What mortgage funding gap means for different lenders

Gary Styles, strategy, risk and economics director of Hometrack, analyses recent mortgage funding gap data to find out the scale of the problem that faces the banks, building societies and wholesale funders

Last year turned out to be one of liquidity risks rather than the widely anticipated credit risks.

Events in the US and at Northern Rock brought liquidity issues back to the fore, catching the Tripartite Authority on the hop.

I believe the events of 2007 have permanently changed how we see liquidity and credit risks for mortgage lenders.

Funding and liquidity discussions tend to be at a high level rather than focusing on the problems lenders have in rolling over existing funding lines and extending new funding. But the issues and challenges vary across market sectors and by lender type.

Table 1 shows the mortgage funding gap for three lender groupings – banks, building societies and others (wholesale funders).

The overall mortgage funding gap is around £98bn assuming little or no new funding is possible from the wholesale market, but this rises to £228bn if you focus only on household deposits as a potential funding source.

The table highlights the huge differences in the funding challenges and gaps across the three lender types.

The banking sector has more than enough retail funding to meet exist-ing on-balance sheet mortgage commitments and societies also closely match their retail funding to mortgage lending. But by definition, wholesale funders do not have access to retail deposits.

The closure of the securitisation Mortgage product availability markets in September combined with the rapid rise in wholesale funding rates quickly eroded opportunities for many lenders, particularly those without access to retail funds.

The issue is further complicated if you look at the need to roll over existing funding lines or replace existing funding sources for all lending activities. There are wide variations in the estimates of the size of this gap but Table 2 shows one, indicating a potential funding gap of £1,533bn.

These figures are subject to many caveats but they clearly show that the mortgage funding gap figure of £98bn understates the extent of the funding challenge most lenders face.

The impact of the funding gap has reduced the overall level of mortgage supply and this has been particularly noticeable in the adverse credit and other higher risk segments.

The number of available adverse products fell from more than 9,000 in June to little over 3,000 in December, while supply to the prime market fell slightly over the same period (see graph below).

We expect this position to continue throughout 2008 and into 2009 as len-ders adjust their appetite for risk.

This is further confirmed in mortgage approvals data. Approvals have fallen by around 23% in the past 12 months while lending by non-bank, non-society lenders has fallen by more than 50% in the same period. The contrasting fortunes of the three lender types have markedly changed the supply of mortgage products to the higher risk segments of the market.

Mortgage funding will remain the most important issue facing lenders in 2008. But slowing demand, weak house prices, and more aggressive pricing in the retail savings market will reduce the problem as the year unfolds.

Also, lenders have significantly re-duced their appetite for risk and are pricing accordingly. This should also help to limit funding difficulties.

We expect the gap between underlying mortgage growth and savings growth to narrow in 2008 and given a return to more normal conditions in the wholesale funding markets, we should be able to put the events of 2007 behind us.