MMR is not the right medicine

27 September 2010 | By Robert Thickett, Samuel Dale

Since it was first announced last October, the Financial Services Authority’s Mortgage Market Review has been the number one topic of conversation.

The first MMR discussion paper in 2009 earmarked self-cert and fast-track as two areas the regulator wanted to cut out of the market and revealed that mortgage intermediaries were to be individually registered with the FSA.

In the wake of this paper, the overnight exodus of lenders offering self-cert effectively killed off that sector but many were still confident that fast-track would have a stay of execution.

But the second MMR consultation paper on responsible lending that came out at the beginning of this July extinguished those hopes as the regulator reiterated its intention to axe fast-track.

There were also a host of other measures such as tightening up the rules surrounding interest-only so that borrowers would need a repayment vehicle when taking out the mortgage.

The MMR has the potential to fundamentally change how everyone in the mortgage chain does business, but what will the actual impact be? Can fast-track still be saved?

To debate these issues Mortgage Strategy, in conjunction with Abbey for Intermediaries, invited a number of key industry representatives to Santander’s London headquarters to discuss the MMR and what will happen to the market if the recommendations become regulation.

WAS THE FSA’S DECISION TO AXE FAST-TRACK THE RIGHT ONE?
Jonathan Cornell: I can see why the FSA wants to stop both self-cert and fast-track because as we saw during the good times there was a blurring of the two. Fast-track isn’t a product, yet sourcing systems had products that were labelled as such. The problem for the regulator is that it wants to create something that will endure - something that will survive not only the miserable cycle we’re in now but hopefully the upswing as well.

And if we leave fast-track as it is, once funds start to flow again there will be a natural relaxation of criteria and we’ll probably get to a stage where lenders will simply say that if they get the right credit score they will fast-track and won’t make any checks.

This is effectively self-cert with an upfront credit check. So I can see why the FSA has bundled the two together as during the good times they blurred.

Andy Pratt: Self-cert still has a place in the market and it’s a question of everyone dealing with it appropriately. There have obviously been some issues in the past but now everything has been tightened up. Without self-cert and with the tightening of criteria that has happened there are lots of customers who have been hung out to dry.

Adrian Whittaker: It’s a particular con-cern for us. Some 36% of all applicants qualify for fast-track and our evidence is that it is not an arrears driver in any shape or form. There are benefits for consumers, lenders and brokers alike. So the question about its removal is a concern.
We undertake rigorous checks of cases that are sampled every month and our evidence is that brokers do have the income verification needed and that they are accurate with regard to income.

Paul Rignall: Brokers are also concerned about fast-track being banned because inevitably there will be a cost impli-cation for lenders. It’s going to raise the likes of Abbey’s cost base and there is only one victim in that scenario - the consumer. There’s no question that it will have an impact all round.

Karen Hedges: Looking back at the self-cert business that was done a few years ago, I think it would have to be re-named. Before we were operating in a different space, where there was a ’pile it high’ mentality, and now we have better quality introducers.
The broker community would embrace a more intellectual approach to underwriting.

DOES THE FSA UNDERSTAND FAST-TRACK?
Iain Laing: There’s progress in the second consultation paper because in the first paper before Christmas the FSA mashed up figures on self-cert and fast-track. The July paper is clearer in that there is a distinction between the two. But what it has written and what it means is a little tricky to interpret.

Taking the letter of what’s in the paper the FSA is banning fast-track where income is not verified. That’s not a problem for us as we verify income and can prove it just as robustly as we can prove our branches verify income. In fact, we’re finding brokers are outperforming our branches.

The proposals would allow fast-track the way we do it to carry on - we’d probably label it differently but the fact is that we contractually oblige brokers to verify income and check that they do so. When they fail those checks we take them out of the process or off our panel so our brokers consistently verify income and satisfy our affordability standards before offers are issued. And our sampling is done post-offer so there isn’t a chance to remove cases from the sample which creates a binding and effective process.

