As an exercise in chemistry a round table and dinner is a winner. The table talk is more focussed than might otherwise be the case and thanks to the food, the wine and the conversation, contributions tend to be less inhibited too. What’s more, if you throw into this crucible a group of senior managers across the industry, you’ve got the formula for a lively debate. That’s exactly what happened at the Lending Zone and HML round table and dinner in London last month.
HML chief executive Andrew Jones hosted the event together with his colleague Ian Cornelius, the firm’s commercial director. The guest list included the ever-controversial Michael Bolton, former chief executive of the now-defunct edeus and now director of sales and marketing, Europe, with Clayton Euro Risk.
But he wasn’t the only guest in the risk assessment game and we wondered how he would hit it off with his old sparring partner in the mortgage world, Brian Pitt, the former director of Beacon Group and Future Mortgages who is now a director of asset management firm Rockstead.
On the active lending front we had Mike Jones who, as mortgage sales director at Lloyds Banking Group, represented the big guns of the industry. And at the opposite pole of the market Barry Searle, chief operating officer of Portillion, represented lenders-to-be.
Between these extremes were Stephen Mitcham, chief executive of Cambridge Building Society, Simon Hanlon, head of customer and asset management at Kensington Mortgages, Bob Young, managing director of CHL Mortgages, Mike Lane, IT and customer services director at CHL Mortgages, and Tony Ward, chief executive of Home Funding.
And representing lenders as a whole was Paul Smee, six months into his new job as director-general of the Council of Mortgage Lenders – during which time, he revealed, he had discovered 30-odd ways of saying the market was flat (see box overleaf). He flagged up the challenge of having two incoming regulators with different objectives, different timetables and different structures. And on his to-do list is a note to remind investors that the concept of mortgage-backed securities is a good one even though it ended up in a rather bastardised and unfortunate form a few years ago.
HOW LENDERS SEE THE MARKET
“We entered 2011 with a market that was becoming increasingly positive,” says Mike Jones. “As a result, it was easy to access liquidity and manage the perennial issues of loans and deposits, what is the gap and how much does it cost to bridge the gap. It was okay for four or five months but in the middle of last year, as the European crisis emerged, it went sadly wrong and funding became a lot more expensive. The banks seemed to recognise that at a different pace. It’s been expensive since late last year. The industry has responded to the pricing stimuli and increased margins.
“That’s gross margins, not net, because the net is the reason for the problem. That’s the cost of funding, driven to a large extent by Europe. We’re in a challenging place, but at least the industry has moved collectively in a sensible direction. But we need to be wary of what happens when things become a bit more positive. Do we chase each other the other way or do people actually realise that this is what it takes for an economic return?”
Ward turns to the macro-economic and political issues.
“If you take mortgages, they’re the biggest asset class in the UK,” he says. “The sector’s bigger than anything else, including independent and commercial loans. From the mid to late 1990s, it’s become an embedded part of the psyche that you have to have a home and you have to have a mortgage, and it will fuel everything else.
“So we’ve become junkies on house price-related debt. The trouble is we’re now trying to deleverage at a consumer level. That’s what Bank of England governor Sir Mervyn King is trying to get us to do – deleverage the consumer junkie that keeps wanting to have fixes. Unfortunately, that’s a large part of what’s slowed down the economy, apart from all the other things that have been going on.
“So the questions are – when do house prices stop platea – uing?” he adds. “What is the Bank thinking about it? Have we reached the bottom? Would the Bank like to see house prices fall a bit lower? Where is it all going? It is probably content with where they are, because it clearly had a view that they were massively inflated. It is probably content that where we are now is low enough, because if you put them much lower, the economy completely falls apart.
“I think the Bank would like to see some more activity in the market, whether it is through house prices stabilising or consumer confidence stabilising, because it fuels the rest of the economy.”
Young is intrigued.
“If the Bank is prepared to see it how does it actually stimulate it?” he asks.
“It is only stimulating it through interest rates and quantitative easing,” says Ward. “It is not stimulating it through anything else. The Council of Mortgage Lenders has been talking about changes to regulation that will see a split between prudential and macro-prudential levers. It has these macroprudential levers so that in the future, if it thinks it’s all getting overheated again, it can give a yellow card to everybody.”
He describes these levers as countercyclical capital buffers. “You will all have to stick some money in the coffers and suddenly you will have to hold on to more capital which is going to choke off any further lending,” he explains. Mike Jones seems unhappy.
“The point here is that it would appear there are conver – sations going on behind the scenes that we aren’t privy to, and the public certainly is not privy to, about what is the right answer for house prices,” he observes.
The consequences of a micro-managed economy could be quite scary, because of the historical precedent.
It’s pointed out that in the 1970s this was exactly how the Labour government operated. It had a Joint Advisory Committee on mortgages comprising members of the Building Societies Association and government, which fixed a monthly lending figure for the industry. It was abandoned in 1979.
“Hence the saying, ‘How do I stand for a mortgage? You don’t, you kneel.’ That was the result,” says Young.
