tony's blog

Wednesday, December 5, 2012

Not to be written off

This week has seen the Bank of England publish utilisation data under the Funding for Lending Scheme (FLS) and the almost universal verdict that the scheme hasn’t worked quite the way it should have. Well I’m not in that camp. At least not at the moment.

Of all the schemes we have seen since the onset of the credit crisis, the FLS is the first one that targets lending to the real economy and incentivises banks and building societies to grow their lending overall. Unfortunately, although data has revealed a strongly growing list of participants in the scheme, latest count there are 35, net lending by FLS participants to 30th September was +£0.5bn and total FLS drawdowns from the Bank were £4.4bn. However, probably unsurprisingly, the media headlines have focussed on the six largest lenders and the conclusion is different: overall lending across these lenders fell by £1.04 billion during the period.

So why is this happening and can anything be done to finesse the scheme? Firstly, falls in lending of the largest banks shouldn’t be a surprise. This group includes Lloyds and RBS, both of which are undergoing radical surgery and deleveraging. The fact that they are shrinking their loan books shouldn’t be a surprise. Secondly, many analysts claim that lending is being focussed on lower risk areas such as low LTV mortgages rather than areas that need help such as first time buyers. I am sure this is true.

Can anything be done about it? Yes but with difficulty is the answer. The FLS is a compromise. It was put together in a very short time and is basically a tweaked Special Liquidity Scheme. The obvious thing to do would be to tweak it a bit further and change the incentives to focus lending activity where it is needed. Although simple in practice I think this is unlikely to happen. The tightrope that the Bank of England had to walk was to balance the needs of the market within the constraints imposed by Europe. Yes Europe! To focus the FLS in the way I describe would almost certainly fall foul of the European State Aid rules and would be deemed to have provided an unfair advantage over other countries. Frustrating but there it is.

So the FLS is doing the best it can. It really is still early days and there are lenders coming on stream all the time. Some of the smaller lenders have already commented on the fact they are able to offer more competitive products on the back of the scheme which can’t be a bad thing. We need to give it some more time and assume that overall it is beneficial to the market. In my view we should be looking to the smaller lenders to make the difference to the key risk areas that need help and not the large banks who can’t or just don’t need to.

One to watch.

Friday, November 23, 2012

You can’t have it both ways

I was a little surprised to see Chairman of the US Federal Reserve, Ben Bernanke’s comments this week about how the overly stringent lending requirements of banks are hurting the US housing recovery. He said that ‘the pendulum has swung too far from the easy lending days of the housing boom complaining that ‘overly tight lending standards may now be preventing creditworthy borrowers from buying homes, slowing the revival in housing and impeding recovery’.

I’m not sure how timely these comments were given that the US Commerce Department subsequently revealed housing starts had risen to their high level for more than four years.

More importantly I’m not sure how helpful it is to suggest its time for lenders to relax their lending criteria at this time. Wasn’t much of the blame for the start of the Credit Crisis aimed at the US for being irresponsible and lending to individuals who hadn’t a hope in hell of repaying their mortgage from day one?

I’m not saying Mr Bernanke is advocating lending to credit impaired individuals but is it the right message to encourage lenders to relax criteria, especially since there are encouraging signs from the US housing market?

Thursday, November 1, 2012

Sifting through the data - or a tale of mixed messages

There seems to be a fair amount of confusion out there at the moment with regard to how the UK economic recovery is going. We have Sir Mervyn King,governor of the Bank of England saying that the UK economy was recovering at a ‘slow uncertain pace’ and it was ‘not clear if positive indicators would persist’ whilst Charlie Bean, deputy governor of the Bank of England, seems much more optimistic suggesting that there were ‘reasons for optimism’ for the UK economy with real ‘signs of progress’.

Conversely mortgage lending seem to be picking up, with the Bank of England suggesting that mortgage approvals are gathering in pace, thanks in some part to the Funding for Lending Scheme, yet house prices remain subdued with the Nationwide Building Society predicting that the housing market will take some time to gain any sort of momentum.

It’s all very confusing and it seems daily we are getting a mixed bag of messages.

For what it’s worth I think that things will gradually start to improve in the UK economy next year and we will see more consistent data coming through. I also agree with John Cridland at the CBI who suggests that we need to get used to a ‘new normal’ of slower growth with annual expansion of 2% looking pretty good.

As for the housing market, I think that too will perk up albeit gradually. However I am concerned about the longevity (or lack of it) of the Funding for Lending Scheme. I think thus far, that it is has been a force for good encouraging banks and building societies to lend and probably assisted financial institutions to price more competitively. But what happens when the Scheme ends, currently pencilled in for 31 January 2014?

Food for thought….

Friday, October 19, 2012

Getting by with a little help

Interesting survey from the Yorkshire Building Society out this week which suggests that 56% of potential first time buyers are concerned about how long it would take to save up for a deposit to buy a first property. The research goes on to say that it can take up to eight years on average so probably a lot longer if you live in London.

It also says that 7% of potential buyers plan to go to their parents to ask for extra help and almost a fifth of first-time buyers who had bought a home in the last year told the study they had had help from ‘the bank of Mum and Dad’ with their deposit compared with 13% of people who bought a property five years ago.

