HIPs could increase risk says Fitch Ratings

Fitch Ratings warned today that government’s plans for the introduction of Home Information Packs could result in increased risk in the housing market for buyers and lenders, as well as investors in residential mortgage backed securities.

The government’s long awaited plans to speed up the house buying process via HIPs and limit the number of failed transactions are expected to become law sometime in 2006 and mandatory in 2007.

Stuart Jennings, head of European RMBS at Fitch Ratings, says: “We believe the proposals could potentially add additional risks to the process of house purchase and the underwriting of mortgage loans by lenders. It could therefore also impact those investing in UK RMBS.

HIPs will include a package of legal enquiries, including local authority searches, title documents, a draft contract and a Home Condition Report giving information with respect to the condition of the property, but crucially not a valuation. As the HCR does not cite a value, the buyer needing a mortgage will still have to pay for a valuation report from a lender adding further cost to the house purchase process.

As a result, there will be pressure on lenders to reduce the cost of the valuation process. Many already perform ‘drive-by’ valuations or ‘desk-top’ assessments for certain new loan applications, such as further advances on existing loans or some re-mortgages. Similarly some lenders have started to use Automated Valuation Models which are increasingly sophisticated models backed by databases of sale prices and previous valuations to give a valuation based on the nearest comparables.

Jeremy Deacon, associate director RMBS at Fitch Ratings, says: “AVMs have their place in underwriting less risky mortgage lending, however our fear is that the introduction of HCRs forces lenders towards using AVMs more extensively in their underwriting, potentially in cases where it may not be appropriate. While human beings can be prone to error, we believe a surveyor valuation and opinion remains crucial, for example in the case of higher loan to value lending or for more esoteric and non-homogeneous properties.”

Deacon adds: “Lenders currently using AVMs have generally conducted extensive testing, however others may be forced down this route due to cost reduction without having performed sufficient testing.

Similarly, the experience of those performing the inspection for the HCR remains somewhat unclear at this point. It is not certain how robust these inspections would be compared to those currently conducted by surveyors for lender valuations. Should lenders increasingly dispense with their own physical inspection for valuation, with greater reliance on the HCR, the question of how these inspections compare becomes crucial.

Questions also surround the quality of the legal work involved in the pack. Whereas this is currently conducted by solicitors, the extent of the legal training that there will be for those preparing HIPs is unclear, raising uncertainty as to whether the lender can feel comfortable in relying on it.

HIPs also introduce the prospect of conflict of interest risk into the house purchase equation estate agents will likely be at the forefront of producing such packs. This raises the issue of whether a lender, or indeed the buyer, should commit their funds based on a marketing pack prepared by an unregulated selling agent with no responsibility to either the buyer or lender.

It is also unclear whether those preparing a HCR could be susceptible to pressure from estate agents motivated by the commission from the sale.
The government has been consulting on this issue since at least 1999 and the formal proposal was announced in November 2003, subsequently forming part of the Housing Bill of August 2004. The lengthy industry consultation illustrates the complex nature of this issue.