Reinventing the market

21 March 2011 | By Robert Thickett, Samuel Dale

The UK mortgage market used to be one of the most diverse and competitive markets in the world for anyone looking for finance on a commercial or residential property. But when the downturn hit in 2007 and 2008 the market dynamic changed.

Previously there were long product combinations, such as a self-cert, sub-prime, interest-only tracker 95% LTV deal, but these types of deals have been consigned by the regulator and the market to product hell and now only vanilla products are on display.

So with the Financial Services Authority putting further pres-sure on the market to temper its imagination where will innovation come from? What markets do lenders need to target and what could the government and the regulator do to assist?

Mortgage Strategy, in association with Abbey for Intermediaries, gathered the great and the good of the industry to debate these issues.

WAS THERE TOO MUCH PRODUCT INNOVATION PRIOR TO THE CREDIT CRISIS?

John Malone: There were too many lenders with too many bad products, so the answer is yes. The one thing we didn’t have then were products that were structured and priced for risk. It was a market purely about growth. All lenders were trying to do was com-pete against each other and the pricing structure was skewed. It was madness that for a good period of time you could get sub-prime products cheaper than prime ones. We experienced a complete dis-tortion and we are now coming back to reality.

Phil Cliff: Those problems were not caused by product innovation but more by risk and price. The mortgage market generally is not an innovative one and that’s why it is struggling to find that key product and panacea to balance the risk appetite with what customers want.

Andy Pratt: A 100% LTV mortgage is not exactly innovative.

Jon Round: It’s not product innovation that was wrong but the extremes it went to. Not all the sub-prime lending that was done was wrong but it’s the limit to which it went. Similarly, some cashback mortgages were good for certain borrowers but the size of the cash-backs that effectively turned deals into 100% LTV mortgages made them too high a risk.

SO WHAT DO WE MEAN BY INNOVATION IN THE MORTGAGE MARKET?

Philip Cartright: When Labour was coming to power in 1997 there were lots of fears about interest rates rising. We did an exclusive deal before they were common, called Election Busting. It allowed cust-omers to go on a variable rate and after the election we would guarantee a five-year fixed rate. I guess that’s what we mean by innovation.

Cliff: If you think how your example has repositioned it in the current market there are still track and fix deals but the fix isn’t guaranteed. You’re fixed at the point that rates are at that time. It is an example of how the market has adapted to current conditions.

Graham Sellar: We used to do cashback mortgages - we gave up to 5% cashback and that was based around house prices rising. We were actually giving customers the equity back at the point of application. In the early 2000s we had a product with 17% cashback.

Sally Laker: One of the restrictions on innovation are systems and that’s why some of the smaller lenders can do quirky products. They are not restricted by a massive system that can’t change. In 2009 we did a 4.99% 20-year fix with Stroud & Swindon’s broker arm In the Loop because it had a new system. We wanted a breakout clause every three years where the broker went back to the client to check that the product was still right for them.

For that they got another proc fee and the client was visited every three years. The worst that could happen was a 20-year fix at 4.99%, which is good, but the borrower could also come out every three years with no redemption penalties. However, no-one else could do this because of the systems rather than the cost.

CAN ANYONE GIVE AN EXAMPLE OF PRODUCT INNOVATION CURRENTLY IN THE MARKET?

Cliff: There have only been two pure innovations in the past 10 years - buy-to-let and offset mortgages. Everything else is a variation of prime, price or risk. I would also include equity release in that. In terms of great innovation, track and fixes are not up there.

Cartright: Fundamentally, the thing we have always tried to get for consumers is a loose cap. You’ve got a discount or a tracker mortgage and people want peace of mind that it won’t go above 7% or 8%. I know lenders think that’s unattractive but it’s a good feature to make sure no-one goes off the rails later. But no-one seems to be able to come up with such a product that has perhaps a payable rate of 4% and a cap of 8% that will offer peace of mind even though rates may never go that high.

IS REGULATION STIFLING INNOVATION?

Pratt: It doesn’t seem to be in product terms. There is conservatism generally in the market but people want to do things and are plann-ing to. System issues permitting, they will look to do it at the right time. It’s more of a corporate governance issue.

Round: I’m not sure about that because if you work in product design then the regulatory landscape will be high on your radar at the moment.

