Bob Sturges is director of
communications at Money Partners
For those of us who have been around long enough, the last 10 years will be remembered as something special for the UK housing and mortgage markets. Fuelled by a robust economy, low interest rates and strong consumer confidence, house prices have boomed at an almost unprecedented rate. Demand for residential property has been further boosted by continuing aspirations for home ownership and the relatively poor performance of other traditional investment sectors, such as equities, pensions and savings. Together, these factors have led to a growth in mortgage lending from just over £57 billion in 1995 to almost £290 billion in 2005.
Part of this is due to the success of the specialist lending sector and the huge upsurge in remortgaging. In 1995, for instance, the latter accounted for 28 per cent of total lending but 41 per cent only 10 years later. Meanwhile, the rise of specialist lending has enfranchised literally millions of customers who would otherwise have been excluded from the borrowing population.
A visable effect
A very visible effect of the success of the mortgage market is the number of new lenders keen to grab a share. Virtually all have their sights set on the faster-growing specialist sector that, with its healthier margins and a more accessible distribution base, makes it easier for newcomers to establish themselves. In turn, this has helped create in recent months what might, without hyperbole, be described as a frenzy of innovation across the sector. As a result, products have evolved from simple non-conforming mortgages for the credit-distressed client to more sophisticated ‘lifestyle’ offerings catering to a wide range of borrowing needs.
Processes and attitudes to risk have changed too. More lenders than ever now outsource significant parts of their operations once considered core to their businesses. They have also developed alternative funding strategies – such as securitisation and covered bonds – which suit their distribution models while enhancing liquidity and financial efficiency. In risk terms, many lenders, but particularly the specialists, have increased their exposure to higher loan-to-value (LTV) business – including 100 per cent LTV loans – while simultaneously ditching traditional income multiples in favour of more flexible, and generous, affordability models.
But it hasn’t stopped there. Innovation in technology is presently all the rage. We are looking at a future where half of all property valuations will be carried out online, paper-based proof of income and identity rendered obsolete and the career prospects for conveyancing solicitors bleak. The main beneficiary is the end-customer, whose choices have never been better. But some in the industry are beginning to question whether all the developments are robust enough to stand the test of time.
Looking at the facts
In a ‘bull’ market the answer is in the positive. A continuing demand for mortgages coupled with rising house values – and therefore rising equity levels and consumer confidence – creates an environment in which homeowners can utilise their property-based wealth to their best financial advantage. But what if the bull runs out of steam and the bear emerges from hibernation?
Without wishing to follow the well-trodden path of scaremongering, this view merits some examination. After all, a number of well-publicised key indicators suggest tougher times are ahead and a possible end to the current favourable economic cycle. These include:
A cooling global economy and threatened recession in the U.S.
‘Real’ inflation running significantly ahead of ‘core’ inflation as a result of rising energy costs, council taxes and student fees.
Personal indebtedness at record levels.
Higher unemployment.
Rising levels of business failures and personal insolvency.
Increasing tax burden on the home-owning classes.
Slowing house price inflation.
In spite of this, the Bank of England’s Monetary Policy Committee (MPC) recently saw fit to raise the Base Rate and has indicated it may need to do so again. This can only add to the gloom some already feel, but does it really signal a sea-change sufficient to cause real concern?
While some of the current news is less than sunny, the fundamentals that underpin the economy remain in pretty good shape. For one, the housing market is operating in its own ‘bubble’ and, to some degree, immune from wider economic influences. Demand for property and finance is being sustained by investors keen to add to their portfolios and by other factors, such as the growing popularity of second homes and immigration.
Borrowers are also generally managing their indebtedness well. Most of the £1.2 trillion of debt – about £1 trillion – is secured debt, and while there has undoubtedly been a rise in recorded arrears and court actions for repossessions, it should be seen in context. For instance, most court actions never actually result in repossession, while the Council of Mortgage Lenders (CML) forecast of 15,000 repossessions in 2006 suggests they will remain at a relatively low level. Moreover, recent statistics from the British Bankers Association (BBA) reveal that the growth in unsecured lending – the source of most bad debt – is slowing as borrowers repay or replace loans and credit card debt through remortgaging their outstanding loans while also improving their savings position.
In the same way, the rise in company liquidations and individual insolvencies should be kept in context. The boom years created a surge in self-employment and therefore company registrations, a proportion of which will inevitably fail or be voluntarily wound-up. Equally, the relaxation of the bankruptcy laws and a growing acceptance by society of debt, and its possible consequences, help explain the rise in insolvencies.
WSUB
With regard to interest rates, these are likely to peak at 5 per cent, possibly 5.25 per cent – particularly if, as expected, the Federal Reserve starts cutting US rates. This should help bring inflation back to the MPC’s target by 2008 at the latest, and so allow room for rate cuts. In the meantime, even a 50 basis points increase is unlikely to impact most homeowners to the extent their homes are at risk. It should also be borne in mind that up to half of all mortgaged households will be protected over this period as a result of the recent take-up of attractively priced fixed rate deals.
Uncertain times ahead
While still generally favourable therefore, there are nevertheless clear signs of change – and more uncertain times – ahead. One concern is that a high proportion of lenders – and their personnel – have only ever known positive market operating conditions. Many have not experienced the effect of a significant downturn. So what should they do to mitigate the consequences of such an event?
To begin with, it should be acknowledged that contemporary lenders are far more sophisticated businesses than those of 10 years ago. Much of this is attributable to their legacy systems that afford even inexperienced staff some protection from unfamiliar conditions. Their risk assessment and customer profiling abilities are also much sharper and more clearly defined. But there are other elements fundamental to a lender’s success in a difficult environment. These include:
- A clear strategy and operating policy that aligns the appetite for risk with new business targets.
- Secure and cost-efficient funding lines that help create value.
- Robust management information reporting and portfolio quality management.
- Efficient account management processes (in the event these are outsourced, a well-designed service level agreement is essential).
- Regular stress-testing exercises to ensure business viability in a tougher environment.
In the first case, the high-street banks recently reported sharp increases in bad debt provisions for their unsecured lending portfolios. In the second, a specialist lender’s debut securitisation suffered an embarrassing downgrade by a rating agency. Some commentators have identified what they consider to be a common cause in both cases – the pursuit of volume coupled with lax underwriting and/or inadequate collection techniques.
Lending and risk-taking are longstanding stablemates. Successful lenders achieve a balance that delivers the right level of return. They also understand the need for flexibility in light of changing circumstances. Where this involves a downturn, specialist lenders are at greater risk than their mainstream counterparts – even though most of their volume now derives from lower-risk near-prime customers. However, the sector is so well established that those who are well-prepared will continue to prosper – particularly if a downturn throws up new opportunities that mainstream lenders cannot exploit. For others, it could be a test that they do not pass.
