Brokers say lender appetite remains robust despite Brexit uncertainty. But is this due only to the BoE’s monetary stimuli, and just how bad are things likely to get?
The UK mortgage market is still reeling from the Brexit vote, according to experts, with uncertainty reigning over funding patterns, lending levels and mortgages rates.
The bombshell decision to leave the EU has caused wild fluctuations in sterling, stock prices and business confidence.
While the earliest date of departure is March 2019, the sector is trying to predict the biggest impact on the economy and on broker business.
The initial effect came from overseas investors holding back money from UK mortgage lenders, while property funds were forced to halt redemptions after a flood of requests.
The Bank of England responded with a liquidity scheme plus a huge stimulus including a base rate cut, quantitative easing and a new funding line for banks.
Mortgage lenders say they are proceeding with huge uncertainty although they insist market fundamentals remain strong.
Brokers, meanwhile, say lender appetite remains robust and there was little change in business activity over the summer, with the exception of some clients delaying deals by a few months.
But experts are warning of long-term challenges, such as banks leaving the UK, higher funding costs and broader economic headwinds.
In August, BoE governor Mark Carney launched a £100bn stimulus for banks in the form of the Term Funding Scheme. The move came alongside a cut in base rate to 0.25 per cent – the first change in more than seven years – and another round of quantitative easing.
At the time Carney said: “The Monetary Policy Committee is determined that the stimulus the economy needs should not get diluted. That’s why it has launched the Term Funding Scheme, which will reinforce the transmission of cuts in Bank rate to the interest rates actually faced by households and firms.”
The aim of the TFS is to enable banks to pass on the rate cut to customers – without taking a hit to their bottom line – by offering them cheaper rates from central bank lending. Carney says the scheme is specifically focused on mitigating the impact of the rate cut and enabling the full stimulus to be passed to consumers. Extra lending will be extended only if banks and building societies expand lending to homeowners and businesses.
Intermediary Mortgage Lenders Association chief executive Peter Williams thinks it is too soon to judge whether confidence dipped materially over the summer, but he backs the BoE.
“It is a sensible move,” he says. “It is a reassurance to the market.”
The TFS has strong echoes of the Funding for Lending Scheme that launched in July 2012 to help banks fund loans for mortgages and businesses. The FLS created a large fall in the issuance of residential mortgage-backed securities as banks identified a cheaper funding route. In January 2014, Carney scrapped the scheme for mortgages because he deemed the market sustainable without support.
Last week, Carney stated that he would remain as BoE governor until June 2019 – short of a full eight-year term but beyond his previous commitment of five years.
John Charcol senior technical director Ray Boulger says: “Since the Brexit vote, the Bank has been keen to provide sufficient comfort to markets to avoid any shortage of capital. It made available a large amount of money immediately, but very little seems to have been drawn down, which suggests there were not many problems.”
In the aftermath of the Brexit vote, overseas investors in particular became nervous and held back money.
In early July, Henderson, Standard Life and Threadneedle faced a flood of redemption requests related to their multibillion-pound retail funds focused on UK properties; they were all forced to halt redemptions. However, all three investment managers reopened their funds in October.
The gating of UK property funds created a fear of further liquidity problems, this time in the mortgage market, which Carney referenced when launching the TFS.
Some cite examples of investors holding back money from UK mortgage lenders in order to take stock of the post-Brexit vote landscape.
“There were a few hiccups in the post-Brexit vote market,” says Boulger.
“Some non-mainstream lenders had funding lines cut briefly, mainly from overseas money with hedge fund backing. They wanted to reassess before committing new funds but, as far as I know, that has been resolved.
“There are no specific liquidity problems now but the Bank was absolutely right to provide confidence that it wouldn’t happen.”
Association of Short Term Lenders director Adrian Bloomfield says the Brexit vote created ripples among larger bridging lenders. Many bridging and short-term lenders are more reliant than traditional lenders on capital market funding from private equity or hedge fund giants.
“Short-term lenders have done well in attracting money from different places but Brexit has done no good,” says Bloomfield.
“One or two overseas investors have taken a look at the market and delayed or postponed investments, especially those with US hedge fund backing. Some of the bigger lenders have been constrained following the Brexit vote but many smaller new players have made up for it.
