Stephen Knight, CEO

Yesterday, the FSA published its long-awaited review into the mortgage market.  There is too little space here to analyse the paper in full.  But set out below are what we believe to be the 12 main points affecting our market, and yours, with our commentary alongside. 

 

1. Lenders will be required to hold more capital and liquidity. Inevitable following the recent crisis, but the result will be less and more expensive funds available in the mortgage market.

 

2. No ban on high LTV mortgages, but reminding us that such a ban exists in Austria, Poland, China and Hong Kong.  Not sure where the comparisons are taking us, but good news nonetheless.

 

3. No limit on loan-to-income, but more verification of income and expenditure.  The current proposal requires the lender to assess “the level of a consumer’s expenditure in determining the affordability of a mortgage product.” As it stands this will create an onerous and judgemental approach to decisioning – future applications will take longer, be more prone to individual opinion, and more open to dispute and arbitrary rejection.

 

4. Self cert is dead.   We will not be offering self cert, but this regulatory shift is a concern for those borrowers who are paying their existing self cert mortgages, and now find themselves stranded on their current product.   The removal of self cert creates a regulatory barrier for these borrowers – more thought is needed to help these current borrowers.

 

5. Regulation extended to all secured loans including second charges and buy to let.  Expected.

 

6. No more “layered risk” where one or more of the following components may not be present in a mortgage advance, i.e. high LTV; no income verification; credit-impaired borrower and lending to debt consolidation.   We believe the FSA is right to take this stance.

 

7. Arrears charges banned where borrowers have entered into an arrangement to pay back arrears by regular contribution.  This is in line with our views – where borrowers are paying back arrears and working with lenders, the costs of managing this arrangement are minimal. This aligns the FSA position with the current FOS views on arrears fees.

 

8. Interest only loans to be underwritten as if they were capital and interest.  This reiterates current rules under MCOB that require lenders to “take account of the cost of any associated repayment vehicle and, if no such repayment vehicle is specified, ‘may’ base their calculations on an equivalent repayment mortgage”.  As such, it is in line with our and most lenders’ current approach.

 

9. Limits on equity withdrawal.  We cannot see the justification for this which will negatively impact borrowers’ choice, flexibility and resultant spending in the economy. 

 

10. Regulated intermediaries will be directly responsible to the FSA for distribution and advice.  We support this stance in principle.  However, it will certainly increase the resource that the FSA needs to manage the intermediary market, and there’s a risk that this will in practice lead to spreading efforts too thinly.

 

11. New rules will be targeted at the “non-banks”, including the possibility of regulating purchasers of mortgage portfolios as if they were the first lender of record.  Too early to say how this could work.  The current, tragic shortfall between equilibrium supply and demand, and current mortgage availability, can only be made up by the international capital markets, so any mechanism that slows that down is bound to impact borrowers’ choice and the availability of mortgage finance.

 

12. Abolition of capitalised arrangement fees.   It will suit some borrowers to capitalise a higher fee and pay less on the monthly payment.  Regulation down at this level of detail could be market-harmful. 

 

Remember, this is a discussion paper so, if you have views that you want the FSA to take into account, you will need to answer the questions they have posed by January 2010.  Although, in response to the feedback, the FSA may consider withdrawing or amending some of the above new requirements, I would plan your life on expecting most of it to be introduced in the second half of 2010, except for the regulation of second charges and BTL – this will take longer as it changes the FSA’s remit and requires parliamentary approval.

 

 

 

 

By Peter Stimson - Commercial Director

I came across an interesting fact the other day. Since 1998 global temperatures haven’t risen. I am not of course suggesting that global warming isn’t a fact or won’t occur, simply that data from the last 10 years does not appear to support the hypothesis. How is this relevant to house prices? Well, despite the fact that house prices are clearly stabilising and in some areas rising, there seems to be a growing body of experts who seem to think that prices in 2010 are set to fall further despite there being little apparent supportive evidence.

Are house prices set to decline further in 2010?

Whilst prices, having falling by circa 23% (peak to trough) now appear to be levelling or increasing, some take the view that the stabilisation is only temporary before another round of price falls occur, in 2010. I was reminded of this last week whilst reading the Fitch view on the housing market. What is particularly frustrating is that the authors of these type of reports rely overtly on pure economics. Housing and house prices, as we have covered in several blogs on our website, isn’t an exact science and treating it as such may not get you to the right answer.

To quote Fitch Ratings. “A 30% fall from the peak of October 2007 would bring this ratio (house price to income) back in line with the long term average. In comparison, the house price declines in the recession of the early 1990s saw the average house price to income ratio fall below the long term trend.” Unfortunately whilst this may be correct in pure economic terms, this theory falls over as soon as you bring interest rates and supply into the equation. As we have also covered in our some of our blogs  the current crisis has seen the breakdown between several factors that may previously have held a relationship.

Our view is that If you want to gain a real understanding of what is going to happen to house prices in the next 12 months or so, the best way to do this is to first understand why prices now appear to have stabilised (or in the south risen) and then look at the outlook for these factors over the next 12/24 months.

So, why have prices recovered?

• Prices fell over 20% peak to trough – By any logic, price falls cannot be indefinite and a point is ultimately arrived at where buyers and sellers reach equilibrium. Our long held view has always been that it was likely to be Q3 2009 given that overall affordability at this time would be at a generational low. As the graph below, which looks at affordability and house prices through time, shows, the historic low point and longer term average between affordability and house prices occurred again in Q3 this year. A co-incidence?