But if you talk to the FSA it is not so clear that’s what it means - it’s what it has written but it’s not necessarily what it means.

WHAT IMPACT WOULD VERIFYING ALL INCOME HAVE ON THE WAY LENDERS OPERATE?
Laing: The principle that all lending should be income verified is easy to sign up to - it’s easy to regulate. But as soon as you get pedantic about who is physically going to do the checking, where it’s going to happen and what you’re going to call it then you get into a space that’s totally impractical. The FSA has set out its path clearly - it has got a big issue with intermediaries being involved in verifying income. But if you talk to the Treasury, the Bank of England and other stakeholders they see the impact on competition and consumers.

Over the years I’ve talked to what I’d call sensible brokers, like the folks round this table, about what value they see in fast-track. And the answer is that if they know the case is going to be fast-tracked, they have got their own standards for evidencing income and know that those standards have been applied. If all those cases have to go off to a lender to assess whether it is happy with the evidence it stops being a fast process.

Parochially, as a lender we’ll make more money from it because we’ll see less price competition in the market and less churn in my book. And we’ll get wider margins that will far offset the operational costs of working it. But for a dynamic and competitive market, it’s a nightmare. There has been fast-track abuse but it is some individuals who are responsible for this and a lot of work has gone into tracking them down. It hasn’t added up to a systemic problem so it doesn’t justify systemic regulation to stop it.

WHAT IMPACT WILL THIS HAVE ON PRODUCT PRICING AND SERVICE LEVELS?
Whittaker: What impact there will be and where remains to be seen but fast-track is an efficient way of processing volume mortgage business.

Laing: Practically, it means 40% more cases with papers shuffling back and forth between ourselves and brokers, and us getting to the point where we have evidence that verifies income in our hands before an offer goes out.

Phillip Cartwright: Iain, you’re close to this, do you have a gut feeling on how it might pan out?

Laing: I don’t, partly because there are changes that are big enough to mean that there is more to this than the FSA’s point of view. Each of the things we’re talking about hit up to 30% of mortgage applicants - big slices of the market. And the market hasn’t been as bad as some of the lurid headlines the paper was published with.

Arrears rates today are still 60% below their 1990s peak after the worst downturn in 60 years, after the fastest and most severe fall in house prices since records began. But somehow arrears have been more stable and repossession rates have already past their peak and settled down. Something has been sensible and aggregate about the way lending’s been done in the UK.

WHAT WILL HAPPEN TO SELF-EMPLOYED BORROWERS TRYING TO GET A MORTGAGE?
Cornell: My feeling is that the self-employed will end up going to where their business banking is.

Laing: I’m not so sure - an accountant’s letter stating their income would satisfy the rules but that still leaves an enormous amount of wriggle room.

Cartwright: Absolutely, they can get a dodgy accountant to write it out, they’re happy - that’s not what anyone wants.

Laing: While the controls don’t stop some of the problems we’ve had they make the process more bureaucratic and don’t solve the basic problem of judging the risk of someone who is self-employed.

There is one paragraph that Ray Boulger, senior technical manager at John Charcol, has picked up on in the MMR which says that if the monthly income doesn’t cover the foreseeable monthly payments and it becomes regulation for this to happen, then it will shut down this space.

Cornell: I’m self-employed so if my invoices don’t get paid quickly I don’t have any money coming in some months. And if the FSA chooses to look at that month’s bank statement it could say I don’t have any money so I can’t pay a mortgage, that’s it.

Cartwright: But a lot of self-employed people take payment in cash. They’ve got a record of paying a mortgage of £1,500 a month - you know they’ve only got £1,200 in their account but that’s because they’re taking loads of money in cash. Builders do it all the time - that’s how it works.

Whittaker: There are good credit cases among people who have irregular income flows. It’s a big problem over the long term in terms of cutting people out of the market.