Two things come to mind. Eight years is a long time to save up for a 20% deposit so perhaps more should be done to help this largely disenfranchised group to get on the property ladder. I think this is an area that the current Funding for Lending scheme doesn’t really address in its present form, positive though the initiative is. Maybe the scheme could be refined to assist this group - it’s a segment of the market that is presently being overlooked. Lenders should be incentivised to target the higher LTV brackets with appropriate products.

And secondly, shouldn’t we as responsible lenders look at developing more innovative products for promoting shared ownership? The market is obviously out there so it makes perfect sense to invest our time and ideas in this area.

There are shared equity initiatives which we could and should exploit.

Wednesday, October 10, 2012

Reasons to be cheerful part II

Despite the IMF’s gloomy outlook for UK GDP this year there is some good news in the funding markets.

Last week I chaired the CML annual funding conference – their 8th and the sixth of which has been held since the credit crisis kicked in. In recent times it would have been easy for this conference to take on a gloomy air, but this time we had some unequivocally positive news to discuss: Where there were some 10-20 Residential Mortgage  Backed Securities (RMBS) investors a year ago (down from literally hundreds before 2008), we are now more than likely looking at 150 or so today and this number is growing. As a result of this, we now have increased demand from investors lowering costs for issuers.  

So investor confidence has improved. But why are investors deciding that RMBS could be a good thing? Well apart from having to find somewhere else to invest bearing in mind that gilt and cash returns are low, defaults in UK RMBS are negligible (0.01% UK RMBS defaulted)*.

Although the UK economy is still in the doldrums, it has not ‘blown up’ or even threatened to do so. We now have the ability to take whatever steps perceived necessary to ensure that the right measures are taken. Having said that, the economy remains in intensive care: it is under scrutiny and active management. I expect, as does the market, that further tweaks to policy and support will be necessary.

The Funding for Lending Scheme (FLS) has played its part too in that it has eased markets considerably and brought down interbank LIBOR rates.  What made this happen? Well the major banks and building societies are not issuing covered bonds or issuing securitised paper to the extent that they were because they don’t have to – they have access to the FLS. This puts banks in a more dominant position from a supply and demand level and this has driven spreads down marking a profound shifting in pricing in the last month. These developments could certainly allow the markets to function meaningfully once again. We now have the very real situation where issuance of RMBS is a cost effective funding mechanism once more and is close to the overall cost of borrowing under the subsidised FLS. Benchmark deals issued recently by Yorkshire Building Society through their Brass No 2 programme and Investec though RMS26 have shown this to be the case.

So what next for securitisation? The stigma that securitisation had is certainly fading and the track record of UK RMBS speaks for itself. Let’s hope the Bank of England sees this and gets behind these positive moves. Personally, I still think the Bank could provide more help to the market through the provision of permanent liquidity facilities to support RMBS and covered bonds. They have already shown themselves to be important components of banks funding and have been resilient in their performance despite the naysayers. And importantly, this wouldn’t cost the taxpayer a penny.


*Source: Standard and Poor’s

Thursday, September 13, 2012

Reasons to be cheerful

Mortgage deposit levels for first-time buyers have fallen below 20% for the first time in three years according to the Council of Mortgage Lenders. Well that’s a reason to cheer even if it has only dropped to 19%. It’s certainly a step in the right direction.

Also encouragingly the number of high LTV products on the market has jumped during August, so says Moneyfacts. Some 36 new mortgage deals with LTVs of 85% or above were launched during the month, some way away from the disappointing numbers in July which fell away to 26. And during August five new products were launched with LTVs of 95%.

So maybe the Funding for Lending and NewBuy scheme is starting to kick in. I truly hope so. However I was disappointed that if the research from Rightmove is to be believed that the public perception of the NewBuy scheme is still very limited. The survey suggested that homeowners and first-time buyers have little knowledge of this initiative – some 34% first-time buyers and 51% of other home movers.

Rather disappointing. Think what could be achieved in lending terms if we could raise awareness amongst all interested parties. I guess it’s largely up to the Government to do this but lenders and builders alike should all play a part.

After all it’s great to have some positive news to report to our beleaguered first-time buyers at last!

Thursday, September 6, 2012

The return of competition

I read, without any surprise, that Tesco Bank has made the first set of rate reductions to its recently launched mortgage range, including their fixed and tracker mortgages.

I suppose by doing that, they are really throwing their hat into the ring.

If they want to be a serious player in the market, I guess they don’t have any other option. With the Funding for Lending scheme working now, some extra £80bn of funding is available for banks to lend direct to consumers so it’s hardly surprising that competition has returned to the market. Also, without doubt, helping competitive pricing is the record low bank base rate agreed by the Bank of England’s Monetary Committee. And this is unlikely to change for the foreseeable future – possibly until well into 2014.

So good luck to Tesco Bank.  I hope it builds their market share because I really think it is healthy to have newcomers out there challenging the existing lender model.

However I do hope they have adjusted their rates within the parameters of a properly worked product pricing model. All too often I have seen lenders set their product pricing as a knee jerk reaction to what’s happening elsewhere within the market. As a generalisation, I think more thought needs to go into setting the headline rate – and not only that but the criteria sitting behind the rate plus the service standards supporting it. (It’s all well and good to have a market leading rate but do you have the back up team waiting to process the application?). And will it contribute to shareholder value?

