basis points or 2 per cent there. And of course, the arrears rates in Australia even though economic conditions aren't as strong as they could be, arrears rates are still trending down and not just in mortgages but in commercial loans as well. So, we've seen a period of low credit growth over the last five or six years since the GFC and during that period the major banks have been very careful in their lending standards, both in commercial and in residential. So, that's another reason for the confidence that in the case of an economic downturn or in the case of house prices falling, there is reasonable buffers in place across the system, particularly with the major banks to cope with that if that does unfold.
Thank you, Jim. We very much appreciated the time and I hope you'll enjoy your visit to Sydney.
Sinegal: Thanks for having me in, David. It's been a great discussion.
Ellis: Thank you.