Malone: If you take fast-track, although it’s not a product innovation issue but a systems-driven proposition which suits a lot of people around 50% or 60% LTV, it helps move that type of lending quickly. But the FSA isn’t supportive of that at the moment.

Cliff: Regulation is definitely, if not constraining, then setting the ground rules by which product innovation can take place. The rea-son we have increased regulation is because of what happened in the past. Some customers now find themselves in difficult circum-stances because of what was provided from a lender’s perspective in some cases.

Prudent risk criteria comes in to say that we can be as innovative as we want but within certain parameters. I don’t know whether it makes it more difficult to innovate but a prudent risk environment means that the need for innovation is still there but more difficult to address. The Mortgage Market Review is clearly the big piece of regulation at the moment along with European Union directives.

David Copland: The concern the FSA has with fast-track is that brokers will still abuse it as self-cert. As a network our criteria includes income verification whether it is fast-track or not. The point has to be made to the FSA that these audits do stop abuses and help weed out the rogues. Lenders’ systems mean they know much more about the borrower than a broker can and the FSA has to realise that lenders do many more checks in the background.

Adrian Whittaker: On the point of income verification we are finding that brokers are providing it and it is significantly within our tolerances. The message seems to have got out there.

Round: But it’s not just the MMR that will have an effect but also prudential rules and capital requirements such as Basel. When we’re talking about first-time buyer restrictions it is these areas that have the biggest effect.

ARE THE DEALS OFFERED BY PROPERTY DEVELOPERS A GOOD WAY OF GETTING FIRST-TIME BUYERS ON TO THE HOUSING LADDER?

Cartright: In terms of first-time buyer deals there has been some recent offerings from Hitachi Capital (UK) such as its unsecured loans and Barratt Developments’ deal to fund deposits from parents. I keep getting mailouts for Santander credit cards so there is clearly the money for secured lending. It is a hard thing for a broker to ask borrowers to get help from their parents.

But if consumers knew someone was lending that money then those who could afford it may take out loans that would reduce the risk and capital requirements.

An 80% LTV product could become the norm and 20% would come from the borrower’s parents not on the property. Such loans need to become more well known. I would like this rolled out not just on new-build but on all mortgage products.

Cliff: The key thing is affordability so it may be structured as an 80% and 15% loan but together that adds up to 95% LTV. There must be affordability checks because otherwise all you are doing is finding a loophole to meet a set of circumstances.

Cartright: The parents might decide to take it out of their savings after a sensible conversation that brokers haven’t had to engineer. They may decide they would rather pay with money that is only earning 1% or 2% rather than borrow it at 6%. The point I am making is that there is plenty of unsecured and secured lending but the two don’t seem to meet.

Sellar: The other problem we have is that first-time buyers are getting older. If borrowers in their late 40s and 50s start taking out secured debt you have to be careful at the advice point.

Copland: The key point being made is that with all the marketing that goes into credit cards the money is clearly there to be lent so you could just shift it over as an unsecured loan. Parents might say they are happy to pay £200 a month for five years while their children get on the ladder.

Cliff: There are two things to bear in mind - parents can lend their children the deposit and from a lending perspective that money could have come from anywhere.

Then there are guarantor mort-gages like Lloyds Banking Group’s Lend A Hand mortgage. My understanding of that structure is that the 20% deposit stays in a savings or investment account with Lloyds group for the duration of the lease. That’s fine if that structure works.

Then there is the situation where the person doing the borrowing is taking multiple deals. Their parents might not be involved but they might be taking credit card and unsecured loans as a deposit so you still have an affordability issue.

Cartright: If there is borrowing on a credit card then that card limit and monthly repayments will all be taken into account when assessing the mortgage.

WHAT SORT OF PRODUCTS HELPED THE MARKET GET BACK ON ITS FEET AFTER THE LAST RECESSION IN THE 1990s?

Malone: If you go back to 1993 and 1994 when the housing market was stuffed, the industry was asked to come up with a product to get the market moving again.

That product was let-to-buy which was pion-eered by two firms - Skipton Building Society and Mortgage Express. If a person wanted to move from their current property to another they could rent out their own property. A let-to-buy product does get the market moving but borrowers still can’t raise the dep-osit for the next property. That’s what we could overcome in the early 1990s because we had lots of 95% and 100% LTV products especially for experienced borrowers.

