The mortgage market past and present

To understand where we are going we need to understand where we have been – particularly in the past 10 years or so. The Global Financial Crisis (GFC) had a profound impact on our markets: up to that point, much of the growth in lending had been funded by wholesale funding and securitisation. That stopped dead in its tracks on one day – August 9th 2007.

We shrank from well over 100 active lenders to only 6 lending anything of note. The number of Mortgage intermediaries halved and gross mortgage lending fell from £356bn in 2007 to about £134bn in 2010. Lenders were all focused on survival and maintaining liquidity rather than growing share of the mortgage market.

More than 10 years on, what does it look like now?  Gross new lending is running at about £65bn a quarter, still some 25% below pre-crisis levels, with annual net lending at £45bn for owner occupied and about £6.5bn for BTL. We have total outstanding mortgages of £1.4tn, up from £1.2tn at the end of 2007. So, to be clear, the growth in mortgage balances outstanding over that 12 year period is nothing more than the effect of inflation over time.  Lending levels certainly haven’t grown in line with house prices, though the drivers aren’t entirely the same. Following the recession in 2008, average wages fell almost consistently in real terms until mid-2014. From 2014 to 2016, inflation was low and wages increased, though they’re still not back to their pre-recession levels. Now, inflation has caught up again, and real wages are levelling off.

Funding today

An over view of funding tells us that a slew of Bank of England schemes have been provided which have now mostly ceased and are in run-off. There has been a resurgence of retail funding and that has both good and bad aspects. Looking at wholesale funding, the market had been recovering well and increasing numbers of Residential Mortgage Backed Securities (RMBS) issues had been seen although in truth it has been smaller specialist lenders and acquirers of portfolios in the main. But this all changed in early January. More of that in a moment.

Whilst retail funding and Bank of England schemes have predominated, a return of wholesale funding and RMBS/Covered Bonds is inevitable – although it might not feel like it right now…

Although this return to normality is good and to be expected, it will squeeze margins more as subsidised funding falls away.

But mortgage markets are overcrowded

As you will see, the majority of mortgage lending in the UK is carried out by relatively few lenders who have streamlined products and processes to both cut costs and also to minimise conduct risks which are now greater after the FCA’s MMR reforms of October 2014.

This in turn has led to a growth in underserved and niche markets and if you look at products in the mortgage market today and compare it with say 20 years ago, I’d say that there is very little innovation.

But we have too many lenders chasing too little business which has inevitably led to margin compression and credit creep. This is not so good.

To be specific, amazingly we have around 145 lenders today compared with around 100 in 2007. Of these, the top 6 lenders command more than 70% of all mortgage lending in the UK and if you broaden it to the top 15, they account for around 90% and focus on high income affluent customers.  So that means that around 130 lenders compete for 10% of the market. About £26bn per annum! And it doesn’t end there. Latest data from the Bank of England tells us that 17 banks have been authorised in the UK since 2013 and there are more in the pipeline. No wonder that credit and price wars have started.

We also have an ageing population with increased outright home ownership and there is now considerable housing wealth concentrated in older home owners, with those over 55 years having wealth of more than £1.8tn. As the borrowers pay off their mortgages, they will reduce the stock of loans outstanding, even with some of them taking out lifetime mortgages of one sort or another.

Pricing and risk are still used to get business in the majority of the market – and the big lending players have the balance sheet firepower to achieve this. For smaller lenders, not to understand this could be fatal.

As we have seen, there has been a range of funding schemes available to banks and building societies which have allowed them to fund mortgages at close to zero marginal rates. This has stimulated the markets but has meant smaller non-bank players have had to concentrate on market differentiators to compete at all.

Now these schemes are in run-off, this will address the imbalance to some extent and allow smaller lenders to compete on a more level playing field.

The effects of tighter regulation and oversupply in the low risk sectors has been that the number of prime customers is now in decline.

The larger lenders have exacerbated this by industrialising their processes and simplifying products. This means that more can be done on an automated basis to both cut costs and reduce regulatory conduct risk. But it comes at a cost.

With house price growth massively outstripping wages growth, the FTB market has fallen sharply.

Coupled with ageing borrowers paying off their mortgage, the mortgage market may well have peaked and is now in long term decline in my view.

But all is not lost – even though approximately 130 lenders are fighting over the £26bn of lending p.a. not transacted by the top 15 lenders, we are seeing a re-emergence of specialist lenders focussing on gaps in the market – including higher risk borrowers.

A note of caution

Income multiples are higher today than pre-crisis and rising as is the house price/earnings ratio which is close to the all-time high we saw just before the credit crisis

Although arrears are low and falling – this is to do with the low interest rate environment and little to do with lenders skills in my opinion!

So now to funding!

It’s hard to think that until the 1980s the mortgage market was entirely dominated by building societies and retail deposit funded.