“We are not back to the credit crunch. There was initial stocktaking because of the shock of the Brexit vote.”
Bridging lenders have a more solid footing today, adds Bloomfield, with alternative funding lines from peer-to-peer financing and even credit lines from commercial banks.
In the wider mortgage market, however, there is less confidence. Last month, British Bankers’ Association chief executive Anthony Browne warned that banks were actively looking to leave the UK because of continuing uncertainty.
“Banks may hope for the best but they must plan for the worst,” he said. “Most international banks now have project teams working out which operations they need to move to ensure they can continue serving customers, the date by which this must happen and how best to do it. Their hands are quivering over the relocate button.
“Many smaller banks plan to start relocations before Christmas; bigger banks are expected to start in the first quarter of next year.”
According to Sifma data, the FLS was partly a factor in the plummeting of UK securitisation issuance in 2013, from £101.2bn in 2012 to just £44.5bn.
In the first half of 2016, the UK performed strongly with issuances of more than £35bn, its best H1 since 2012. But in August a research paper by Bank of America analysts said the TFS would cause UK RMBS issuance to stay low and would push a return to normality further into the future. The mortgage bond market was likely to suffer, the paper said, because BoE funding would be cheaper and would drive down the cost of retail funds.
Building Societies Association statistics show the average cost of a one-year bond fell sharply following the base rate cut, from 0.96 per cent in July to 0.86 per cent in August. The interest rate on two-year bonds fell from 1.13 per cent to 1.02 per cent, the lowest recorded level.
This means banks have two avenues of funding that are cheaper than capital markets, which will create significant distortions.
“The TFS is Funding for Lending on speed,” says Clayton Euro Solutions CEO Tony Ward.
“It is a completely subsidised flat rate whereas the FLS was dependent on growth or asset size. This is a major liquidity boost to banks.
“I can’t see UK RMBS transactions being of any significance. I think there will be a number of smaller transactions, with a couple in the pipeline today around £300m–£500m. I don’t expect the mega-deals we saw before the crisis.”
Boulger says banks will always seek the cheapest funding line given the erosion in recent years of the stigma around BoE support.
“The need for lenders to offer RMBS issues will continue to be fairly limited,” he says. “It delays normality and in an ideal world you wouldn’t have government intervention with Help to Buy or other schemes. But there will be issues for a number of years.”
Yet some argue the restrictions around the TFS may not fit all lenders’ business plans and there will be occasions when more expensive funding is suitable.
A director at a UK mortgage lender who wishes to remain anonymous says: “Sometimes you may launch a slightly more expensive securitisation to keep your programme flowing and maintain momentum. But initially you look at the most cost-effective source and clearly the government scheme is the most cost-effective for most banks at the moment.”
Ward thinks a return to normal securitisation markets is essential to maintain a functioning mortgage sector with sustainable funding lines.
But other factors are at work beyond the TFS because capital markets have been in a state of flux for the past 12 months.
“The UK funding situation has been driven by the medium-term economic situation rather than the specifics of the Brexit vote,” says economic consultant Gary Styles
In May, UK Asset Resolution, the government agency managing the Northern Rock and Bradford & Bingley mortgage books, completed the sale of £13bn-worth of mortgages. The deal, unveiled in November 2015, saw US hedge fund Cerberus Capital Management pay £520m.
Lenders say such large government deals have the potential to clog the market for others looking to make issuances.
Ward notes there are far fewer buyers of European mortgage bonds today, making deals harder to find.
In the aftermath of the Brexit vote, the BoE sought to both address liquidity concerns and lower the cost of mortgage borrowing as an economic stimulus.
In order to take funding from the TFS, banks must have a growing mortgage lending book and provide rates reflecting cheaper funding costs.
According to Moneyfacts data, two-year variable-rate mortgages have risen in price in recent weeks. In September – the first full month for which the August base rate cut applied to the sector – the average two-year deal stood at 1.94 per cent; in October, however, it rose to 2.01 per cent. Nevertheless, at the time of writing the level remains below August’s rate of 2.13 per cent, which applied before the base rate cut had taken its full effect.
