Press release 30 March 2009

Checkmate Mortgages Limited today announced the appointment of John Hunt to the position of Managing Director, Finance & Risk.  John immediately joins the Board and has responsibility for Finance, Risk and Compliance, reporting to Stephen Knight, Executive Chairman.

John qualified as a chartered accountant with Arthur Andersen, and as a Master Blackbelt in Six Sigma with GE Capital.  John has additionally worked in Credit Risk with Capital One and GMAC RFC UK, where he was Director of Credit Risk responsible for lending policy, risk analytics and business intelligence.

Commenting on his appointment, John Hunt said: “I am delighted to join the team at Checkmate.  This is a fantastic opportunity to help strengthen consumer choice in a difficult mortgage market and I look forward to working with a great group here.”

Concluding, Stephen Knight said: ” We waited a long time for John, but I’m sure we’ve got the best in his field.”

Checkmate continues to negotiate with potential funding sources whilst it completes the testing of its online decisioning and processing system.  An announcement will be made as soon as a launch date is known.

 

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.

 

 

 

 

 

As the US and UK seem to be exhibiting similar economic trends the ‘rationale’ follows that experiences in the US and UK housing markets will be very similar. After all, both countries had long sustained periods of house price growth, both experienced increased diversity in products including large sub-prime sectors and both countries had a large scale dependence on capital markets to fund products.

 

If you look at housing market trends post Q2 2007, again they appear parallel in almost all respects. Both countries have/are seeing large scale property falls , obtaining mortgages for properties is much more difficult and the specialist sector has disappeared. It should therefore follow that the performance of actual mortgages should follow suite, right? No, Wrong.

 

 

The implicit flaws of the ‘slippery slope’ argument

 

The ‘follow the leader’ argument simply doesn’t apply to the two housing markets for a whole host of reasons including:-

 

·         Very different housing markets in terms of complexity, relative over/under supply and social housing provisions;

·         The quality of mortgage business written in later years of the housing boom and the impact of regulation (the US mortgage market was largely unregulated at a retail level);

·         The role of capital markets in funding and the relative structuring of mortgage securitisations (the US was much more dependent on capital markets for funding); and

·         The difference in national psyche

 

You may think that the last point is rather obtuse. However, experience shows this last point to be probably the most important of all. If you have two customers on either side of the ‘pond’ experiencing the same circumstances the ‘rational’ results on average should be same. The simple reality is however very different. This isn’t just a UK versus US argument:  it is an argument that applies to any two countries you care to compare.  

 

In a previous role I worked extensively in Holland , Germany and Italy and one of the earliest conclusions I reached was that taking one business model that works in one country and transposing it in a different jurisdiction doesn’t work. You have to adapt to the different legal requirements, the different distribution and processing requirements, the different customer requirements but most of all the different consumer behaviour. They don’t just speak in different languages in foreign countries, they think and behave in fundamentally different ways.

 

 

The evidence of the increasing disparity between the US and UK

 

If you aren’t convinced of the level of disconnect between the credit performance of the US and UK housing markets, have a look at some of the statistics:-

 

Repossessions or foreclosures

 

The CML is anticipating some 75,000 repossessions in 2009 in the UK. The US had 290,361 foreclosures in Feb this year alone (RealtyTrac) up 6% on January levels.

 

Given the population differences if we look at the levels of anticipated repossessions in 2009 by percentage by annualising the US February figures (which could well underestimate the numbers) we get the following picture:-

 

 

 

 

 

 

 

 90+ days arrears and cases in litigation;

  

UK arrears for all borrowing total approx 1.95% of outstanding balances (CML). US arrears for prime borrowers only totalled 3.74% (Source: Mortgage Bankers Association). US sub-prime 90+ arrears and cases in litigation total an almost unbelievable 23.11%! Given that approaching 1:4 loans at the height of the US market was sub-prime, this perhaps goes a long way to explaining the above graph. When you combine 90+ day arrears and cases in litigation for all loan types, you get the following picture:-

 

 

Whilst performance continues to deteriorate on both sides of the pond, even the most negative commentator cannot fail to draw the conclusion that the performance of the two markets is in no way linked.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

By Stephen Knight, Executive Chairman Checkmate Mortgages

  

 

When Buy To Let (BTL) first appeared in the UK mortgage market it was regarded as a highly niche, commercial product requiring higher rates, lower LTVs and delivering greater risk than prime residential.  Wrong.  Take a look at this graph:

 

 

 

 

In every example, except the second half of 2008 (where a large part of the increase is technical), arrears on BTL let has beaten prime residential.  Yet commentators continue to talk negatively about BTL. 

 

Those of us involved in the BTL market soon began to realise that investors’ BTL portfolios were their future pension that they were not prepared to put at risk.  A well organised BTL borrower expected some voids and in many ways was better equipped that the prime residential borrower to overcome financial problems as there were several sources of income.