When Home Funding Limited started originating for German Bank Westlb back in 2007 we had an innovative product pricing model which we actively looked to share with our broker partners. This enabled us to have a win/win scenario with our distributors as they were proactively involved in pricing the product. We were able to originate genuinely bespoke products which challenged the market but also enabled us, acting on behalf of the lender, to offer products which were profitable.

I believe that with the right model sitting behind you, there really is the opportunity for lenders to come up with products that build market share and that make money.

Friday, August 31, 2012

Funding for Lending – the panacea?

I’m a little worried that commentators are already judging the success or failure of the recent Government and Bank of England Funding for Lending scheme without giving it a fair hearing. I’m not sure what good it will ultimately bring (but surely having this in place is better than having nothing at all) but realistically it is early days. After all the scheme was only launched in August and it will take time for applications, never mind completions to flush through the system. However already I have seen various comments from analysts suggesting that it will do little to help the first time buyer market. Moreover there are fewer deals around for higher loan to values than a year ago and this needs urgently addressing if we are to kick start the housing market.

It is a pity that non bank lenders and smaller banks and building societies will be unable to benefit from this scheme, particularly when those are the very lenders which are likely to be the ones to focus on the niche markets that we so desperately need to revitalise. Perhaps this can be addressed in time and I urge the Government to think again about this omission if they are going to get the money where it is really needed.

Whilst I agree that we need more money to flow into key markets it is understandable that banks are being cautious. Even with extra available funding, they are still more likely to adopt risk averse behaviour and ration their lending to a smaller audience of borrowers as a means of conserving balance sheets. 

So then it comes back to the question as to how we help those who have a deposit of less than 10% to put down? It is true that there is an issue here. Average rents are increasing and we are locked in a spiral as more first time buyers are locked out of the housing market so have to turn to the private rental market. Maybe we should wait to see how the Funding for Lending scheme pans out.  Then if it really fails to deliver and has done little to help this target market we maybe need to think of providing new ways to fund these loans. After all the demand is there. 

Thursday, August 9, 2012

No man is an island

It was the Goldman Sachs analysis this week that caught my eye. It highlighted recent lending activity across regions. No surprises then that banks across Europe have reined in cross border lending given: 1) the amount of regulation that they now have to contend with and 2) suspicions that the euro may implode in the future.

So unsurprisingly you have national supervisors compelling local banks to build up capital and liquidity at the expense of other EU countries. As one regulatory source has said:’As the crisis has deepened there has been a rationale for national regulators to make sure their own country is ok’. So a case of batten down the hatches then. Not great considering we are all part of the global market and what impacts in one country usually has a much wider knock-on effect internationally.

I suspect this comes down to confidence as banks in Northern Europe appear to be curbing their exposure to Mediterranean countries for fear that their loans will be repaid in reintroduced national currencies. Understandable but given we live in a globalised economy we cannot afford to take this unilateral ‘I’m alright Jack’ approach. There has to be a balance between regulatory controls and a common sense attitude to cross border lending. Otherwise the markets will grind to a halt and it could go horribly wrong for us all.

Friday, August 3, 2012

The Great House Price Conundrum

Is it house prices up? Or house prices down? Or house prices remain the same? Well I guess it depends on what survey you are looking at. The recent Nationwide House Price Survey supports that view that house prices have fallen again last month and are 2.6% lower than they were a year ago. However the Land Registry reports that house prices have risen slightly over the year albeit sales of £1m plus homes has dropped sharply. There certainly is a variance of views at the moment.

I think what it is fair to say is whatever analysis you are looking at is that the market is starting to stall somewhat. It is still early days with the new Funding for Lending scheme so it is unclear as to what good this will do. Early comments suggest that whilst it has been good for people with a large deposit to put down, it is less helpful to those customers on higher LTVs but maybe this will change over time.

So how important is maintaining a robust housing market for the economy? Hugely important. Not only does a healthy housing market deliver jobs in various sectors but owning your own home is still a huge aspiration for many people living in the UK. It is also a huge lever in instilling greater consumer confidence in the economy at large.

Whilst the IMF suggests there is a correction to be made and we still have a house price bubble in the UK, I tend to dispute this view. I think that demand will always outstrip supply (we can’t build enough houses to meet demand) so I don’t believe that house prices will crash anytime soon. However I predict house prices will remain at best stagnant for the rest of this year and the market needs as much support as possible to encourage lenders to provide funding across the board supporting all LTV groups. Let’s hope the Funding for Lending scheme does the job it was set up to do. 

Thursday, July 26, 2012

Clouds on the horizon

Following the disappointment of UK GDP figures released this week registering a 0.7% drop, I was heartened to think that third quarter GDP will see an improvement. The bounce back in the third quarter will relate in part to the positive impact of the Olympics and the likelihood of an increase in private sector pay deals which will outstrip RPI inflation for the first time since 2009. So with more money in our pocket, that’s great news as the assumption is that we will spend more and drive the economy back into positive territory.

However trawling through economic news today I was disheartened by news from the US department for agriculture that has warned that food prices are likely to rise in the US next year due to a drought gripping large parts of the Midwest. It reported that this is the worst seen since 1956 and prices are expected to rise by between 3% and 4% in 2013. Corn and soybean price have already soared recently as fields dried out and crops withered.  Richard Volpe of the US department for agriculture told Reuters that ‘the drought is really going to hit food prices next year’ adding that the pressure on food prices would begin to build later this year.