 

• Supply, is constrained This isn’t simply an issue of people holding off buying or choosing to stay put, it is also a long term demand/supply imbalance which has only been exacerbated over the last 18 months as new building has dramatically fallen.

-  Interest rates are low and are likely to remain so.  Whilst the strong relationship between Bank Base Rate (BBR) and actual consumer interest rates (both deposit and lending rates) has broken down, it is easy to forget that new mortgages are still available (albeit to a smaller section of the market) at rates which are amongst the lowest for decades. Additionally, many existing borrowers are finding that the products they took out in the past revert to BBR plus a small margin. In short borrowing is for most people very affordable.

If we accept the above as the primary reasons why house prices have stabilised, for prices to again fall, it is logical that one or more of these factors has to change or another factor has to enter the equation to negatively influence prices. 

The outlook for 2010 and beyond

Of those who believe that house prices are set to fall further again next year, three principal arguments seem to prevail.

• Firstly, as more property comes onto the market the demand/supply imbalance will resolve itself making the property market much ‘softer’ causing prices to fall.o If, as I have seen, the argument is that rising prices will encourage more people to sell/move, I have yet to see any real evidence of this. Additionally the forbearance that lenders are showing to those in arrears means that there is not a ‘wave’ of repossessions or forced sellers hitting the market, more a steady ongoing supply. With interest rates so low, most people can ‘sit it out’. In short we do not see a rapid adjustment to the supply situation occurring at the pace needed to cause prices to decline.

• Secondly, as unemployment rises throughout 2010, peaking in 2011, the argument goes that this will deter many from entering the market and create more forced sellers.
o Unemployment and the general confidence issue it creates in the market, undeniably have an influence on property prices . However I would argue that the fear factor is here already as we are over a year into a major recession. Unemployment numbers may continue to rise for the next two years, impacting individual borrowers, but the forbearance shown by lenders and the relative impact this additional group could have on the market overall is limited.

• Thirdly and most significantly, is the impact on the housing market when interest rates start to rise. With BBR at just 0.50% and unlikely to fall further, the biggest worry is that when rates rise (as they inevitably will do), affordability decreases and prices fall. The important piece here though is around timing.

The future for interest rates

When rates were cut to 0.50% in March this year, there was still a large degree of uncertainty around the length, depth and severity of the recession. More than six months further on, a clearer more generally agreed view is emerging of likely future events. Whilst we now may be at or indeed even past the bottom of the recession, recovery is likely to be long and slow and complicated by the large and growing government deficit. This means that there is little upward pressure on rates in the short to medium term and we believe rates may stay low for several years to come. This is being reflected in swap rates which, from rising in the spring, have been consistently falling over the last few weeks reflecting the general concerns over the recovery timeframe.

 

This doesn’t of course mean that we are entering a Japan style ‘lost decade’ period, simply that with interest rates likely to remain low, the factors that could push house prices lower in 2010 don’t to us appear to be there. Time will of course tell who is right!

By Stephen Knight, CEO

The Lloyds HBOS Permanent (Perma) deal marks a turning point in the UK RMBS market.  Don’t believe the commentators that say it isn’t, because many of them were still predicting as recently as last month a freeze in the securitisation market until 2011. 

 

The Perma deal was 2x over-subscribed, and upsized as a result, with secondary pricing settling lower than the initial pricing by around 50bps.  This is exactly what you want for an RMBS issue and it is an indication of strong underlying investor demand. Not only was the deal over-subscribed, we understand that there were also over 50 different investors from 15 countries buying the paper.

 

I have seen comments along the lines that the pricing is too expensive. Well, it might look expensive against the crazy prices that marked the unsustainable market pre Northern Rock.  But the cost of issuing the deal actually looks good when compared to: firstly, the mortgage rates which are currently being charged to new borrowers, and which all borrowers (and the market) will have to get used to under the new liquidity and capital regimes being imposed by the FSA and, secondly, against the alternative cost of other liquidity instruments, notably the cost of raising senior unsecured debt from the markets.

 

The most significant aspect of the Perma deal which received negative commentary, was the “put” option.  This enables investors to require the issuer to take back the residue of loans outstanding at the end of five years, which has in turn meant that the assets cannot be removed from the issuer’s balance sheet.  Some commentators have said that this structure means that the Perma deal is a one-off and not indicative of the return of the RMBS market.

 

However, we do not see it like this. To encourage investors to return to the market you are initially going to have to deal with some of their concerns. As the first deal of note for well over a year, to expect a structure mirroring pre-2008 is unrealistic. As new deals emerge, based on new originations, we do not think that the “put” options needs to feature. 

 

Is the securitisation market now open again?

 

The answer is that it is now starting to re-open, with clear demand from investors for new paper structured in the right way.  Given that the majority of the Lloyd’s HBOS mortgages were historic back book loans with a relatively low spread, this looks very positive for newly originated non legacy assets, paying a sustainable rate of interest that reflects current mortgage margins. When these loans are securitised, it will start releasing important new funding to a market that is tragically under-supplied. 

 

The damage being caused to borrowers and the economy by the current woeful level of new mortgage lending needs to be urgently addressed.  The deposit-taking lenders are doing their best, but only six organisations are achieving 85% of all lending and they are snowed under.  Only the international capital markets will make up the shortfall that the UK mortgage market needs, and this will come through securitisation where, according to the rumours I’ve heard, there are several further deals in the pipeline.