 

I also query the evidence when commentators say that tenants are more likely to be in lower paid jobs meaning that BTL borrowers will suffer more as the recession continues.  Research I was involved in a few years back indicated that renting amongst young professionals was the preferred tenure until settling down beckoned in their 30s.  They wanted to live a little, pay off their student debt and be near their social centre.  This idea that homeowners are somehow superior to tenants in a way that is material to the economy, should only be written down with a quill pen.

 

Neither do I think that there is an “Aha” moment in the fact that BTL arrears marginally increased above prime residential in H2 2008.  The liquidity freeze has disproportionately affected BTL as the products have dried up, meaning that the book of outstanding loans is increasingly static, thereby distorting the arrears figures.

 

Whilst commentators are often all too happy to try and focus on the perceived negatives of BTL, the positive impact this product has had in the wider economy is often over looked. Whilst owning has many positives it is not conducive to social mobility. Before the introduction of assured shorthold tenancies and subsequently BTL, anyone who needed to re-locate, work temporarily in a new location or who simply didn’t yet want to buy would have found renting difficult due to a lack of suitable properties and also very expensive. In many instances people were ‘forced’ into buying simply as the alternative was too unpalatable. BTL has meant a fall in overall owner occupation rates from 70.9% in 2003 to 68.3%  in 2008 but provided genuine choice for people. Owning may provide people with a ‘stake in society’ but a thriving BTL sector gives consumers greater choice about when and if they make that choice.  

 

One mainstay of the old-fashioned approach to BTL underwriting is to rely on rental cover of 125% or 130%.  Actually, it was never ‘cover’ in the sense of offering the lender any real protection.  It was some young surveyor’s best guess as to the rent that could be achieved (which might be materially wrong) if the property could be let (which might not happen, at least straightaway) subject to market conditions (which the surveyor will claim indemnifies him for any aspect of his advice).

 

I always preferred underwriting the borrower and assessing his attitude to credit and ability to pay rather than pretend that I had “rental cover”, and recent events speak more to my theory because rental cover has never been better yet BTL arrears have increased.   Because rents have stayed steady, but interest rates have fallen dramatically, some BTL borrowers have 150% + rental cover, but that does not appear to have helped.  I say that’s because alleged rental cover is not that significant for underwriting purposes.

 

When markets make dramatic adjustments the baby sometimes get thrown out with the bath water.  I hope that this doesn’t happen to BTL and that we can soon get back to a wide availability of this important product, de-bunking those myths along the way.

 

 

The most notably consistent refrain of bankers and politicians over the last few months has been “I didn’t see it coming”. A perhaps rather obvious statement if you think about it, as clearly if you did and didn’t act, the charge would be incompetence rather than perhaps just oversight. The important question is of course “why didn’t you see it coming?”.  There are obviously a number of complex factors at play here, but I’d like to add just one of my own: infectious unquestioning optimism.

 

 

Running with the herd or “I didn’t see it coming”

 

There is an obvious but perhaps over-looked aspect of human thought, that of rational or perhaps irrational extremes. People on the whole either tend to be optimistic about given situations or pessimistic and are heavily influenced by personal events, the people they work and socialise with and by news events. If a personal position is good and the general view or consensus is optimistic, there is tendency in thought and behaviour to assume that what has happened in the past will be the position in the future as this is what our experience has shown us. Equally, if the recent experience is negative there is strong tendency to project this negativity far into the future even if the facts do not support this view.

 

I mention all this as I noticed that many of the same people who were on the ‘unbridled optimism side’ two years ago now seem to have jumped camps to the ‘unbridled pessimism’ school. If you look at events over recent months it is not hard to see why this view has changed. Literally everyone in banking and financial services either knows someone who has, or may indeed themselves have, lost their job and those in employment may be facing the threat of redundancy or at the very least is likely to have received a much smaller bonus. In addition there is also a ‘poacher turned gamekeeper’ aspect in that many investment bankers who created some of the ‘toxic assets’ are now on the ‘buy’ side and pessimism may suit as a negotiation positioning

 

 

It’s not linear

 

All of the above adds up to some very pessimistic views of the market that I have heard first hand in the last few weeks, often about the UK housing market.  As we have detailed in several blogs, the recovery of the housing market is central to economic stability and recovery, not just of the UK but the world economy. House prices are notoriously difficult to predict in detail (Note: Those pundits that think they ‘predicted’ the crash by forecasting it every year for several years in succession, rather like predicting someone’s death: you were going to right at some-point but wrong every point before…) but there are still some basic economic tenets that underpin the market. Everyone of course has their own views here but some views I have listened to where people are simply projecting recent house price movements inexorably forward simply defy logic.

 

In a recession events peak at different points in the cycle with for example, unemployment noticeably lagging (unemployment may well still be rising as economic growth turns positive).  We are firmly of the view that house prices will be a lead indicator of the beginning of the end of the recession, not a trailing event.

