There is common agreement that the likely gross lending figure this year of circa £145bn is insufficient to allow the housing market to function effectively. With only those people with a large deposit, strong income and squeaky clean credit having any realistic chance of obtaining a mortgage at present, clearly a ‘normal’ functioning market would be significantly larger. The question though that I have yet to see anyone attempt to answer is “what size should or would the market need to be in order to function effectively?”

 

 

What is ‘normal’?

 

To start to answer the question we need a definition of what ‘a normal, functioning market’ actually looks like. As much as the £145bn market now isn’t ‘normal’, clearly the peak of the market of £365bn in 2007 could also be described as ‘not normal’, particularly in hindsight. To try and arrive at an answer we have defined ‘functioning’ as a market in which anyone who has reasonable credit, sufficient income and a deposit of at least 5% to put down, can obtain a mortgage at a ‘reasonable’ rate (i.e. not the sort of rates on offer now at 85%LTV and above!).

 

In effect ‘normally functioning’ is where the mass of the general population can obtain finance providing they can demonstrate the means, ability and willingness to repay and can share in some of the risk by putting a deposit down. This obviously excludes some of the more marginal areas that helped create the large market in 2007, such as sub-prime and 100%+ loans

 

Now comes the maths. If we start by looking at the peak of the market and subtract accordingly, we can get to a view as to where the market needs to be both now and in the medium term. In the figures below I have been aggressive in my assumptions so that the ultimate figure we arrive at is a minimum functional market size.

 

·         Buy to Let (BTL) – This was £44bn at the peak. Given price falls, we are estimating that the demand in this sector of the market has halved as many small landlords and speculators will steer clear  

·         Self-cert – This was running at a similar level to BTL lending at the peak. This sector has now effectively closed but we are assuming that half the borrowers here could substantiate their income if they were required to and could therefore qualify for a mainstream loan

·         Remortgages at the peak accounted for approx 36% of gross lending, or circa £131Bn. Given negative equity and a number of customers who are opting to stay on lenders SVRs we can safely assume that this number has at least halved. Deducting for BTL and self-cert remortgages (to avoid double counting), this means remortgaging would fall by circa £56.9bn

·         Sub-prime – This represented approx 8% of gross lending at the market peak. However as around 70% of the activity here was refinancing, losing this sector from the market means a reduction (after accounting already for the remortgage drop off) of approx £9bn

 

Deducting the above numbers from the 2007 peak brings the total down by approx £110Bn to £255Bn. Then, assuming an average 21% price decline (HBOS UK index, peak to trough)  translates into a direct reduction in lending, this means that an effective market size that satisfies most current demand would be a minimum of £200bn. I would clearly emphasise the word current in this estimate – going forward a year, this size will be inadequate…

 

 

Remortgaging remains the unknown quantity

 

Whilst this number is significantly below the market peak, we need to bear in mind that this number is likely to be artificially and temporarily low given what has happened to interest rates. Low SVRs, often linked to Bank Base Rate (BBR) has meant that many customers in the last 12 months who have come off a fixed rate, are better off staying on SVR rather than re-financing. The big unknown though is what happens not if, (but rather when) rates start to rise? We have now tens of Billions of mortgages on variable rates where customers have previously opted for the security of fixed rates. Even if fixed rates are not as an attractive option as rates start to climb, many customers will want security. As rates rise we would anticipate a remortgage surge adding at least £25Bn onto the gross lending figures.

 

 

Sub-prime and High LTV lending (100%+)

 

How and if and sub-prime lending returns is a matter for debate. However what is clear is that in certain areas of the country (as highlighted in a Fitch report in 2008) over 10% of mortgages granted in 2006 and 2007 were for customers with some form of impaired credit. Without sufficient finance here, there is a real risk that customers become ‘stuck’ long term, preventing parts of the housing market from functioning. The absence of high LTV lending (which we do not envisage returning for the foreseeable future) simply exacerbates the negative issue for borrowers who took out these products. Even if you don’t regard these lending areas as ‘normal’, their absence will impact the market’s recovery.

 

 

Implications

 

If we have a required funding shortfall currently of at least £55bn, rising in all likelihood to £80bn+ in the next 12 months (this is all without any house price rises assumed), the question remains unanswered as to not only who is going to lend this additional sum, but how is it going to be processed?