“There’s been no end of stuff in the press over the last four years or so, usually King related, saying that the market is overheated and there are asset price bubbles, and the biggest one is house prices,“ he says. “All of it is true and I agree with him. But I think the Bank would be content that we have seen enough deflation in house prices. It’s not saying that these are the right prices, because the market decides the prices. But if the Bank were to say that it wouldn’t be unhappy if it stabilised at this level, that it doesn’t want to see it roaring ahead again, and that it’s confident it could stabilise because it’s dealing with all the macro-prudential levers and working with the chancellor to stabilise everything else – then that would be positive.”
But Mike Jones isn’t so sure.
“So young people aren’t buying a house today because they’re not sure whether their job will still be around, and it might be difficult to sell,” he says. “They’re not sure if they will buy, because they’re not sure if they might have a family, which means a different house, and they’re not sure if they can sell.
“And from what you’ve just described they might actually lose money on it as well – it adds up to one of three things which actually is in our gift as a country to decide not to talk about.”
“Or they could save £25,000 before they even think about it,” puts in Lane.
“That’s my point,” says Mike Jones. “How many blocks do you want to put in the way before people will be prepared to fully commit to a housing market?”
THE HOUSING SUPPLY ISSUE
Smee admits that he finds the government’s new-build indemnity scheme interesting because it is specifically part of the growth agenda, not the housing agenda.
“That’s all about creating jobs on building sites, which is a message from it that it wants to see an increase in supply as the means by which house prices are regularised and indeed employment is created, rather than artificial stimulus to house prices themselves,” he says.
Ward is surprised.
“Do you honestly think it is that sophisticated?” he asks. “It’s a pure jobs creation programme.”
Mortgage funding is Ward’s special interest. He even organised a conference on the mortgage funding crisis that first raised its ugly head in the summer of 2007.
But Ward’s event took place some years later and was the means by which he brought together a mortgage funding group which involved the major players. It’s still active so what is Ward’s assessment of the situation?
Looking back, Ward says that lots of people had been focussing on retail deposits but they weren’t the answer – it had to be securitisation and that was the main thrust of the conference.
The Financial Services Authority spoke at it, as did the Treasury and the Bank.
“The following week we lobbied FSA chairman Adair Turner, Lord Myners, FSA chief executive Hector Sants and King with a paper saying, ‘This is the size of it, this is what will happen, it needs to be got hold of and here are some things you can do,’ which King didn’t do,” Ward says.
Despite King, things have eased in terms of funding.
“We started in late 2009 with Lloyds group doing some securitisation deals but they’re not really deals as we would remember them – these were typically structured bond issues, placing some triple-A paper, but not all of it, and the rest of the risk tranche is kept,” says Ward.
“And there have been variations of that done since then.
Where has it got to today? Have markets eased or not?”
In general he thinks things have got better and that liquidity has eased.
“Smee mentioned that securitisation is a good thing,” he says.
“We would like King to think that too because he has been quite against it.”
Has the UK securitisation experience been good? Ward thinks it has and cites the ratings agencies’ assessments of it as proof with no defaults at all.
“In Europe, the UK is the best performer, as far as I am aware,” he says. “We’re light years ahead of the US and better than Europe as a whole.”
THE HOUSEHOLD DEBT TIME BOMB
Michael Bolton, however, doesn’t buy that story. “Investors don’t buy the UK residential mortgage-backed securities wonder-story,” he declares. “Why? Because we’re sitting on a 0.5% base rate. They’re not stupid. They’ll pay for the next three or four years in the UK; they are particularly distressed. As soon as they see interest rates begin to rise, they’re saying to us we’re out of the UK. Your problem is three or four years down the road, from a credit perspective.”
Surprisingly, Ward doesn’t disagree.
”When the base rate is normalised back to around 4%, we’ll have serious problems,” he says. “Therefore, in the interim if you are looking at your UK balance sheet lender perspective, you have opportunities to try and batten down the hatches. “
Pitt agrees. He is hung up on the idea that if base rate normality is around 4%, there is a a lot of pain to come.
“I was speaking to somebody last week who had a significant mortgage book, who reckoned, facing a 1% hike from 0.5% to 1.5% that 75% of the book would go down,” he says.
THE NEXT BIG MIS-SELLING SCANDAL
We move on to what Bolton calls the interest-only debacle, which he recalls took off in 1995 and continued to grow right up to 2007.
“Given a 25-year term, it doesn’t take a genius to figure out we are looking at the edge of a cliff in 2020 as all that brokerwritten, interest-only residential starts coming to end of term,” he says.
“We’re forecasting flat property prices for most people for the rest of this decade. It’s a disgrace. We should be forcing borrowers to move to repayment loans now, while they’ve got the time to try and get back on top of their mortgage repayments.”
The big question he postulates is what to do with interestonly borrowers when they are 60, have reached the end of their 25-year term and still owe £200,000 on their £200,000 loan. Ward argues that it wasn’t this that lay behind the big lenders changing their interest-only lending criteria.