 

 

Logic not sentiment

 

In a Blog a couple of days ago, we looked at US house prices and their influence on the global economy. With the publication of the latest HBOS figures this week, we have updated our assumptions on the UK market. Below is our latest view on house prices versus affordability

 

   

  

In brief, ‘House prices’ in the graph above are the HBOS Seasonally Adjusted quarterly index, ‘Affordability’ is defined as the relative change in average wages and mortgage interest rates with both indices starting from the same relative point in 1997. To take both indices forward we have assumed that for ‘Affordability’ wages are essentially flat and that ‘actual interest rates’ (that which a consumer actually pays) do not fall below 4.0%. For house prices we have simply projected the current rate of decline forward.

 

 

What does the graph tell us?

 

Two important things to note: (1) The ‘cross over’ point where the two lines meet and where the long term affordability index lies, will be reached towards the end of Q2 this year. From this point on we believe that if house prices continue to decline the market is ‘over-correcting’. (2) The affordability indices is based on mortgage rates remaining approx where they are now.  If liquidity improves, competition will intensify and mortgage rates should fall making loans more affordable.

 

In terms of timing, we believe that the market will over-correct, but by the end of Q3 stability will begin to occur in the UK housing market. There may be a period of ‘bumping along the bottom’ but the large scale price falls we have been seeing over recent months will be over. Are we right? Well obviously time will tell, it is perhaps too early to talk about ‘green shoots’ but there are some encouraging signs emerging. The most important thing in all of this though, as we have covered before, is to base your views on facts. The eventual outcome may sometimes differ, but I’ll take reason over sentiment anytime      

 

 

 

 

 

 

 

 

 

 

The latest Case Schiller index (for December 2008) which tracks US house prices has recently been published and shows a picture of continuing house price declines. Although the picture at first glance would appear gloomy there are some signs of a flattening in the rate of decline.

 

 

 

 

 

On a month to month, seasonally adjusted basis prices fell by 1.88% in December (the latest month available). However this falls needs to be taken in context with the strong seasonal nature of the US house prices as the graph below demonstrates.

 

 

 

 

Regional differences

 

As usual the Case Schiller 20 city index does mask some strong regional discrepancies, not just in terms of rate of decline but also from the point at which they started declining.  Cities such as Seattle, Portland, Dallas and Charlotte, experienced a house price peak much later in the cycle, hence if you measure the price change from the start of the ‘national decline’, performance in these areas overall is still reasonable compared to the national average. However if you measure from the point when prices peaked in each city/region, prices are now falling in the previous ‘stable’ areas at comparable rates to areas such as Phoenix and Los Angeles. For example, prices in Seattle are down circa 9% since June 2006 but over 18% from the city peak in July 2007.  Prices in Charlotte peaked in June 2008 and are now down 9.0% in the six months since.  Undoubtedly the current recession is having an impact across the US in areas that were otherwise relatively stable.   

 

 

Why US house prices matter to the global economy

 

As we have covered before, there is little actual direct linkage between house prices in the US and the UK (although the point of stability may be the same). However, with over $6 trillion of US mortgage debt out in the markets in various forms, until US prices stop falling the prospects of a global recovery are greatly reduced. Falling property prices means increased losses for holders of mortgage backed securities (MBS), a mark down in MBS prices and a reluctance by banks to lend new money when the risks remain high and there is no clear exit route (given that securitisation markets remain effectively closed). As well as the direct impact on the banks and asset holders themselves, falling prices have a major impact on consumer spending patterns. The good news is that President Obama clearly understands the importance of trying to stabilise the US housing market

 

Is there any good news?   

 

Well surprisingly yes. Whilst falling house prices are not good for the economy, the quicker prices adjust the quicker the bottom will be reached and an line can be drawn under losses. Rather like having a tooth pulled, a short sharp adjustment is better than a long drawn out affair. Our stated position has always been and remains that Q3/Q4 this year will mark the turning point for the housing market for four significant reasons:-

 

 

 

1.    Prices in the UK will be off nationally, peak to trough, by circa 30%.  In the US they will be off by circa 35%. These price falls are the consensus peak-to-trough falls agreed by most industry analysts. In a UK context, lower prices combined with low interest rates will bring buyers back into the market and there is tentative evidence of this happening already.   

2.    Mortgage rates on both sides of the Atlantic are at historically low levels. Whilst the full extent of the rate cuts are not yet being passed on, rates in real terms are very affordable. For example many two year fixes are now under 4.0%.

3.    The governments on both sides of the Atlantic are putting in place a number of measures to kick start lending both to businesses and homeowners. In the UK, as well as the Northern Rock recommencing lending, a condition of the government assistance to the both RBS and Lloyds is that they significantly increase their lending. Unlike other initiatives we understand from senior sources at both banks the pressure to increase lending is intense and should not be under-estimated.    

4.    Many believe that there could be investor demand re-emerging for bland, simple securitised structures which will increase lending and positively impact house price dynamics.

 

We believe that asset price, borrowing rates and supply of funding, will converge in Q3/Q4 to bring about stability. There may be a period of ‘bouncing around the bottom’ where trends are hard to define, but the period of continual house price falls will be over.

 

The end is not yet over, but it is in sight…