The grip tightens

19 July 2010 | By Christine Toner

It may be headed for the scrapheap in 2012 but the Financial Services Authority seems determined to make an impact before it’s absorbed into the Bank of England. Last week the regulator published a responsible lending consultation paper as part of its Mortgage Market Review.

The FSA’s first MMR paper on October 19 2009 clearly spelt out to brokers its intentions for self-cert and fast-track, along with changes to affordability testing. The industry mounted a concerted attempt to fight its corner, in particular pleading for fast-track to be spared.

So the publication of the paper last week was not only a failure on the part of the industry to fight its corner but also a clear sign of how, with the mortgage market still firmly in its grip, the regulator is looking to fundamentally alter the way the sector operates.

The banning of self-cert and fast-track are the main headlines but there’s plenty more in the consultation paper - income buffers for sub-prime borrowers, mortgage affordability to be assessed by lenders on a repayment basis with a maximum term of 25 years, tougher capital requirements for non-banks - the list goes on.

So in the face of such fundamental reform the question on the lips of brokers and lenders is - where do we go from here?

“We are disappointed because the FSA has failed to tackle the market risk it created by its approach to regulation,” says Michael Coogan, director-general of the Council of Mortgage Lenders.

And Robert Sinclair, director of the Association of Mortgage Intermediaries, says he has concerns that the proposals will lead to a reduction in the availability of advice for consumers.

“Some are questioning where this leaves brokers and whether they will have a part to play in the market,” he says. “But brokers will always have a place because borrowers always need advice on mortgages for the properties they want to buy.”

And Sinclair warns there could be dire consequences for consumers if the FSA puts in place legislation that undermines the position of brokers.
“The broker is the key player who holds the hand of borrowers through the process,” he says. “And they also keep lenders competitive - if there was no advice sector lenders could create a cartel, and the FSA wouldn’t want that.”

While the principles behind many of the proposals were met by an air of acceptance, it is the prescriptive approach of the regulator that has sparked criticism.

“In broad terms, much of the paper is sensible in theory,” says Amir Ghani, policy adviser at the Building Societies Association. “But we are concerned about where the MMR process is headed. It places the onus on lenders and while we think that’s a good thing we’d like to see a balance between lender and borrower responsibility.

“Given the direction we’re going in it doesn’t seem as though we will achieve that outcome.”

And indeed, the issue of responsibility is a central theme of the paper.

“The FSA has shifted responsibility into the hands of lenders, thereby reducing the responsibility of consumers who are best able to make decisions about affordability,” says Coogan.

In the paper the regulator calls for stricter affordability tests and a disposable income buffer for borrowers with impaired credit as part of a big shake-up of the sub-prime sector. The FSA is uncertain how such a buffer might work in practice but one suggestion is to subtract a percentage from a borrower’s disposable income.

Stricter affordability rules for lenders could have a serious effect on the broker community.

“Lenders will have all the responsibility for affordability checks,” says Coogan. “This means they will have to do the same work as brokers because they can’t rely on anything the latter have already done.”

He says that since lenders will have to replicate the process undertaken by brokers this will add to the cost and time of processing mortgages. In short, it will not be consumer-friendly.

“Intermediaries still have a valuable role in advising on products but it will affect their value as a distribution partner,” he adds. “Lenders won’t want to tell brokers to carry on as they have been doing because they - lenders - will be fully responsible.”

Coogan questions the value of shifting responsibility to lenders and also asks why consumers should not take more responsibility. He says a better option would be to provide financial guidance in the form of pre-purchase counselling.

“Vulnerable customers could get help through an independent source not involved in the mortgage process,” he says.

He adds that this would mean responsibility would remain with customers, which would not undermine the role of brokers.

The FSA has also beefed up its rules on arrears handling after finding a wide variation in the fees firms charge, with many unable to even explain why they charge the fees they do.

It has changed MCOB 12.4.1R so that arrears fees must reflect a reasonable estimate of the administration undertaken by firms. Companies can no longer charge arrears administration fees calculated as a percentage of the outstanding arrears or debt.

Michael White, chief executive of Email Mortgages, welcomes th FSA’s decision on these fees.

“The action proposed on arrears administration costs makes sense as I don’t think loan delinquency will improve markedly any time soon,” he says.

“But with regard to responsible lending it’s already clear that a correction is underway. This is due to a combination of lenders wishing to rebuild their balance sheets and the regulatory requirements already in effect.”

John Fairhurst, managing director of Payplan, says lenders are concerned about their staff giving advice when discussing options.

“Lenders’ commercial effectiveness relies on them controlling arrears and using repossession only as a last resort,” he says.

