UK MORTGAGE MARKET - A NEW ERA

Stephen Knight, Executive Chairman, Checkmate Mortgages

My diary over the last few months has included meetings across our industry, and both inside and outside Government. From this activity it is clear to me that our market is undergoing fundamental change. Those who take into this new era a wish to continue as before will likely fail. Those who embrace the change may see increased opportunity. I have set out below the headings under which I see the main changes occurring.

Intermediaries

Still considered by many in authority to be a significant cause of customer detriment, there is a growing anti-intermediary atmosphere. Hardly any of the new policy-makers were active in the mortgage market ( as I was ) when direct business dominated, and customers were abused with quotas, queues and inappropriate insurance selling. Good intermediaries deliver choice to customers and keep lenders on their pricing and service toes, but too few of those with power recognise this. I expect consultation, and subsequent action, by the FSA on the amount and  timing of procuration fees that lenders can pay, with lenders more accountable for the actions of intermediaries. This  won’t destroy the intermediary market, and the bigger firms will increase share. But it is bound to be felt in overall intermediary numbers and, as a result, customer choice. I expect new rules to additionally cover how lenders pay their sales staff.

Securitisation

Securitisation is still seen as having an important role in the mortgage market but with a very different focus. In the past securitisation was increasingly used as much as a risk transference vehicle as a funding mechanism. Given the authorities’ concerns over systemic risk and financial ‘contagion’, issuers are likely to be required to maintain the risk of the assets on their balance sheet.  Rather like the temporary Government guarantee, securitisations will be based on the covenant of the issuer rather than, as previously, the rating for the collateral, and are likely to look more like covered bonds than some of the securitisation deals of the past. Specialist lenders will need to link with the larger banks to effect securitisation deals in the future which will, in turn, reduce the supply of mortgage funds. My concern about these changes is around the law of unintended consequences. Overseas organisations not regulated by the FSA may be able to exploit loopholes that disadvantage UK institutions and issue in, for example, the US market. We must never forget that we trade in a global market, with the capital markets a sophisticated example of this.

Portfolio selling

Matching those who were good at selling mortgages, but who had limited balance sheet capacity, with those institutions with a substantial balance sheet, but less distribution coverage, was a logical market development. Many billions of loans were sold in this way to the economy’s advantage. However, some problems have emerged. Some sellers were less concerned than they should have been to ensure that all interests were aligned to the only thing that really matters long term, which is a better customer outcome. Some buyers, despite undertaking comprehensive due diligence, claim not to have understood that, in terms of subsequent arrears, prime, self cert, BTL and sub prime all perform differently, such that loans must be compared within their asset class to get a true picture. Whilst the role of portfolio trading in the demise of some financial institutions has almost certainly been over-played, the transference of assets between financial institutions is again seen by many in authority as adding to systemic market risk. Whatever the background or rights and wrongs of this argument, I don’t believe that the authorities want to see this market re-emerge and gross lending will be impacted accordingly.

Capital

Currently, the Basel II requirements apply to deposit-takers only. There is a feeling that this should apply to all lenders. I think that is extreme for wholesale-funded lenders, with no customer savings at risk, but it could happen. Whatever emerges from current discussions, the regulator will require (and are requiring) all lenders to apply higher capital ratios,  which will be felt in mortgage pricing. Discounts below the cost of funds are pretty much a thing of the past. Already, the FSA applies capital ratios to the loan to value (LTV) (which is why I feel they do not need to be prescriptive about the exact LTVs lenders can offer) with the result that above 75% LTV lending will remain restricted and expensive for the foreseeable future. But look out for secured/unsecured combinations that seek to exploit this loading by averaging rates.

Loan to Income (LTI)

I expect further regulation in the area of LTI. My guess is that the FSA will require lenders to see evidence of  income, thereby killing self cert at a stroke. I hope there is no prescription beyond that because some borrowers have a lifestyle and attitude to credit that could support borrowing of  five times income whereas other should not be lent more than two times income. Watch out for the pre-consultation discussion paper. If good sense prevails, the focus will be on more sophisticated affordability models.

Buy to Let (BTL)

I am more convinced than ever that BTL will be regulated, although this will need primary legislation. The same could apply to second charge lending.

Change of Government

Some I have spoken to are placing unrealistic expectations on an incoming Conservative government with its generally lighter regulatory touch. For a start, the election is probably a year away and anything could happen. There is also the point that the next government will have to wrestle with borrowing at historical levels. Tinkering with the mortgage market, or second-guessing the FSA, is likely to be low on their list of priorities for some years to come. I hope and expect the Tories, if elected, to scrap HIPs though at some point.

Where are the opportunities?

There are always opportunities. The key is to be open-minded about where they are likely to fall. Holding onto pre credit crunch models and values will fail. But as soon as the liquidity freeze unthaws, the opportunities will be evident. At Checkmate, having now built our new system and held our experienced and talented team together, we’ll be ready when the time comes!

Stephen Knight