So why should we be concerned? Well the US is the world’s largest exporter of corn, soybeans and wheat and a rise in prices will impact economies worldwide.

In June, UK food inflation fell to 3.5% from 4.3% - its lowest level in almost two years. However if the drought in the US doesn’t end, prices could once again rise. Colin O’Shea, head of commodities at Hermes Fund Managers said: ‘If we do not get rain in the near term then corn prices and related crops will continue at these elevated price levels. As a result the Governor of the Bank of England many not get the falling inflation numbers that he so desires’.

The last thing we need is for inflation to become a problem once again. Let’s pray for rain! In the US at least….

Thursday, July 12, 2012

What now for the Brics?

Of all the recent economic statistics to come out, the numbers that concern me most are those coming out of a recent report from HSBC which suggests that growth is slowing in the four big Bric countries - Brazil, Russia, India and China. These have been some of the fastest growing economies of the past ten years, and have been largely responsible for keeping the global economy moving forward. Yet now they are facing a sustained slowdown which has largely been blamed on the euro crisis and deterioration in the US economy.

Let’s look at these two issues. Well sadly I predict that the euro crisis is set to run for some time. Even Sir Mervyn King seems despondent accusing EU leaders of failing to tackle the fundamental causes of the crisis and adopting a policy of ‘kicking a can down the road’. He suggests that ‘there is a great black cloud of uncertainty hanging over businesses’ and until they know how things are going to pan out, ‘they are holding back from investment and spending’. His comments seem to make sense albeit will do very little to instil confidence in the UK.

I think economic data from the US is a little more encouraging, after all statistics suggest that the US trade deficit narrowed in May with exports to Europe rising. Yet analysts have warned this may not last suggesting it is ‘unlikely to be sustained in the coming months’. I am however encouraged that the Federal Reserve will act to provide further stimulus if things get worse although I can’t see a rapid return to growth in the US.

So going back to the Brics. Of all the emerging economies, China in particular has responded rapidly to a slowdown with its government easing the curbs it imposed back in 2010 which at the time were brought in to cool an overheating economy and curb inflation. Beijing has cut interest rates twice since the start of June and announced various additional stimulus measures. These measures initially appeared to do some good but with external influences affecting demand for China’s commodities, forecasters have now put back prospects of a rebound until at the earliest later this year.  

I fear we will have to wait some time until the world’s second largest economy, along with other Brazil, Russia and India, once again drive global markets.

Thursday, July 5, 2012

LIBOR and Barclays - the real world

If you look at the British Bankers Association website you will see that each contributing bank to the LIBOR rate setting has to answer the question: “At what rate could you borrow funds, were you to do so by asking for and then accepting inter-bank offers in a reasonable market size just prior to 11 am?”

So BBA LIBOR is not necessarily based on actual transactions. This is an important point.

It seems to me that the latest scandal to hit the markets is little understood by most of the vociferous market spokesmen and commentators.

I am not condoning wrongdoing that Barclays have owned up to but we do need to get this in perspective. First of all LIBOR is not some mathematically computed number which is always accurate to within fractions of a basis point. It is a number derived by dealers in prime banks talking to each other having observed the yield curve and the latest supply and demand for money in the markets and for them at that moment. It is a matter of opinion.  

Even if Barclays were a sole outlier in the LIBOR rate setting, the effect would have been eradicated. Every BBA LIBOR rate is calculated using a trimmed arithmetic mean of all rates submitted to them. Once all rates are received the rates are then ranked in descending order and the highest and lowest 25% of submissions are excluded - this is the trimming process. 

Looking at the second of the two breaches by Barclays; that they rigged the LIBOR rates between September 2007 and May 2009 by making LIBOR submissions which took into account concerns over the negative media perception of Barclays’ LIBOR submissions.

In other words they were looking to mask any Barclays’ specific problems.

Well I well remember this time vividly and as someone who has operated in the sterling money markets since the 1970’s I can assure you that what was happening at that time was far from normal. We were seeing major banks worldwide finding difficulty with raising money in the markets to cover their liquidity positions. The first major warning sign of the credit crisis that I observed was a movement in 6 month LIBOR in excess of 65 basis points above Bank Rate and with no yield curve cause. In other words it wasn’t that banks thought that rates would rise, it was simply that banks were struggling to fund themselves and would pay “whatever it cost” to cover funding positions. Very scary! There were rumours abounding about ‘major banks being in difficulties’. In this market it must have been tricky for any bank to fix a normal LIBOR setting for the BBA. To signal that your bank had a worse position that others and therefore had a problem must have been a real cause for concern.

I could quite understand in fact why it may have been prudent to agree with the Bank of England that a ‘normalised’ LIBOR rate should have been quoted and to take out the peaks and troughs of a far from normal market. But this does not appear to have been the case based on Bob Diamond’s evidence yesterday. Let’s see what Paul Tucker has to say. I’m not trying to make excuses for others and certainly have no axe to grind with Barclays but in relation to the LIBOR fixings in extreme markets maybe we need to reflect on just what was happening in a very hostile real world.