“Lenders and loan administrators must ensure they are seen to be working with customers to find outcomes which suit them, but at the same time staff can’t recommend a course of action for fear of being seen as giving advice.

“The FSA’s response is interesting in that it does not see lenders as putting themselves in the position of advice-givers,” he adds.

The regulator states that when a firm assesses the individual needs of borrowers the appropriate solution will most likely emerge from conversations with them.

“In the course of this it is unlikely that a firm will put itself in the position of giving a personal recommendation, hence providing regulated advice,” the FSA says in the paper. “Where more than one option is relevant given the customer’s circumstances, information will be given to them about the options that are available and the customer will choose that which is most appropriate for their circumstances.”

Fairhurst says he’s not sure that lenders will feel there’s enough substance in that statement to give them comfort.

The paper also provides a list of the most toxic product combinations along with the percentage of borrowers for each combination who are in arrears or have been repossessed. For straight credit repair deals 26% of borrowers are either in arrears or repossessed but as other product combinations are added the percentage in arrears or repossessed quickly rises.

It points out that 42% of borrowers with a credit-impaired self-cert mortgage for debt consolidation at 80% LTV or above are in arrears or repossession, making this the most toxic product combination.

But Danny Lovey, proprietor of The Mortgage Practitioner, slams these figures as merely stating the obvious.

“The FSA doesn’t seem to have listened to anything the industry has been telling it,” he says. “Pointing out that most arrears and repossessions involve 80%-plus LTV debt-ridden, self-cert borrowers is hardly rocket science. And at the same time it’s saying that the fast-track system fares better than others with regard to arrears. This looks like a lack of joined-up thinking, what with it banning fast-track and self-cert.”

The argument for banning self-cert and fast-track has been raging for some time and, as expected, the paper puts an end to both products by requiring lenders to verify borrowers’ income in all cases. It says lenders must have evidence that the declared income figure is accurate.

“Although lenders will be responsible for verifying income and assessing affordability consumers will be more actively engaged with the mortgage process by providing evidence of their income to demonstrate that they can afford the mortgage,” the paper states.

But it adds that to give lenders the flexibility to be innovative and meet the needs of various market segments it does not propose to be prescriptive about the means of proving income.

It recognises that most fast-track lending is good quality, with poorer quality loans generally going through the self-cert route. But it says the absence of self-cert is likely to increase the pressure to accommodate consumers who are unable to prove their income by alternative routes.

This move has received mixed reviews.

“How can it be treating customers fairly to deny self-employed consumers the ability to borrow against their own assets?” one broker asks on Mortgage Strategy Online. “As usual, this is overkill from a regulator more concerned with covering its back than serving consumers. Why not insist that all self-cert borrowers take independent legal advice?

“What right does the FSA have to dictate to us how we use the equity in our properties? I hope the new government will quickly realise how far the FSA has overstepped the mark.”

Fahim Antoniades, group director at Mortgage Centre IFA, argues that there’s not much lucidity in what is being proposed.

“On one hand the FSA wants to put a stop to fast-track but on the other it acknowledges it has a lower arrears record than both self-cert and income-verified,” he says.

“This stems from the fear that fast-track could be open to abuse as a substitute for self-cert. But what the FSA fails to understand is that if fast-track is better quality than income-verified, credit scoring works. It doesn’t matter what title you attach to the method of assessing affordability by way of a credit score, the statistics show that checking affordability in this way is more accurate than looking at payslips and bank statements.”

Ghani says the BSA is concerned about the impact on existing customers who can’t satisfy the new requirements.

“Those currently on self-cert deals who have irregular income streams are not excluded but they will find it difficult to prove their income,” he says. “We are working with the FSA to ensure that not only the traditional arrangements but also those we end up with do not adversely affect these borrowers.”

But Alan Cleary, managing director of Exact, disagrees and argues that the assertion by some that self-employed borrowers on self-cert products are now trapped on lenders’ SVRs is wrong.

“This is factually incorrect, and our assessment of more than £5bn of mortgage asset gives us a good insight,” he says. “In most cases self-employed borrowers can verify their income, as can those who have chosen self-cert mortgages.

“The majority chose self-cert because it was convenient and cost little more than a verified mortgage. Only those who have had a change in circumstance or exaggerated their income are stuck.”

Meanwhile, Paul Hunt, managing director of Phoebus Software, says the FSA’s decision on self-cert is good news.

“Self-track and fast-track should never have been introduced in the first place,” he says. “The FSA didn’t take account of due diligence. If you can’t make the effort to check if the client can afford the mortgage they shouldn’t get it.

