tony's blog

Friday, November 18, 2011

The Ticking Time Bomb

With all the chaos in the eurozone recently, coupled with concerns in the US about stagnated growth and stubbornly high unemployment, it is little surprise that there are knock on effects in the UK economy. These external influences coupled with a resolution for the Government to stick to ‘Plan A’ mean that various business groups are now clamouring to scale back their forecasts for GDP growth for this year and for 2012 - and who can blame them. We are certainly living in an uncertain world at present.

Unemployment certainly remains a worry. Recent figures from the Office of National Statistics revealed that unemployment has already risen to its highest level for 17 years, rising to 8.3% or 2.62m. Specifically youth and long term unemployment remain a particular concern with these figures rising dramatically. The number of 16-24 year olds out of work has reached 1.02 million (21.9%).

You may recall, from the blog I wrote in May, about my concerns for a rise in unemployment in the future. I suggested that unemployment is a lagging indicator of the economy and had yet to reflect the impact of the austerity measures - the slowdown in consumer spending and the pending cuts in the private sector. I further speculated that the private sector would be unable to fully compensate job losses in the public sector. Economists seem to agree with me. John Philpott, chief economist at the CIPD said the latest figures ‘confirms that the private sector just isn’t creating enough jobs at present to offset public sector job cuts’. Well I think this will remain true but worryingly with GDP so weak I can’t see how we can expect to see anything but depressing statistics on the job market for the next year or so at least. And with higher unemployment of course there are lower tax returns and consequently less income and this is certainly going to impact on the Chancellor’s deficit plans.

In its latest quarterly economic forecast, the CBI predicted that unemployment will continue rising next year, peaking at 2.75m in Q4 2012. Accountancy group BDO has predicted a worsening situation in the labour market with its Employment Index falling to 93.4 in October from 95.9 in September. This is the first time this year that the index has fallen below the crucial 95.0 mark, showing that hiring intentions across the board are likely to remain weak.

So what’s to be done? Well I think now is the time to be proactive. I’m in agreement with CBI and some of the ‘Plan A plus’ proposals which look at many measures but includes proposals  to target tackling youth unemployment  and investing in education and skills. We also need to think of some plans to tackle long term unemployment and give people the confidence, skills and resources to get out of this vicious cycle.

This is a good start. I don’t think we can afford to sit around with a wait and see attitude.

Tuesday, November 8, 2011

The Return of Equity Release

Equity Release: universally considered as the bad guy on the block in lending terms. Much maligned by critics, why has it had so much bad press over the years?

Well there are many myths attached to it, probably the most universal being the consumer risks losing his home. (According to research by Safe Home Income Plans (SHIP) some seven out of ten consumers believe that opting for equity release means you have to move out of your home.) However the simple fact is that as long as that property remains the main residence, the customer can remain in it for the duration of his life. 

More concerns follow: you won’t be able to leave an inheritance; your children will be saddled with debt; you won’t be allowed to move home and equity release is ‘unsafe’ and ‘unregulated’ etc. Yet all of these fears are pretty much unfounded if the right product and provider are chosen. Early products didn’t have the safeguards and protections that they do now. This type of lending is seen as specialist and carries risks not found in conventional mortgage lending; hence it has had its own regulatory regime for some years now.

My view is that equity release has to be a force for good if handled with care and compassion. We can’t get away from the fact that the UK population is ageing and going forward there is insufficient pension provision out there. Moreover many borrowers don’t have the capital put aside to pay off the interest only element of their conventional mortgage so there is a genuine need for this product. I can only see that demand for equity release products will grow in the next few years. Its time has finally come in my view. What is important is that the right products are in place to cope with the demand so this much maligned sector gets some positive PR at last.

As Andrea Rozario, director general of SHIP said: ‘The wealth locked up in a property…will continue to be the greatest asset most people have as they approach retirement’. So they should make the most of it.

Thursday, November 3, 2011

The way out of this financial crisis: the art of deleveraging

So last week we thought the Eurozone debt deal had been done. And on the face of it, it looked like good news, or at least the stock markets seemed to think so as shares rose across the globe. Of course the devil is in the detail and I would like to see just where the extra monies to support the stability fund were coming from. And will €1trillion be enough? Also the European Banking authority has said that the European banks must raise £91bn of new capital to protect themselves against losses resulting from any future defaults by June 2012 which seems rather a tall order. There certainly is a need to push the measures through rapidly to ensure confidence is retained in the markets.

But that was last week and as we now know, things have moved on swiftly, and not for the better, with the announcement of the Greek referendum which has thrown all Eurozone bail-out plans into chaos. Leaving aside the Greek issues and whether they will or will not be able to sort out the new challenge, it is worth looking at the underlying effects on the banks and the economies of rebuilding capital. This is not just a Eurozone phenomena, it is global.

I have to say I concur with the comments Mervyn King made to the Treasury Select Committee last week. He alluded to the fact that whatever decisions were made in Brussels, this would not be a long term solution but would only ‘buy a year or possibly two years breathing space’ and the ‘underlying problems hadn’t changed at all and they won’t change’. So is this just papering over the cracks then?

As I have mentioned before, the markets have never really been entirely fixed from the original credit crisis four years ago. The world prior to August 2007 was a very different place where it was commonplace for governments, banks, companies and even consumers to over borrow which in turn stimulated economies too much. This was made possible by a too optimistic view of continuing rising economies and asset values and was encouraged by relaxations to the capital and liquidity requirements of banks. This meant that not only were they able to lend so much more for any given €1 of capital but they also needed far less by way of a return on that loan to meet their threshold return on capital. Everything was set up to “over-stimulate” the global economies and that’s exactly what happened. This led to unsustainable asset price inflation which subsequently became an impossible situation when things went wrong. And with the beauty of hindsight we can see that this was always likely to happen.

Today banks are building up capital and liquidity to more realistic levels. Mervyn King mentioned that when the QE programme started, banks had a leverage ratio of 40 to 1 and now it is 20 to 1 so they are going in the right direction. However banks have some way to go; Mr King has expressed that he would like the leverage ratio to go lower. And that’s not just within banks but corporates and government too.

There are three main ways a bank can achieve this deleveraging: issue more equity capital, retain more profits as part of Tier I capital reserves or shrink loan books through deleveraging programmes. Europe’s biggest banks have ruled out tapping the equity markets to find this money. If they are not to call on more government bail-outs then they will have to trim their balance sheets. This will be evidenced by a combination of lending less (bad news for the economy as it will slow things up even more) and actively reducing assets from their balance sheets.

Active deleverage programmes are going to become more familiar to us all and we will see increasing incidences of banks actively “re-broking” their mortgage books out and encouraging borrowers to move their accounts away. We will also see an increase in mortgage and other asset sales if I am correct.

Some banks are managing their deleveraging programmes themselves but to manage this effectively calls for a wide range of key skills including cross-selling techniques, JVs with other lenders and of course corporate finance experience. This is not something that every lender will feel it has the ability to deliver so we can expect a growth in specialist asset management businesses like Home Funding which can manage this on an outsource basis in order to meet the banks’ overall strategic objectives and financial needs. It does seem to be a very pragmatic solution and we are going to see more and more of this type of activity going forward. However there is an art to this and the key is to get the balance right.

It would seem that wholesale deleveraging could help put the markets back on an even keel and I for one welcome it.