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?

 

 

 

 

 

 

 

Stephen Knight, Executive Chairman

The Treasury Select Committee recently reported on lenders’ practices when it comes to mortgage arrears.  They expressed concern that some lenders were not being sympathetic enough to borrowers in areas such as securitisation and high LTV lending.

There was certainly some substance to the Committee’s findings, and we don’t deny that securitising lenders might be swifter to repossess than a High Street lender.  The issue is however, what benefits borrowers most?   Choice, or six lenders dominating 80% of the market, which is what we have at present?

Put simply, securitisation converts a savings product for big institutions into a mortgage product for the man in the street.  In-between is a contractual relationship between investor, issuer, lender and borrower that is more complex than borrowing in your High Street. 

What the Treasury Select Committee did not address is whether the extra funding and product competition available through securitisation is worth the different conditions that need to apply, because institutions surely aren’t going to invest in mortgages if borrowers have to be given unlimited time and flexibility in which to renegotiate the payment of their loans.

Today, August 2009, is a good time to judge the situation.  For a variety of reasons, securitising lenders are out of the equation.  The only source of mortgage money are a handful of High Street lenders, some of whom are offering abysmal service.

Twenty five days to issue a mortgage offer?  Technology is currently available to produce an offer in twenty five minutes.  When we pointed this out to a lender recently, it just shrugged its shoulders and said the equivalent of “No competition means we can take as long as we like”.

Current estimates are that gross advances will be £145bn this year versus £368bn in 2007.  This is a 60% decrease in availability.   Existing borrowers might be experiencing a sympathetic approach to arrears fees from the high street lenders.  But new borrowers struggle to get a loan above 75% LTV!

Wouldn’t borrowers rather have choice, even if this comes with a different approach to arrears management, than no choice at all?  

The Treasury Select Committee’s criticism goes beyond arrears.  The Committee is concerned about low LTV lending, which we agree is holding the market, and opportunity, back.  But with the FSA requiring several times as much capital for above 75% LTV lending as below, shouldn’t the criticism be directed at the regulator (another Government department) rather than the lenders themselves?

If we were to return to the situation where capital allocation evened out based on the portfolio then I am sure there would be high LTV lending available from lenders.   As it stands at present, the rates that would need to be charged on high LTV lending are so onerous to cover the capital requirement that it is no surprise that the vast, vast majority of the £145bn which will be advanced this year is targeted at lower LTVs.

The Treasury Select Committee also addressed arrears charges.  But, as the CML points out in its response, if lenders did not charge for arrears management, then these costs would be averaged out across the entire mortgage book, to be met in large part by those who were not in arrears.  How fair is that?

We think that the Treasury Select Committee does a great job in holding industries and individuals to account.  Most of their work is very good indeed.  In the area of mortgage lending, however, we think that they should support competition, even if the diversity requires different lending terms.

After all, in a highly competitive world, borrowers always have choice, and do not need to accept the terms first offered to them.  Contrast that with today’s bland environment where borrowers have virtually no choice at all

 

One of the biggest issues that still seems to be prevalent in much of the reporting we see is the tendency to draw comparisons with the past and from this to try and extrapolate the future. Whilst it is a natural human trait to look to past experiences to try and determine outcomes, the word that continues to best describe the events of the last 24 months continues to be ‘unprecedented’.     We have tried over the last few months to try and de-bunk some of the inaccuracies that have arisen as a result of trying to draw comparisons with the past. To date we have looked in depth at two areas, the housing recession of the 1990s  and the comparisons that have been drawn between the US/UK housing markets.  However in the last few weeks we have noticed two new areas of ‘look back and compare’ which we again believe could be mis-leading   Addressing the new inaccuracies  The stabilisation of the housing market (which is now being consistently reported by most indices) seems to have taken some commentators and analysts by surprise. Having spent several months talking down or even dismissing the improving figures as largely aberrations, often principally on the basis that with transactions levels ‘so low’ and mortgage finance constrained, the view in some quarters was that price stability could not yet be attained. Now that the evidence is too strong to be ignored, the latest mantra that seems to be emerging to explain the current stabilisation of prices is that of a short term or temporary housing supply issue that, once it corrects and more supply comes onto the market, prices will continue to fall.  Let’s take each of these points in turn:-   Transaction levels;- There is no denying that a lack of available mortgage finance, particularly at higher LTVs and for more specialist sectors (be that large loans, non-conforming or Buy to Let) is having a significant impact on consumers’ ability to obtain loans and was a significant factor behind property price falls. However simply referencing past transaction levels doesn’t on its own tell you much other that the obvious (see graph below). As well as there being other factors at play here, such as negative equity limiting transactions and a lack of stock in the market, the main reason for the low transaction levels are unprecedented i.e. This is the first time (outside of war) where there has been a liquidity freeze. There is therefore no historical data to show the relationship between transaction levels (partly enforced) and prices. Lack of available finance has driven prices down but taking  low transaction figures on its own, ignoring housing supply issues and ignoring the fact that property is now the cheapest it has been in real terms since 1997 really doesn’t tell you where the bottom is. Even without a strong recovery in available finance a bottom will be logically reached at some point as markets adjust to the new reality.        Supply: Whilst estate agents are reporting low level of stock (RICS reports that June stocks were 32% lower than a year ago) the supply issue is nothing new. Why supply therefore has become the new rationale for price stability is therefore something of a mystery to us. The supply issue has always been there. Making this now the central point of an argument as to why prices have/are stabilising suggests that the influence this has on prices may have been under-played in the past (something we believe) Under-supply in London and the South East has been a problem for many years and is getting worse exacerbated by a rising population, falling household size and a lack of new build.  In addition, we are hearing lots of anecdotal stories of Home Information Packs (HIPS) deterring some of the ‘unsure’ sellers from marketing their property (particularly the type defined as “I might sell if I can get the right price”).  Supply in our view is and will continue to be an ongoing issue, particularly in parts of London and the South East. Negative equity is certainly behind some of the low stock numbers but other factors also come into play and low stock may be a rather longer term self-perpetuating issue in that people won’t sell if they can’t see anything they want to buy. Although we subscribe to the view that a longer term sustainable rise in prices can’t occur without big improvements in mortgage finance, the current stock situation does mean that many experts central tenet that prices can’t rise until transaction levels improve dramatically is proving to be incorrect.    House prices going forward   Time will tell as to whether our view that the current price stabilisation is a permanent rather than temporary feature of the UK housing market is correct.  In economic terms we are certainly not out of the woods yet with rising unemployment set to be a feature for at least the next year.  However trying to quantify the impact of such factors such as unemployment and consumer confidence is in our view more of an art than a science. Looking back historically at such factors doesn’t really help as it is very difficult to view history out of context. The only fundamentals we believe that it is possible to use with any accuracy in a historical context are affordability (interest rates and wages), supply and price. Looking at these three factors tells you quite simply that housing is the currently the most affordable it has been for a generation.