Lord Turner published his eagerly awaited review and recommendations last week. Lord Turner writes in a clear and authoritative style and there is much to agree with and learn from in his report

 

 

Mortgage regulation review

 

Whilst the vast majority of the review looks at the banks and how to ensure a more robust banking system, Lord Turner also announced a review into mortgage regulation and specifically the question(s) as to whether mortgage LTVs (Loan-to- value) and LTIs (Loan-to-Income) be regulated either via  ‘hard’ rules or via the possibility of ‘through the cycle’ limits (i.e. in times of buoyancy greater restrictions apply than in difficult times). Additionally, two alternatives were also mentioned, namely tighter regulation of mortgage selling and greater use of capital requirements for higher LTV/LTI loans.

 

 

Checkmate’s view of product regulation

 

Whilst the Turner review briefly highlights the pro and cons of product regulation, with more detail to come in the September report, Checkmate is very firmly of the view that direct product regulation risks stifling what has always made Britain and the UK mortgage industry great: Innovation! To highlight in a bit more detail our concerns we will look separately at the two main areas of debate, LTV and LTI 

 

 

Loan-to-income restrictions                                                    

 

Rumours circulating before publication that the report would recommend a maximum income multiple of 3x proved to be wide of the mark.  However our view remains that any prescriptive formula, be it income multiples or a debt-to-income (DTI) calculation, misses the point that overall borrowing capacity is very much dependant on an individual’s attitude to credit. Lending someone the equivalent of say 5X their income can be appropriate equally as much as not lending someone 2 x their income.

 

There is scant evidence to date that income multiples play anything other than  a cursory role in loan defaults. People mainly tend to default on loans for one of two broad reasons:- (1) Due to a life-changing event such as unemployment, divorce, bereavement, where lending 2 or 5 x income wouldn’t alter the impact materially or (2) The customer’s attitude to managing their credit was poor, where again what you lent them would have not materially changed their willingness and propensity to pay. With customers in the second category, it isn’t a question of what multiple you should give them but whether you should lend to them at all!

 

There is an additional and related point in that if you regulate mortgage borrowings, what about other forms of credit? Customer’s over-indebtedness, is invariably not about being lent ‘too much’ on their mortgage but caused by the plethora of other borrowings that customers may subsequently take out. It is the credit cards, car loans and personal loans that accompanied the ‘live now pay later’ philosophy that have caused the problems. This comes down to a the willingness of financial institutions generally to lend driven by the availability of cheap money and the willingness of too many people to borrow it (incidentally, how many of you have noticed that the ’free’ credit card offers in the post seem to have stopped?).

 

 

Loan to Value Restrictions

 

We would argue that lenders have on the whole always been aware of the strong correlation between LTV and default probability and in the main have been responsible. The problems as reported stem from a few lender’s flawed business models where aggressive and continued expansion  could only be achieved by a widening of the risk profile.

 

If regulation seeks to limit or ‘ban’ 100% mortgages again we would argue that there has and will continue to be a portion of the population where a 100% mortgage is a sensible option. For example, young professionals out of university on a career progression.  If the alternative is a lower LTV loan topped up with other loans or credit card borrowings this surely makes less sense? I suspect that most of the people reading this article started out on the housing ladder with a 95% loan. If limits are imposed here, you risk the recovery of the housing market as we try and tempt the one major missing group back into the market : First Time buyers.

 

Above 100% LTV the defence become less robust but we suspect that legislation here would be rather pointless as funding is unlikely to return to this sector given the events of recent months. You also need to remember that in principle at least the over 100% mortgages worked in a logical way in that often people buying their first home had other debts and it made (financially at least) more sense to combine them in a lower overall rate. We suspect here that it has been the delivery of this product rather than the product itself may well have been the issue, which goes back more to the business model issues rather than product itself.