Just as an afterthought however, Bob Diamond’s letter to Andrew Tyrie ahead of the meeting said The interventions in question were typically on the short term one and three month rates relevant to the wholesale markets and not the longer term rates used to set, for example, retail mortgages.What planet has Bob Diamond been on? Mortgage rates are set relevant to short dated LIBOR rates such as 1 month and 3 month and not 6 or 12 months.

Sorry but this just doesn’t add up! Get a grip Mr Diamond.

Friday, June 22, 2012

How Central Banks should work

I was heartened to hear Deputy Governor of the Bank of England, Paul Tucker’s words last week hinting that there needs to be a shift in approach as to how the British authorities deal with the lack of affordable credit being made available to British companies and households. Mr Tucker went so far as to say that recent regulation could be proving counter-productive and that banks should be ready to draw on their liquidity buffers rather than hoarding cash.

And then we had the George Osborne/Sir Mervyn King announcements of making funding and liquidity available to the banking sector last Thursday night.

This is a very significant change in policy for the Bank of England and should be noted.

It has been interesting to see how Central Banks have focussed their efforts in a continuing and volatile market situation: in the US the Federal Reserve Bank has extended its ‘Operation Twist’ – a scheme to lower long-term interest rates, which had initially been due to end this month.

It also confirmed its intention to keep short-term borrowing costs at ‘exceptionally low levels’ amid concerns over the US jobs market but they have stopped short of unleashing a third wave of money-printing, or QE3. They have also been active in purchasing debt instruments to ensure a strong supply of credit to the markets.

But the Bank of England has been more conservative and until now at least have eschewed the traditional role of the Central Bank which is to be a lender of last resort, particularly in times of financial distress. The widely accepted critical role of a Central Bank was defined by Walter Bagehot - a 19th century English intellectual who summarised the lender of last resort function with the dictum “lend freely at a high rate, on good collateral.” This has been an anathema to the Bank of England until now where the view has been that it is not to the role of the Bank of England to support the banks – that way leads to moral hazard and encourages loose lending and liquidity practices with the knowledge that the Bank of England will be there to pick up the pieces if it goes wrong.

But all that now appears to have changed.

With the broad supply of money contracting (cash and money in bank accounts), the money multiplier is no longer functioning. Add to that the tendency for banks to hoard cash and rebuild capital reserves and it’s no wonder that the economy has been grinding to a halt amid fears of another credit crunch. Add to this the Eurozone worries and it has been enough to create a major policy change for the Bank of England.

Thus far the Bank of England has been reluctant to take a revised course of action directly to ease banks’ funding costs, preferring to use their quantitative easing (QE) programme to improve liquidity. However it is apparent that banks have not using the facility as intended, choosing to stockpile the money in safe assets and deposits with the Bank of England rather than inject the money into the economy as intended.

It was time for a radical rethink and I’m pleased for the change in stance. Now is not the time for an excess of caution. The markets may be the best capitalised and have superb liquidity positions but if we are not careful the markets and economy will stagnate.

Now is the time for the Bank of England to act like a traditional Central Bank and be prepared to lend against good collateral. I’m delighted that it is doing so now even though it’s taken an awfully long time to get here.

Thursday, June 7, 2012

The World as One

Over the last few days Barack Obama has joined the fray on the great eurozone debate and agreed with David Cameron that an ‘immediate plan’ was needed to stabilise the single currency and restore market confidence. He has spoken to Angela Merkel and Italian Prime Minister Mario Monti on the need to strengthen the eurozone. Some may say what business is it of his. I say good for him.

This is despite the regular ‘Beige Book’ survey of the US economy showing a rise in growth over the past two months. For those who wonder what the Beige Book is, it’s a survey that canvasses opinion from business across the US for the Federal Reserve eight times a year and is hugely important to the central bank in helping them set their monetary policy.

Some could argue that the US has limited exposure from fallout of the eurozone crisis. In fact David Cameron has reported that the British economy is six times more exposed to the eurozone than the US economy. True but then again the US isn’t completely untouched by what happens in Europe as there is a huge risk of contagion to key oversees American markets and a euro break up could have a devastating effect on the US exposure to trade with emerging markets, in particular China. So they are right to be concerned. Warren Buffet, billionaire investor and respected commentator has acknowledged that the chance of the US slipping back into recession are ‘very low’ unless the eurozone crisis escalates further with ‘events in Europe developing in some way that spills over here big time’.

So world leaders have a right to have their say. We must be prepared to accept that the global economy has changed significantly and they all have a part to play in helping to stabilise world markets. Individual states cannot afford to operate as a silo unit. 

Nor would we want them to…

Tuesday, May 22, 2012

Battening down the hatches - what a Greek exit would mean for the UK mortgage market

At the beginning of the year, I wrote a blog predicting a Greek departure from the euro. I suggested that this was the inevitable scenario given that Greece has debt at 144 per cent of GDP and its economy was and is in a downward spiral of contraction and austerity. Well, now most analysts have come out of the woodwork and seem to agree with my view.

