Equity release in the balance

Lending Strategy 01 November 2009 | By Christine Toner

The past two years have seen several well known lenders brought to their knees by the credit crunch.

Organisations once thought untouchable have been forced into desperate rescue bids, banks that were high street goliaths have faced bankruptcy and the whole sector has been shaken to its core.

However, in recent months there have been definite, albeit small, signs of recovery. Gross lending in September was up 2% compared with August, house prices have shown a small rise and confidence is growing.

But while the rest of the industry is clinging to signs of recovery and hoping the worst has passed, one sector seems to be suffering from a delayed reaction.

The past few weeks have seen several lenders leave the equity release sector.

Early in October Saffron Building Society said it would temporarily pull out of the sector having already met its lending quota for the year. The society says withdrawing from the market will ensure its portfolio remains balanced.

“We believe equity release presents a growth opportunity and will review our options next year,” says a spokeswoman.

And Saffron was not alone. Northern Rock also decided to pull its lifetime mortgages claiming it will honour existing applications and that terms and conditions for lifetime mortgages currently in place will still apply.

Meanwhile, Newcastle Building Society will close its equity release by the end of the year and Coventry Building Society made waves when it too decided to suspend new equity release lending.

But why the exodus? Interestingly, figures from trade body Safe Home Income Plans show equity release has fared better than mainstream mortgages of late.

They show equity release business for Q3 2009 fell by 22% year-on-year compared with a massive 63% fall in the mainstream market, although it should be remembered the sectors vary considerably in size.

According to the Council of Mortgage Lenders, gross lending in Q3 was £38.9bn. SHIP says the equity release market value in the quarter was £236.2m.

So if the sector is not faring too badly what’s going wrong?

Nigel Hare-Scott, managing director of Home & Capital, says the impact of the credit crunch has come in two phases.

“After the exit of weaker players such as Mortgage Express it seemed the provider base would go from strength to strength as new entrants came in such as Liverpool Victoria and Coventry subsidiary Godiva,” he says. “This situation has sharply reversed in the past six months with the departure of several providers that do not have annuity books to fund their equity release products.

“On the demand side, the reduction in residential mortgage interest rates has caused many potential consumers to postpone utilising equity release to redeem their mortgages.”

But Jon King, managing director of Hodge Lifetime, has a more positive view.

“Equity release has fared well compared with mainstream mortgages”, he says. “It does not rely on clients buying a new house so volumes have held up pretty well. The withdrawal of some of high LTV products has also seen demand rise for reversion-type plans.”

According to David Cooper, marketing and distribution director at Just Retirement, the fall in demand is a result of consumers’ changing priorities.

“The crunch has had some impact on the equity release market but not in the same way as on the residential mortgage market,” he says.

“We’ve seen demand fall marginally as consumers try to make sense of rapidly changing markets.

“This has resulted in a relatively small number of potential customers backing away, particularly those who had been seeking to release monies for less essential purchases such as home improvements and travel.”

Cooper says a larger number have been hit by falling property values. Those who wished to withdraw the maximum for their age may have struggled to be accepted for equity release mortgages due to falling property valuations.

“A growing number of retirees use a part of their equity release to repay mortgages and debts,” he says. “Where the maximum advance cannot cover, say, an existing first charge on a property it may not be possible for them to proceed.”

Cooper says these two groups account for most of the fall in the market.

What’s the problem?
But since almost everyone in the industry agrees that the fall in demand has been relatively small, and with the securitisation market potentially back in business, why have so many lenders decided to pull out?

King says the main reasons so many firms have left include targets and the collapse of securitisation.

“Many firms relied on funding models based on trade sales to other lenders or securitisation, both of which became problems in the crunch,” he says. “Lenders with a more balanced approach to funding have fared better.

“Anther factor has been the need to achieve certain volumes to make exposure to this market worthwhile.”

But Hare-Scott thinks the targets argument may be an excuse.

“There’s been a curious mix of reasons given for the withdrawals,” he says. “In reality, it is most likely that the Financial Services Authority has tightened up reserve requirements. The reduction in funding has caused the retreat of home reversion providers.”

Cooper agrees that the lack of long-term funding is to blame but adds that some withdrawals have been the result of more unusual issues, for example, Northern Rock and Mortgage Express which both nearly collapsed. He says at their respective peaks these lenders commanded virtually 50% of all new equity release advances. “These firms found that retail deposits and other short-term funding is not appropriate for longer term guaranteed rate lending. We have therefore seen the withdrawal of Godiva, Saffron, Bristol & West, NatWest, Retirement Plus, Standard Life Bank and others.”

Other providers that left the market did so because the funding they secured from third parties was pulled.

“In Retirement Services and Partnership both took this approach but when their funders decided to review their exposure to long-term equity release mortgages they withdrew,” says Cooper.

“The result is that most equity release mortgages are now funded with long-term assets from life assurers’ policyholder funds, in many cases those of annuity purchasers.

“Here, funds are commonly locked in for long periods and require a fixed rate of return for a long time. This makes the matching of the assets and liabilities effective,” he adds.

Just Retirement launched its equity release products on this basis four years ago. Aviva, Prudential and most recently LV= take similar approaches.

Andrea Rozario, director-general of SHIP, says companies with alternative funding models are thriving.

“Lenders leaving the market is not due to lack of demand but funding issues,” she says. “Equity release has been more resilient than other areas because a large number of providers have a different funding model to residential mortgages. For instance, many are backed by large insurance companies.”

Despite the exodus of providers many still believe there are equity release opportunities in the crunch.

First-time buyers are continuing to struggle to raise funds for the big deposits now required to get on the property ladder so some home owners may decide to release equity to help their children.

But this is not the most common use of the product. Hare-Scott and Cooper agree that debt repayment is the biggest reason for entering into equity release, particularly for those with high borrowings or mortgages on unfavourable terms.

“We have seen an increase in demand for funds to repay debts and that trend seems likely to continue as more mortgages reach their terms with insufficient funds to repay them,” says Cooper. “The growing prevalence of unsecured debt will be a similar driver.”

Since the crunch hit many individuals have been made redundant as companies try to curtail their outgoings. This has brought more demand for equity release.

“Something that we are seeing more demand for - and something I believe will become an increasingly important part of the market - is in the generation of monthly income,” says Cooper.

“There have been limited ways to achieve this until recently although most potential customers have wanted lump sums to start with and the facility to access further amounts when required. Drawdown contracts have fulfilled these requirements and more than half of all new equity release sales are now in the form of drawdown deals.”

With the securitisation market stunted for the past year and funding still an issue those still in the sector could be forgiven for being somewhat downcast. But instead, the industry as a whole appears to be overwhelmingly positive.

Cooper believes while the funding model may have changed there are other avenues to be explored.

“In future it seems likely that the primary source of equity release funding will be from life assurance, in particular the annuity industry,” he says.

“It is possible that the trustees of large defined benefit pension schemes could consider investing in equity release mortgages. The way funds are invested to fund pensions pretty much mirrors the process of life assurers so the diversity and risk benefits of such an investment may make it attractive to fund managers.”

According to King, the future is bright.

“Equity release has a great future,” he says. “The trend towards living longer with lower pensions means home owners will consider housing wealth as part of retirement planning. And this is likely to LSbe a worldwide phenomenon.”