Laing: The hard thing to understand is that population is about 20% of the market - it’s not small. The people who think about these rules live in the world of salaried incomes. I write credit policies, I have the benefit of a salary that is most of my income and most of the folks at the FSA do too. It’s hard to put yourself in a world where your cash flow depends on when someone pays an invoice and that’s what 20% to 30% of this market deals with - uncertain and variable income flows. But they can still be confident they’ll have the money to pay their mortgage, they just don’t know exactly when and how.

If we decide that’s not a suitable population for mortgages then that’s a massive political decision.

WHAT IS THE PERFORMANCE OF THE SELF-EMPLOYED IN TERMS OF ARREARS?
Laing: The self-employed are more risky than salaried employees but you can plug them into a scorecard and set your cut-off, and the majority you can lend to and see good performance from.

Our arrears rate on lending is 1.5% arrears and 98.5% don’t ever get into arrears of more than three months. Repossession rates are a few basis points, loss rates are a few basis points - if that’s not tolerable levels of risk then clearly we need a much smaller mortgage market.

But if we want to keep the kind of market economy we’ve got to have an appetite to keep lending at that level and for the self-employed that’s entirely predictable - you just choose the risk you take.

WHAT DO YOU THINK OF THE PROPOSED CHANGES AROUND INTEREST-ONLY?
Laing: Interest-only without a regular savings vehicle works for the self-employed customers we’ve just been talking about. They have variable income and can satisfy affordability as if for capital and repayment. But they don’t know when the income is coming because it’s commission, bonuses or profits they earn from their business, or when something illiquid in their business pays through.

We can assess their affordability, we can prove that they can afford the mortgage but they can’t fund and sensibly support a regular savings vehicle. That’s a useful part of the interest-only market.

It has higher risks, but it has predictable higher risks that you can plug a scorecard into managing. The MMR would eliminate that. It’s about 16% of the market so it’s a big chunk that vanishes on the back of the MMR.

Control is needed but there’s also a valid customer need to address and, it’s funny coming from the FSA, it hasn’t necessarily started from customer needs in trying to design this stuff.

Interest-only backed by regular savings is actually the more questionable part of it. It’s harder to stack up because you are looking for a savings vehicle that after tax pays down the principle with the same kind of risk profile that just paying down the principle delivers - that’s not easy.

Ben Thompson: We did a survey recently at an event we had and the greatest area of concern with regard to the MMR was interest-only, which I was surprised by from an intermediary perspective.

Laing: Some borrowers’ repayment strategies can be totally un-verifiable. It can be a concept in the future that will change people’s circumstances. None of us know when we’re going to retire so none of us know how things are going to play out. So by writing credit policy on what you tell me about your future strategy, all I’m really doing is asking you for a different lie. And I end up with the conscientious customers who are uncomfortable lying who I decline and the less prudent customers who will give me any story I ask for will get through.

Gemma Harle: Also, for a mortgage broker to start validating payment vehicles is a dangerous place to be in terms of the come-back on them and people straying into advice that they’re not qualified to give.

WILL the MMR LEAD TO FURTHER FALLS IN BROKER NUMBERS?
Thompson: An interesting question sits at the heart of that - what’s the optimum size of the market, both from a lender and industry perspective? You don’t want it to fall too far because the top five or six lenders are saying that in two years’ time the market will be back to a degree. From the Association of Mortgage Intermediaries’ figures for mortgage permission, it is evident that there were between 30,000 and 32,000 brokers at the peak and that it was 12,000 about three months ago. So I would guess that it’s a little less than 12,000 now.

Cornell: I think it’s less than 10,000.

Thompson: So do I - as I understand it, one lender dealt with 10,300 people over the last 12 months - I think that probably supports the numbers you’re giving. So 12,000 seems quite high at the moment.

Laing: If the MMR creates more bureaucracy, this along with higher prices means less churn in the market - it has to. More bureaucracy and less churn has to mean brokers lives are less profitable which has to mean less brokers. I suspect the broker industry is past the worst but this has to give it another kick.

Rignall: I can see it being the final cleansing.

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