In my posting, I also suggested that although Greece would take a massive hit, optimistically its departure could be manageable if the markets were convinced that no other countries would follow, particularly vulnerable countries such as Spain and Italy. I said that it would need international officials to put a firewall around Greece to avoid the markets getting spooked. Of course all this holds true today although thus far I’m not sure if European officials are doing enough to reassure the markets as witnessed last week. Confusion reigns supreme with Angela Merkel and President Hollande saying that they want to keep Greece in the euro but Christine Lagarde, head of the International Monetary Fund raising the possibility of orchestrating an ‘orderly exit’ for Greece from the eurozone.

So there you have it, although I still predict a Greek exit sooner rather than later, I guess much hangs on how the Greek elections in June turn out.

So what would a return to the drachma mean and how would the UK, in particular the housing market, be affected? It all comes back to my earlier point and how the exit is handled. Worst case scenario it will be complete chaos. In the words of Charles Dallara, the International Institute of Finance chief,  the damage to the rest of Europe from a Greek exit would be ‘somewhere between catastrophic and Armageddon’. Therefore potentially a complete temporary collapse of the banking system although from a UK perspective, Mervyn King, Governor of the Bank of England has suggested that contingency plans are in place were this to happen after warning that the eurozone was showing signs of ‘tearing itself apart’.

Even in the best case scenario, the UK would inevitably be affected by this scenario. Already there are signs that investors are spooked as customers withdrew their monies from Santander UK in the wake of the downgrading of the bank’s credit rating. And we should expect more of this jittery behaviour.

On a national level, certainly economic growth would collapse as our export market would nose dive bearing in mind half our market is in the eurozone. Plus our goods would be that much more expensive to buy as our currency increases in value being perceived as a (relatively) safe haven.

As for the mortgage market, I foresee banks resorting to behaviour last seen at the outset of the Credit Crisis, storing up capital and abandoning aspirations of market share. This is evident already to some extent and with more stringent regulation on the horizon, in the form of Basle III which will have a wide ranging impact on bank’s capital holdings, this behaviour is set to continue.  With total disruption to banking capital markets, it will prove harder for banks to raise new debt and significantly more expensive. So the cost of funding would inevitably rocket and homeowners would be hit by increases in mortgage rates. Banks would be keen to pass on costs to the consumer so upward pricing of mortgages would persist. On top of this mortgage availability would dry up and the possibility of obtaining credit would dwindle. This will inevitably have a knock-on effect to house prices which will fall significantly as consumer confidence is dented further. The exception to this would be the London market where luxury houses in particular will rise exponentially. Already Savills reports that homes costing more than £1.5m jumped by 39% in April as investors from Greece and Spain in particular seek a safe haven for their monies.

All in all, not a rosy picture then. But going full circle, back to my blog again, it all comes down to how orderly our plans are to resolve the situation. Because resolve it we must before we, and our EU partners, can move forward. 

Thursday, May 3, 2012

The Chinese Way

What a contrast. Let’s stop for a moment and look at how the UK is dealing with an economic downturn as opposed to China and we will see that we are literally worlds apart.

Just to recap. The UK has gone into a technical recession with GDP shrinking by 0.2% in the first quarter of 2012. Deleveraging is the order of the day. Banks are looking to shore up their capital in light of new regulation which is starting to kick in. Plus they have MMR shadowing them and the impending restrictions on capital requirements resulting from Basle III requiring banks to increase levels of highest quality capital to 7% by 2019.

And Mervyn King is putting in his two pennies worth stating that banks haven’t gone nearly far enough and need to improve their ratios considerably from 20:1. So the resulting impact is that banks are choosing to lend less, both to businesses and consumers. Lloyds Banking Group announced recently that it is planning to cut its share of the UK mortgage market from 28% to 25% and no doubt other lenders will follow. Inevitably credit will dry up or only be available to the less risky elements of society and will be risk priced accordingly.

Sadly of course this will have a knock on impact to the economy with mortgage lending faltering and a subsequent knock on effect to house prices. Thus potentially dampening the economy still further. But let’s wait and see.

And what of China? Well China’s manufacturing activity seems to have turned a corner expanding for the fifth month in a row, easing concerns about a sharp slowdown. The worries about a global slowdown and its impact on China’s economy had seen the country take steps to ease monetary policy in order to boost growth. China’s central bank has cut the amount of money banks need to hold in reserves twice in the past few months to try and stimulate lending in the country. The move saw Chinese banks extend new loans in March, much more than forecast. Analysts said the increased availability of credit had started to have a positive impact on the economy. And subsequently, China’s economy is likely to grow at an annual rate of 8.5% in the second quarter, up from 8.1% in the first three months of the year. So good news for the Chinese.

Of course we have to put in some caveats. The UK economy is vastly different to that of China with different concerns and pressure points. The government, Bank of England and FSA are hugely worried that unless we take these measures we are vastly exposed to a potential second banking crisis. I take on board these points. Still, maybe, just maybe, there are some lessons to be learnt from the Chinese approach?   

Friday, April 20, 2012

And the watchword for today is….

