tony's blog

Thursday, August 12, 2010

Confidence tricks

Everywhere you look confidence is an issue. The recent Nationwide Consumer Confidence Index reflects that consumer confidence continued to fall during July. Economic news from the Bank of England suggests we will charter “choppy waters” for the coming 12 to 18 months. But perhaps the real figures of note behind yesterday’s revisions to growth and inflation (and indeed future consumer sentiment) are the unemployment figures. While unemployment fell 3,800, the number taking part-time jobs rocketed 115,000 to a record 7.84 million and the number of long-term unemployed grew. Furthermore wages slipped further behind the cost of living.

Unemployment (or fear of it) really matters because while the fear of what is coming can already be seen through the consumer confidence survey, the impact of these cuts has yet to be felt. Will the private sector be in a position to take up the slack created by the slaying of public sector excess? This is the single biggest factor that will determine not only the success of the coalition but also banks’ appetite for lending.

Whether in mortgages or business loans the banks remain nervous. The holding strategy recently announced of setting up a committee to examine the lack of small business lending sums up the banks current attitude. If we are really going to get liquidity back then banking and investor confidence remains key. They not only have to see a future but believe it is attainable. This is a waiting game but also a catch twenty two. Again confidence is the key.
What is certain is that as soon as one moves, the others will.

Tuesday, August 10, 2010

The Elephant in the Room or ‘has anyone seen my prop?’

So where do we go next?

The analogy I’ve started using is the one about the building that had subsidence and was propped up with Acrow props. For building read the banks and financial system and for Acrow props read Special Liquidity Scheme (SLS), Credit Guarantee Scheme (CGS) and Quantitive Easing among others.

The trouble is that these ‘props’ start to be removed next year and the Bank of England is adamant that they won’t be replaced. But I’m afraid that it doesn’t stop there. According to the Bank of England Financial Stability Report published in June, there is a total of £165bn of repayments due under the SLS and £120bn of guarantees under the CGS by the end of 2012. These are the props of course. In addition, by the end of 2012, the Bank of England forecast around £480bn of unsecured senior debt, subordinated debt, covered bonds and securitisations maturing or callable over the period. That’s an eye watering £765bn for the market to find by the end of 2012 which equates to an average of £25bn a month. With the debt crisis in Greece we have nowhere near achieved this year to date. The building is looking a little shaky at this point!

The Bank is clearly well focussed on this but has also made it very clear that they expect the industry to find this money themselves and that there will be no further Government or Bank of England bail-outs. So can they? Frankly I doubt it. If they can’t and there’s no assistance then have no doubts, with the props taken away the system will crash again.

Banks globally have continued to de-leverage since the onset of the credit crisis and in the UK this has meant that banks have assets of around 19 times their capital rather than the 30 times we saw at the end of 2008. This has manifested itself in declining asset classes including not only those esoteric types of asset, the derivative, but also in the tangible loans made to other banks, corporates and individuals. This is one of the reasons that Vince Cable has been urging banks to lend more. The banks are saying they are lending as much the market currently demands. This may or may not be true in the SME sector, I’m not an expert, but it doesn’t sound right to me in relation to mortgages. Residential mortgage loans represent the largest single asset class in the UK at around £1.2tn. It is mind-blowingly massive. To fund this, banks and building societies are having to use retail deposits and wholesale markets. Although retail deposits are growing overall they are simply not sufficient in scale to meet the problem. As competition hots up in this sector, they will become less useful as a funding mechanism due to increased expense and volatility as they change hands between deposit takers more rapidly. Not only that, mortgages are inherently medium to long-term assets and funding them solely from demand to one year maturity deposits simply doesn’t work if you want a stable market. Ask any Treasurer. If you are still in doubt about the over-reliance on short term debt to fund longer term assets then look at Northern Rock and remember the queues. The Bank of England recognises this and is exhorting banks and building societies to lengthen maturities of funding saying that an increasing reliance on short-term funding is undesirable and would perpetuate the structural fragilities in funding profiles that have caused disruption in the last three years (so we agree on this). The stability the Bank of England is looking for can only be achieved by issuing term maturity debt instruments and in particular Covered Bonds and Mortgage Backed Securities.  

Building Societies get a special mention where some £22bn of maturing fixed rate bonds will need refinancing in 2010. With highly competitive retail deposit markets building societies will have to either cut back further on lending activities or look to other sources of funding such as pooled securitisation ideas and strengthening core Tier I capital. Looking at Kent Reliance and their deal with JC Flowers we can see they have already gone down this route. Further consolidation in this sector looks inevitable from where I’m standing. Amazingly, the Bank of England is suggesting that the relevant provisions of the Building Societies (Funding) and Mutual (Transfers) Act 2007 are implemented to eradicate the preferential status that wholesale lenders achieve when lending to Building Societies.  In other words they want banks lending to Building Societies to carry more risk than at present so as to encourage them to take a more rigorous approach to assessing risk and controls over the Building Society sector. Isn’t that what the FSA should be doing rather then getting banks to do it? My fear is that this will just make it much harder for Building Societies to borrow from banks and hasten their sector’s demise.

So the banking reporting season is under way and the results by and large seem positive and encouraging. Sadly I’m not so sanguine. It seems to me that we have a massive elephant in the room that no one is talking about. I don’t think the banks and building societies can refinance £750bn through the markets alone and if they can’t then without Government support the market and the economy has a very big problem.  Slowing of lending activity will slam the brakes on recovery. If the props are removed too soon then the whole edifice is in danger of falling down!

Friday, August 6, 2010

Where's the cunning plan?

Well I failed to get a blog out in July, a month which saw the FSA launch their CP 10/16 Responsible Lending paper. My excuse was that I was on holiday at the time and when I was faced with trying to download a 186 page document onto a Blackberry in Portugal whilst sipping a glass of Vinho Verde I gave up.

I did see the industry response however, most of it hostile to the FSA.

I’m back now and have read it and have been able to consider my feelings.

In short there is nothing of any great surprise in the document so to that extent I don’t think the industry response was proportionate, as the FSA would say. Would I rather we didn’t have another slew of regulation to assimilate? Of course I would and so to that extent it doesn’t make me feel any better because it just isn’t going to help get the mortgage market back on its feet.

The problems the industry are facing have nothing to do with irresponsible lenders , borrowers or bad practices, regardless of how much of that actually went on, but a Global credit crisis and ensuing liquidity shortage which has not gone away. So to that extent the potential changes to regulation don’t make things worse at a macro level – they just give us a number of additional things we need to focus on. More importantly it doesn’t make it any better either.

Is this the FSA’s fault? Short answer has to be no!

So where does it leave us and where next for regulation?

What I think is missing from a policy perspective is what is the overall vision and strategy for the UK? What level of home ownership does David Cameron see as being the desirable for the UK going forward and is it consistent with the ‘aspirational views’ broadcast by his housing minister Grant Shapps? And do we really expect to have a vibrant market with masses of products, innovation and lenders to choose from? If we do then CP10/16 does little to further that aim given that its focus is on stable markets not supply and innovation. At some point I would love to see a clearly annunciated strategy and vision which the multipartite authorities are able to frame their policies and proposals around. We wouldn’t expect a company to operate without an overall strategic plan and business plan would we? Why should the economy be any different?