Moneyfacts says the September low was “unsustainable” due to reduced confidence about a range of economic issues.
However, Boulger thinks the fact that many lenders have not passed on the base rate cut to customers is immaterial; he says the largest lenders have passed it on, which makes the majority of mortgage lending cheaper.
“In the previous two or three Bank rate cuts, banks have not passed it on. So without theTFS it is very probable that lenders would not have brought down their SVRs – and most have,” he says.
Critics of intervention
Not everyone approves of the Bank’s interventions, however.
“The TFS provides an artificially low cost of funding for those institutions that can get access to it, which does not include everyone,” says Mortgages for Business managing director David Whittaker. “It creates an un-level playing field and I’m not sure that is a good thing. The Government may broaden its remit, or decide if it will last beyond the Autumn Statement.
“Frankly, I am not sure how much cheaper you can make money without giving it away on street corners. If people don’t wish to borrow money when they can get a five-year fixed-rate mortgage for under 3 per cent, what greater incentive can you have to buy property? It is not about cost but about their perception of confidence.”
Rates have hit historic lows in response to the monetary stimulus that followed the Brexit vote. The challenge now for both brokers and their clients is to try to predict the UK’s medium-term prospects.
YOUR VIEWS: How will Brexit affect your broker business?
Aaron Strutt, director, Trinity Financial
Lenders still have huge appetites, whatever dramas are thrown at them. They tell us they want to hit their targets so they are lowering rates, offering larger loans and doing everything they can to try and shift their money. You never know if and when things are going to change. People who have been around long enough know it can all grind to a halt overnight, so you have to be brave to say it won’t happen. There are some difficult times ahead.
David Whittaker, managing director, Mortgages for Business
The current market is not about what lenders wish customers to borrow, but what customers want to borrow. It is whether they wish to borrow after the Brexit vote. For buy-to-let, professional landlords are continuing, but those less sure of their medium-term strategy are taking a breath. They are also being pushed by brokers to get deals done before the [new buy-to-let regulatory] stress tests come into force in January. There are competing pressures on landlords.
Mike Fitzgerald, director, Emba Group
The Government doesn’t know what is going to happen in the next year or two. Everything seems good at the moment with low rates, more deals coming through, lots of lenders doing business and higher LTVs. We are moving along with our fingers crossed but we are worried that Brexit could start to go wrong and put pressure on businesses. People buy houses only when they feel confident about the future. The elephant in the room is Brexit.
Will Brexit lead to higher mortgage rates in the long run?
First, the media view is that no one knows what Brexit means. And second, depending on whether they were for or against Brexit there is a bit of propaganda from politicians.
The reality, ignoring the politics, is that Brexit means a devaluation of sterling, which has a short-term negative impact on the economy by reducing demand.
Short term could be anything from six months to 30 months. In the medium term, over two to five years, the UK will have cheaper goods with the cheapest currency in Europe.
The power of government is also being underestimated for its role in changing the nature of a Brexit economy for this country.
Some say the UK is powerless to boost mortgage lending but there is no reason why the Government should come up with supportive schemes. The British government gets unduly criticised.
There will be challenges but the Government and the banking sector will see only one real threat to the mortgage market: that international capital markets will be less willing to lend money to both banks and the Government.
It could cause lenders to apply a risk premium to their lending, which would make the cost of borrowing for UK institutions rise in international capital markets.
The UK government is the only government in the world to have never failed to pay its debts, and the same is true of banks, even with the bailout.
International lenders love to lend to the UK because of the structure of government and the long history of making debt repayments. The British are well known to play by the rules with a stable political environment.
The key factor is that the risk premia will rise, meaning a higher cost of borrowing for UK mortgage lenders by perhaps 0.25 per cent to 0.3 per cent. The actual level is unknown.
Either the cost of borrowing will rise or competition could see lenders taking a lower profit margin if they are trying to drum up business.
Residential mortgage lending and low-LTV commercial mortgage lending are the most profitable areas for banks in a low interest rate environment.
I don’t think it is going to be a major talking point for banks.
It will be other issues instead, such as the EU regulatory framework and passporting rights into the Continent.
Mehrdad Yousef, industry consultant