In addition to the various debates around the implementation of MMR, the dissipation of interest only loans and the merits of NewBuy schemes, there lurks a sinister spectre which in itself could have more impact on the mortgage world than anything else at present.
It’s been there for a while. In fact the original version (Basle I) may have very well driven the start of the credit crunch. This spectre is none other than Basle III and its implementation.
What does this mean? Well, a whole range of things and I would be happy to take anyone through them in more detail. In fact I’m in the process of drafting an essay around the whole subject matter which I hope to publish shortly. However for the sake of this blog I’ll keep it brief. In a nutshell, banks will be required to hold considerably more capital and liquidity than they have previously.
Some are already addressing this through de-leveraging. Those of you who have read my previous articles and blogs will have seen me mention this before. Perhaps I was getting ahead of myself but it is certainly something that banks are picking up with a huge amount of fervour today in their bid to aggressively dump assets and cut back on lending.
On Wednesday the IMF forecast that a drastic contraction of European balance sheets during the next 18 months could jeopardise financial stability and economic growth in Europe and beyond. In its Global Financial Stability Report, the IMF warned that European banks looked set to shrink their balance sheets by $2.6 trillion (€2 trillion) over that period. It is suggested that a quarter of deleveraging will come from reductions in lending, alongside sales of securities and assets as banks try to shore up their finances.
The most worrying aspects of this activity are, of course, how it will affect the economy. There is a danger that this could go into an uncontrollable tailspin, threatening to drive Europe into a new vicious cycle in which business and households are deprived of credit. This will, in turn, depress the economy leading to more strains within the banking system. The International Monetary Fund has already said that credit supply in the euro area could shrink by 1.7% as European banks dump almost 7% of their assets by the end of 2013.
So restricting credit lines could have a significant impact on the economy – in particular house prices where borrowers, primarily first time buyers even with NewBuy, have limited access to monies.
But almost bizarrely on top of this, you have the euro area and the City of London calling on banks to maintain the flow of lending to the economy on top of raising capital ratios.
So what’s a bank to do?
Well it certainly has to comply with Basle III and that means taking action. Deleveraging is certainly the watchword but how to do it profitably and without alienating your customer base is a fine art – one that some practise well, for example Bob Young at Capital Home Loans, but others may need a little help with.
At yesterday’s HSBC Great Housing Market Debate 2012 the mood was fairly sanguine about the prospects for recovery and house price rises. I’m not so optimistic given the global liquidity issues. I think we are getting ahead of ourselves a little. One thing’s for sure though, be prepared to see that term deleveraging around for some time to come. 

Tuesday, March 20, 2012

The price of AAA

The latest news from Fitch doesn’t seem like good news. The ratings agency announced on Wednesday that the UK’s highly-prized AAA credit rating was at risk and more likely than not to be downgraded. It said the ‘risks and uncertainty’ surrounding the Coalition’s austerity plans were ‘material’. The credit rating agency put a slightly greater than one in two chance on a downgrade for the UK over the next two years. This follows Moody’s report last month that also put Britain’s AAA rating on a negative outlook. This has spooked the markets somewhat although Standard & Poor’s is yet to follow along the same path, maintaining the UK’s current AAA status.

Some would say that this is a major setback for George Osborne ahead of the Budget and gives him little room to manoeuvre and give any unfunded handouts. However it can be argued that this gives him the perfect excuse to stand firm and maintain his tough stance on austerity measures. In fact the Treasury has already said that the decision by Fitch was a lesson for anyone hoping for giveaways in the Budget.

I think on the whole the Chancellor is right to take this stance. I am much more optimistic about the state of the economy going forward than I have been for a long time, albeit unemployment remaining stubbornly high. I believe the government should stick to its fiscal austerity plans and in doing so, I predict that we will see modest growth in the second half of 2012.

So the message is stand firm. In doing so I believe that the UK is likely to retain its AAA rating.

Steady as she goes.  

Wednesday, February 22, 2012

It's all about risk

So what’s to be made of the recent furore over interest-only loans? There seems to be much comment in the market following Lloyds Banking Group’s decision to bring in changes to interest-only mortgage criteria after Santander cut its interest-only LTV from 75% to 50%. Last week, Accord announced the withdrawal of their 75% and 85% LTV products following an uplift in interest-only applications blamed partly on the recent decisions taken by Santander and Lloyds. Leeds is the latest lender to announce cuts in criteria.

Are interest-only loans all bad and if not then why are lenders running away from them?

It’s worth remembering that these products came out of the growing market for endowment and pension backed mortgages in the 1980s and early 1990s. The mortgages were heavily marketed and distributed through IFAs who were also selling the investment product. From a lender’s perspective, they were happy because there was a known repayment vehicle, and in the case of endowments, these were assigned as security. However, as it wasn’t possible to assign a pension, lenders inevitably moved away from assigning endowments in the interests of speed and easy processing and by the mid 1990s no lenders were assigning endowments. 

Somewhere along the line some lenders also dropped the need to investigate whether a repayment vehicle existed at all and then interest-only really took off. If you were a lender that tried to investigate the viability of repayment plans then you were deemed “too picky” by the intermediary and so followed suit or lost market share. Today we have thousands of interest-only borrowers who have a loan but no way to repay it. This has been compounded by underperforming low cost endowments and where there was a settlement by the insurer in lieu of damages, the proceeds would have been paid directly to the borrower rather than being credited to the mortgage account. They will have been spent long ago. The interest-only time bomb is a significant issue which still needs resolving.

And that is what the FSA are trying to prevent from happening again.

Interest-only loans aren’t being outlawed going forward but the principles of ensuring sensible repayment plans are in place are being re-established.