“Prior to self-cert the self-employed had to prove their income with three years’ worth of bank statements.”

He argues that by scrapping self-cert and fast-track the market will have to go back to that.

“I don’t think it’s a big issue but those who are newly self-employed and don’t have two years’ trading history will have a problem and the FSA needs to find a way around this,” he says.

Non-bank lenders are among the worst hit in the consultation paper, with the regulator believing there is a case for introducing a more risk-based prudential framework for them. Essentially, this would mean that the riskier their products are, the more capital they will have to hold.

“The paper makes the point that deposit-taking banks are probably the biggest beneficiaries of the proposals and that competition will be weakened, not least by the planned assault on non-banks,” says Peter Williams, executive chairman of the Intermediary Mortgage Lenders Association.

“The FSA has struggled to get to grips with this important sector and its solution is simply to make them look more like deposit-takers. It overlooks the important role of the sector in innovation.”

Williams adds that the industry has a big job to do in winning any battles over the MMR.

“The FSA certainly has the media onside, which easily slips into linking risky products with the credit crunch and thus making the case for market change and contraction,” he adds. “The FSA has offered its view and now it’s time to bring the politics back in.”

One of the less surprising elements in the paper is the proposed change to interest-only mortgages. The regulator says it plans to consult on any rule changes to these, but essentially a valid repayment vehicle should not be the sale of the property.

Lloyds Banking Group recently announced that borrowing of more than £500,000 will only be available on a repayment basis as part of a strategic review of its interest-only products. Other lenders have also made changes in this regard, apparently pre-empting the regulator’s changes.

Brokers commenting on Mortgage Strategy Online are not happy.

“Even more stupidity,” says one. “What the regulator is saying is that an individual can no longer be responsible for their own decisions and the state must decide what they can and can’t do when it comes to their financial planning.”

Ghani says the trade body welcomes the fact the regulator is consulting on what it will do with interest-only and that it’s not changing anything at this stage.

“It would be too soon to act on this, based on insufficient analysis of the available information,” he says.

The regulator has also ruled that mortgage affordability must be assessed by lenders on a capital repayment basis, even where the mortgage is interest-only, and on a maximum term of 25 years.

Ray Boulger, senior technical manager at John Charcol, says this is one of the biggest surprises in the paper.

“There is a valid argument in the current environment for calculating the maximum mortgage on a repayment basis but no logic in limiting the term to 25 years,” he says. “A fundamental element of affordability is the repayment term. And anyway, what’s so special about 25 years that it should be put in this exalted position? The FSA is making a big mistake in basing calculations on a specified term.”

Boulger says one of the main reasons 25 years is still considered by most people to be a normal mortgage term is that it was a sensible term for an endowment mortgage.

“Now that hardly anyone takes out a new endowment mortgage there’s no logic in continuing to regard 25 years as a normal mortgage term,” he says.

He argues that if people are encouraged to consider their mortgage term many will think about 25 years but some will opt for a shorter term and some a longer one.

“Obviously, the shorter the term the less interest will be paid and the more quickly equity in the property will be increased, and vice versa,” he says.

“By stipulating a 25-year term the FSA is likely to encourage some people to regard this as the default term and hence they will not consider a shorter term even if they could afford to pay the mortgage back more quickly. That’s bad regulation.”

The FSA says that where a loan term extends into retirement lenders must assess income into retirement. It says this could be done by confirming that the applicant has a pension provision.

Lovey says while this seems sensible there are limits to its feasibility.

“For example, how do we know at what age someone will retire?” he says. “How do we know the goalposts will not move on the retirement age in the future? If a client wants a 25-year mortgage until he is 70 and his retirement age is officially 68, is it sensible to try to confirm with his employer that he will work until he is 70? No.”

And before the industry had a chance to digest the changes outlined in the paper FSA chairman Lord Adair Turner issued a stark warning to the sector.

Speaking at the British Bankers’ Association conference, Turner told delegates that if the regulator finds incentives, structures or products that are likely to lead to poor customer outcomes it will take tough action to ensure customers are protected.

Underlining the shift from consumer to lender responsibility he spelt out to his audience that the new measures marked a profound change in the way the FSA deals with the mortgage market.

“This paper amounts to a big shift in our willingness to intervene in the free market relationships through which borrowers and lenders would otherwise make choices about appropriateness, risk and return,” he says.

Furthermore, as Mortgage Strategy revealed last week, the number of brokers used by lenders could drop by as much as 60% after the Mortgage Market Review.

So last week may have signalled a turning point in the mortgage sector and, most notably, in the role of brokers. As the regulator’s grip tightens on the market brokers can only hope the life is not squeezed out of their industry.

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