Getting together to chat with Mark Jannaway, director of OC&C Strategy Consultants, about the state of the non-conforming market was always going to be a challenge.
With the dramatic events which surrounded Northern Rock fresh in our memories, we joke that by the time the interview is published, the market may have been stung by further issues and therefore what we say might be completely obsolete.
However, while the sector might have hit the hyperdrive button in recent weeks as the fallout from the US began to really hit home, the UK non-conforming market has been growing at a phenomenal pace for a few years now.
A flourishing demand for products and advice, stimulated by an economic liberation in the way people regard money, and the spending of it, has seen the adverse sector mushroom. Everyone, from the multi-national bank to the sole broker, has responded to the opportunities, jumping aboard the great non-conforming gravy train.
An abrupt halt
But as is always the case, the party has to end sometime and this Summer has seen this train halt fairly abruptly. As with any hiccup, people become cautious as they wait for the market to settle once more. However, what is interesting is that the whole mortgage industry is gripped by a different type of nervousness this time around.
“Obviously banks operate globally now and they’ve got written exposure beyond UK shores,” Jannaway points out. “The challenge at the moment is that nobody understands the level of exposure in different markets, such as the US, and it’s obviously very difficult for them to make a judgement on what that knock-on effect is going to be.”
It is this lack of information which has blighted the UK market. No one has experienced a crisis like this before, as the way mortgages are now arranged has changed dramatically. The days where the local building society manager made a lending decision based on who you were have been replaced by hedge funds trading portfolios of loans on a global basis. These are unchartered waters and no one knows where the light at the end of the tunnel will be.
“Emotional is a good word,” Jannaway believes. “I think people start acting in ways that are disconnected with the underlying data, which is the important thing. The problem with emotions is that they can run indirectly and are difficult to predict. The period of market growth has been quite long and as a result, people often forget what has happened in the past. They therefore aren’t bringing as much information to bear for the current situation, which isn’t ideal but it’s not as if this is the first time the market has slowed.”
Underlying message
But the underlying message from those with vast experience in the sector is that things will get better. While what has happened in the US may be an important factor in the current situation, the influx of American banks has helped drive the growth we have experienced in the non-conforming market. For Jannaway, the fact they have remained here, despite the crisis engulfing them back home, shows that the UK mortgage market is fundamentally strong.
“I think they will raise interest rates, as they have done, to make sure they manage the inflow of volume as they want to see it. I don’t think they will exit though. I think they have got the depth of pockets to ride out the storm and they know there will be a lot of players who won’t, so they will come out the other end stronger for it.”
Therefore, the long-term future of the UK non-conforming market looks secure. But a pressing short-term problem, both for the US investment banks and UK mortgage lenders, is the lack of liquidity in the capital markets. With many lenders in the adverse sector looking to securitise their mortgages, it is essential they can sell their portfolios on or they will be unable to fund new products. However, very little interest is currently being shown by investment companies who were previously snapping up any non-conforming asset.
“The $64,000 question is how long this will last.” Jannaway comments. “People are very conservative at the moment and as a result, the interbank market is likely to remain fairly illiquid, at least for a period of time as people reassess; firstly, what their own balance sheet situation looks like and more importantly whether they are comfortable with the parties they are dealing with.”
However, as many people have said throughout this period, investors don’t like sitting on piles of money and Jannaway agrees they will be back in the market, but only when the time is right and when people have got their emotions in check.
“Ultimately, the price will get to a point where there will be some attractive investment opportunities so you would expect that to stimulate some capital back in. There are already a whole bunch of funds being set up to purchase ‘distressed assets’, which is a clear sign that hedge funds and others are saying these mortgages may not be performing but they still have a value.”
Concern
Until that point though, many lenders will be concerned whether they can secure future funding and get portfolios off their books. Much has been made of the advantage which balance sheet lenders now find themselves, compared to their securitising counterparts, but Jannaway believes it will be other factors which will influence whether a lender will get through the current hostile climate.
“If they can’t get a securitisation away at a profitable or meaningful size then they won’t have any funds to raise new loans. The challenge then becomes if you are not a scaled business and you’re not originating loans, but you have a cost base to maintain and manage. It’s going to be interesting if the technology based players, who by definition should have fewer people and a lower cost base, come out of it better than the high service non-conforming lenders, who are going to have some pretty expensive sales and underwriting people.”
For Jannaway, this is where the battle for the future of the non-conforming mortgage market will be won and lost.
“You have this fight between technology based propositions going direct to broker versus high service, more special case, manual underwriting propositions. For me, there is definitely going to be a migration away from the servicing to the technology side. The guys in the high service scale will find the market they are going after getting smaller and smaller and there are too many people fishing that pond for all of them to survive.”
Feeling the squeeze
But it won’t just be the high service lenders, in Jannaway’s view, which will be impacted. Packagers have played a role in the non-conforming market for so long; placing cases which the broker may not have the ability to process. However, as high-tech lenders make it simpler for brokers to deal directly with them, packagers will feel the squeeze.
“You could almost argue that the packaging sector is leaning towards what is happening on the lending side. Conditions are changing, they are getting tougher, and as a result, packagers are having to change the way they do business and the nature of the proposition that they handle.”
However, this all reverts back to the uncertainty plaguing the market. Nobody has any definitive idea of what the market will look like when it settles down. What is hoped is that lessons have been learnt and lenders will be more aware of the risks.
“Hopefully, it will make sure lenders think a bit harder about what they are lending and as a result, the nature of the customer base they are targeting.”
Stronger than before
So lenders, packagers and brokers will all be battered and bruised but those who survive will be in a stronger position than before. The days of an effervescent environment, with players looking to make a quick buck piling in, are over. Only the smart will survive.
“The downturn and the change of conditions are good in some ways because a lot of people have been able to set up a lending proposition. Effectively, anyone could set up, make some money and profit from that increase in volume. If the rates go up and the volume slows, that will differentiate the stronger players versus the weaker players. The market is becoming more about scale and efficient processing and it will push the boundaries between who will win and lose.”
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