Centralised lenders started to appear in the early 1980s and the first UK securitisation was in the mid-1980’s – the so-called ‘MINI’ deal.

Now, apart from retail funding, we have securitisation and Covered Bonds (similar) and many other options such as ‘flow deals’ where a lender writes loans and then ‘sells’ them to a funder which could be another lender or a fund such as an asset manager.

We have had P2P lenders where they source matching funds from individuals and then lend the money to borrowers.  And they are broadening out beyond retail funders to institutional funding to become ‘market place’ lenders. In the case of Zopa, the World’s first P2P lender they have also become a bank.

What is a lender? A broker? An originator? It’s all blurring and these terms are somewhat interchangeable.

Back to first principles

Warehouses – not a building in this case but a temporary facility which funds mortgages until you have enough to able to sell them as a portfolio or securitise them. These are generally a 1 year maturity facility and providers are usually banks. Banks like to see a clear ‘exit’ i.e. they don’t want to be left funding a bunch of mortgages for 25 years – they want it to be a temporary funding. When the ‘exit’ isn’t clear, they can become very nervous!

So what happened in January when there were clearly a few problems? We came back from Christmas and then all hell broke loose.

Secure Trust Bank announced it was pulling out of the mortgage market. I believe that was more to do with my earlier comments about too many lenders chasing too little business. I think they just decided they couldn’t find a profitable low risk niche that met their requirements so they are out for now. Sensible!

Then Fleet announced it was pulling products. My reading of what happened is as follows:-

  • Year-end had just closed so investors had squared away their immediate investor needs.
  • Significant Geo-political risks remain and not just in the UK. But then we have Brexit.
  • Brexit means uncertainty and if you were an investor who didn’t need to invest just yet with the whole year ahead of you, why wouldn’t you wait until Q1 was out of the way so that at least you could see whether we left the EU with a deal or not?

You have to remember that there aren’t too many investors operating in the UK RMBS markets compared with pre-crisis days and some of them are just ‘yield tourists’ – chasing deals globally where they see the best returns and risks.

And if you were a bank providing a warehouse and you couldn’t see a clear ‘exit’ you might wish to reign in lending until the picture became a little clearer. Simples!

This should be seen as a short-term issue – it’s happened before and I daresay it will happen again.

Worry not!

Securitisation is now re-emerging

Securitisation was absent in any meaningful way from 2007 until 2012 – more latterly because major lenders just didn’t need it given the plentiful supply of liquidity from the Bank of England at subsidised rates.

The bad press applied to RMBS was, at least as regards Europe, unfair. The UK has been 80% of this market in Europe and defaults on UK RMBS have been and continue to be close to zero. Ill-informed coverage around credit and liquidity issues and lazy bundling with the very different US market led to securitisation being dubbed a ‘bad thing’. To be clear, RMBS provides funding to maturity and is designed to survive major stress scenarios. And it has come through with flying colours.

Retail funding for mortgages – how useful?

There’s nothing wrong with retail funding, but it is not the panacea to all funding problems as some people think given inherent pricing and maturity mismatch. With new deposit takers on the block such as Goldman Sachs with Marcus, don’t expect retail deposits to be a cheap source of funding. And if price wars break out then one effect is that deposits move from one account to another with increased velocity. This has the effect to shorten the duration of the funding with any one institution. Not a good thing when mortgages are long-term assets needing a long-term funding solution.

More competition means costs escalate and less money is available to fund longer-term assets – duration shortens and with the effect that retail funds become a less useful and more costly way of funding going forward .

Diversification of funding is the key! It is essential that we don’t focus on just one form of funding – we need retail and wholesale.

To summarize

The UK mortgage market is challenging and in long-term decline: first time buyers are falling away given tighter conduct and prudential rules, house prices continue to escalate with supply/demand imbalance outweighing, over time, even short term Brexit impacts,  and wage settlements not keeping pace with inflation. Like many countries in the world we have an ageing population – around £1.8tn housing wealth is with the over 55year olds and they are paying off their mortgages.

The trouble is that many are asset rich and income poor and this, coupled with the legacy of mortgages with no repayment mechanism is giving rise to a growing need for lending into retirement. Expect to see continuous growth in that market.

We generally have much less product innovation than we did but remember, the UK still ranks No1 in the World for technology innovation in financial services

Securitisation is making a comeback but far fewer investors than there once were.

There are too many lenders, too few borrowers.

The UK may have plateaued in some respects but it is still a very significant market with advanced products, technology and regulation

The UK has major headwinds – at least for now with BREXIT

Expect lending to get tougher – some lenders won’t make it as things stand given we have too many competing for the same business and, if I’m right, the mortgage market has plateaued and is in long-term decline.

There are opportunities but it would be fatal to get caught up in price wars with the mainstream lenders.

One thing is for sure, 2019 will not be boring!

You can download this article extracted from the Mortgage Gazette as a PDF here