From a brokers perspective it has been argued that the FSA and lenders are over-reacting with tightening of rules and cuts in criteria but I think this overlooks the whole picture. In fact there are two main reasons for the lenders slide towards a more prudent approach to this product and their recent tightening of criteria: the first is that going forward, lenders will be required to assess affordability on interest-only mortgages on a capital and interest repayment basis unless there is evidence that the borrower has a “robust” vehicle in place to provide for repayment. The lender will be required to obtain evidence of the repayment vehicle prior to completion of the loan and will be expected to check on the performance or continued existence of the vehicle during the life of the loan. The lender’s policy for interest-only mortgages will be required to be set at board level.

Beneath that though is the fear that lenders will be challenged retrospectively on these decisions which could lead to regulatory and reputational sanction. In short, the interest-only product is now seen to carry more risk.

Secondly, and this is significant, despite more positive noises in the market, funding and capital remains in relatively short supply. Any one of the major lenders could lend multiples of their current volumes if they wanted to and they are having to regulate business volumes in a variety of ways. Additionally, higher LTV mortgages require multiples of the capital that, for example a sub-80% LTV mortgage would. Capital is scarce and with Basel III just 10 months away it’s getting scarcer. Is it any wonder then that one of the ways lenders have chosen to manage their risk, capital and funding issues is to cut the criteria back by invoking a lower LTV on these higher risk products? Essentially they are requiring the borrower to put in the capital rather than do it themselves.

Interest-only lending has its place but is an undeniably higher risk product for lenders and one that should rightly remain as a niche rather than mainstream product. That’s how it started; the market just lost sight of that.

On the positive side, there is a great opportunity for a new niche player here who is prepared to understand and manage the risks properly.

Monday, January 30, 2012

The next big thing

So what do we have to look forward to in 2012?   Mortgage lending is likely to be flat and unexciting and in my view, mortgage growth will not be high on the agenda for many CEOs’or finance directors of banks and building societies, regulators and central bankers. My prediction is that focus will continue on building up capital and liquidity reserves and being able to weather any storms that may yet be unleashed from the Eurozone in particular. Isn’t 2012 supposed to be the year the world comes to an end? The Bank of England will want to see that if nothing else, the British banking system survives.

To achieve this deleveraging will continue to be a key requirement. Sir Mervyn King has been vocal on this point saying that although banks leverage ratios have halved to 20:1 from the levels they were at before QE started, they are still too high. This is consistent with a recent report published by McKinsey Global which stated that Britain’s total public and private sector debt had risen to a rather massive 507% of GDP. Unlike Sweden in the early 1990s, McKinsey don’t consider that we have deleveraged anything like enough at present

There are three main ways a bank or building society 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. Other mechanisms such as freeing up capital through risk transfers will also have their place and I see that Barclays have already availed themselves of such a transaction earlier this month.

We will see an increase in banks actively encouraging borrowers to move their mortgage accounts away through one means or another. We will also see an increase in mortgage and other asset sales if I am correct. And I’m not the only one who sees things this way: Bob Young from Capital Home Loans has also identified the importance that deleveraging will have in 2012 and that it needs to be done intelligently. Like me he believes this has to be done with considerable thought and skill utilising a number of mechanisms, not just the simple re-broking of loans that we sometimes see.

Some banks are managing their deleveraging programmes themselves but to handle this effectively calls for a wide range of key skills including cross-selling techniques, JVs with other lenders and of course corporate and structured finance experience. This is not something that every lender will feel it has the ability to deliver so we can expect a growth in advisory and outsourcing to insightful individuals and firms.

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.

Tuesday, January 3, 2012

An orderly withdrawal

Well it’s that time of year isn’t it? We all dust ourselves down from the new year frivolities and start making predictions for the year ahead. Flavour of the month is of course the European crisis and the great debate as to what is going to happen to the eurozone.

There are of course the pessimists who see a disorderly break up as inevitable and disastrous consequences for the European economy and there are those that are more sanguine who see EU leaders resolving to repair the root of the mess. Last week, Mark Mobius a fund manager from Franklin Templeton predicted salvation by July. ‘The European crisis is not as deep and terrible as people think’ he said. ‘Nations…are in a process of negotiations and that takes time’.

His scenario depends on many changes happening in France’s elections, successful negotiation of the stability pact and progess in financing the rescue funds. All big asks, I think.

For what it’s worth, I'm not sure I see the euro as viable over the medium term, largely because the big debtor states have no chance of repaying what they owe. Greece is of course first in line for departure. It has debt at 144 per cent of GDP and its economy in a downward spiral of contraction and austerity. Redemption therefore seems improbable and it is becoming increasingly clear to me that Greece is not going to last much longer in the single currency.

So what would happen? Well, I think when we get to this inevitable scenario, it all depends on how orderly the departure is. Undoubtedly the situation needs to be handled carefully. Whilst the Greek economy would undoubtedly take a massive hit, Greece accounts for only 2 per cent of eurozone GDP, so optimistically its departure could be manageable if the markets were convinced that no other countries would follow. It would need international officials to believe that they can put a firewall around Greece; it needs the market to believe that this is an exception. The last thing we need is for it to get spooked.

The success of this scenario is very much in the detail.