We have got to go back to that and the government then was behind that proposition and supported lenders. That was the forerunner to buy-to-let. I was involved with the creation of that product, particularly with TSB, which owned Mortgage Express at the time. That’s the kind of innovation we are looking for but we need lenders willing to do 95% LTV mortgages.

Pratt: One of the aspects of the market that is frustrating is LTV. We often gloss over it but it is a key part and we get good quality first-time buyers come in with a 5% deposit but we have to send them away and tell them to save another 5%.

SO INSTEAD OF FOCUSSING ON FIRST-TIME BUYERS, SHOULD WE BE FOCUSSING ON FIRST-TIME SELLERS?

Malone: The first-time seller creates opportunities. That’s where the let-to-buy would come in and that’s the innovation that would create movement in the market.

Copland: Lenders don’t have the appetite to lend at high LTVs as they are getting their fill at lower levels. It’s a funding and capital requirements issue. Unless there is more competition to drive up LTVs the risk and capital is too high.

Cliff: But there are schemes that will help first-time buyers through shared ownership and new-builds. You don’t have to take the risk of house prices and unemployment and interest rates. It makes it risky for lenders to offer high LTV loans. You want someone else to share the risk whether it is parents or a builder.

Laker: If you go back to the 1970s, first-time buyer deals were 90% LTV mortgages with a secured loan top-up from insurance companies. It was a blended rate that meant it averaged out. The first-time buyer took the risk and the affordability was on that blended risk. If there is a way of splitting that risk, such as parents taking an unsecured top-up loan, you can split the risk.

Cliff: That would be a simple proposition by splitting the risk because the parents would have a separate credit agreement and when they received the money they could hand it over to their children to use as a deposit. I don’t see a need to use it as part of the same deal.

Copland: Could you market that as a standalone product - the loan of mum and dad to buy a house? So instead of throwing the money through lenders’ credit card divisions they could do it with a sep-arate product.

Laker: If it was government-sponsored with tax relief on the loan that would help get first-time buyers moving. They could have first-time buyer relief that meant if someone would provide a top-up loan they could offer tax relief.

Cliff: Tax relief on savings deposited for mortgages is a great idea.

WHAT OTHER TYPES OF ASSISTANCE COULD THE GOVERNMENT PROVIDE?

Malone: During the last recession there was huge unemployment and the government wanted to use house building to reduce the num-bers. There is a different set of challenges now but if unemployment hits three million you could see the current government using housing to boost the economy again.

At the moment I don’t think it has the appetite to move the housing market in the same way as the early 1990s. Back then there were also many more companies to sell life products but they’re not as happy to do that now. I can’t think of any firms doing it now.

ARE MORTGAGE INDEMNITY GUARANTEES A VIABLE WAY OF HELPING LENDERS PROVIDE HIGH LTV DEALS?

Copland: There was a lot of talk of MIGs recently and the problem wasn’t the MIG but the capital requirements. In Italy the MIG act-ually offsets the amount of capital that lenders have to put aside so the loan is treated as a lower LTV deal. There are also some countries where governments will guarantee that MIG which is something else we don’t do.

Jon Round: When you look at the losses some MIG providers have made it is not surprising there are so few around currently.

Malone: Someone has to pay for it so first-time buyers will have to. In the late 1990s Abbey’s MIG kicked in at 90% LTV and charged around 8%. Brokers were up in arms about it for years.

Round: That high MIG premium was on top of standard rates but today’s high rates for 90% LTV deals would make it even more expensive.

Malone: But we are talking about something different when we refer to MIGs because the average property price now is £160,000 com-pared to around £50,000 in the 1990s. Suddenly the first-time buyer or the parents have to find even more money so there is a cost ele-ment to all this.

Cliff: In terms of developing a MIG, the old version and structure of of it wouldn’t really work. But there are things that lenders and builders can do that may or may not be helped by government intervention and might be able to bring a new version of it to the marketplace. It’s definitely something we see merit in.

Front row: Adrian Whittaker, key accounts director, Abbey for Intermediaries; Sally Laker, managing director, Mortgage Intelligence Holdings. Middle Row: Jon Round, financial services director, LSL Group; Philip Cartright, managing director, London & Country; Phil Cliff, director of mortgages, Santander UK; John Malone, group chairman of PMS. Back row: Graham Sellar, head of intermediary mortgage and general insurance development at Abbey for Intermediaries; David Copland, managing director, Pink Home Loans; Andy Pratt, managing director, Alexander Hall.

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