“Just pulling back LTV doesn’t address the FSA issues about repayment vehicles,” he says. “If you just want to do less of it as a lender, that’s one way to deal with it. I think the broker market doesn’t really understand that.”
“What we’ve done is treat interest-only as a niche product in the way that we see it for the future,” says Mike Jones. “You can look to the future and you can say what we are writing now, we are confident about. What we can’t do is change the past.”
Ward suggests there is a strong argument, with the exception of buy-to-let, to ban interest-only lending unless there is a low LTV.
Pitt says that whatever the excuse was on interest-only, it was always about the broker’s ability to sell it cheaper.
“It was all about cost,” he says.
“Interest-only will turn out to be as toxic as self-cert,” Bolton predicts. “Obviously, there’s a public perception that lenders have to maintain. There’s no difference between the two products and brokers have managed to second-guess all the systems.
“So with interest-only, there are two camps. You can annually check where the equities are, but as a lender do you want to go through all of that huge cost?”
He implies that both the industry and the FSA were aware of the issue but thought it was just being ignored. Similar stupidity was shown over payment protection insurance, he suggests. “PPI is a marvellous example,” he says. “I can remember sitting around the same table four years ago being lambasted by the FSA because we were not doing enough PPI.”
SORTING OUT THE INTEREST-ONLY MESS
“I don’t know if the FSA will go as far as to force lenders to do it, or if lenders will take the initiative,” says Bolton. “But there’s a huge market potential for third parties to visit interest-only borrowers and help them sort out the repayment problem.
“You’re not going to trust the broker to go and visit your borrower and you haven’t got the ability to do it either and say, ‘Right, your mortgage term ends in eight to 10 years. You’re on interest-only, your house is worth £200,000, your mortgage is £180,000 – tell me how you think you are going to pay back.
Your broker is long gone. You’ve got no policy because there was no policy ever to begin with, so tell me how.’
“Then this third party will come back to you and say, ‘Right, there’s a deal to be done here.’ You can flip them onto a 10-year capital and interest mortgage because they can afford it right now. So, whoever goes to visit on your behalf will have to do the full affordability test, because this is a huge issue.”
Mike Jones thinks there are two things to consider – how you start at the front end and what goes on today.
“What we’ve done this time round is to make it more real for individuals,” he says. “The issue inevitably is the back book and how it is handled. There are things that we’re doing and we’re all learning on this journey.
“None of this is easy, because we’ve some respectable customers who are equally trapped by the world they find themselves in, because they would like to take advantage of new offers, which the rules of today say they can’t have. How do you allow those individuals to protect themselves? This is a big, complicated world we’re in.”
Bolton’s response is that while it may be unpalatable, politicians, the FSA and trade bodies are going to forget this for a few more years because it is not their problem.
Image: Seated from left: Stephen Mitcham, chief executive, Cambridge Building Society; John Murray; Bob Young, managing director, CHL Mortgages; Andrew Jones, chief executive, HML; Barry Searle, chief operating officer, Portillion; Mike Lane, IT and customer services director, CHL Mortgages
Standing from left: Brian Pitt, director, Rockstead; Ian Cornelius, commercial director, HML; Tony Ward, chief executive, Home Funding; Michael Bolton, director of sales and marketing, Europe, Clayton Euro Risk; Mike Jones, mortgage sales director, Lloyds Banking Group; Paul Smee, director-general, Council of Mortgage Lenders; Simon Hanlon, head of customer and asset management, Kensington Mortgages
The market might be flat but regulation’s racing ahead
I’ve been in my new post for six months and have discovered about 30 different ways of saying the market is flat. Sometimes it’s flat and we’re feeling optimistic – sometimes it’s flat and we’re feeling pessimistic.
However, it does seem that over that time, little has moved in terms of the volume of transactions.
What has moved clearly is regulation. We’ve had the second instalment of the Mortgage Market Review. It’s been widely welcomed as better than the first instalment but the more we pick at it, the more we find a need for clarification, unintended consequences and difficulties of definition.
It certainly hasn’t got advice right and how that has been defined. So that I think is a challenge.
We’ve also come to terms with the fact that we now have a totally different regulatory structure. We will have two regulators – the Prudential Regulatory Authority and Financial Conduct Authority – with different objectives, different timetables and different structures.
And indeed, we’re almost proud to say that they may be asking us exactly the same questions. We may be giving them the same answers and they may be drawing different conclusions from what we’ve said. And that seems to be an inherent tension being built into the system.
Simultaneously, on a macro level we’ve a new untried Financial Policy Committee. Every time it wants to pronounce about something, it just happens to use the example of the mortgage market as a place where it could make its influence felt. So there’s a lot of regulatory flux.
With the funding position, there was a false dawn last summer when people felt the economy was easing. It seemed to have tightened quite considerably at the end of last year. I don’t know whether there’s been an improvement in the funding position at the beginning of this year – it seems not.
Paul Smee, Director-general Council of Mortgage Lenders
Mortgage brokers – are they a thing of the past?
According to Michael Bolton lenders are pushing margins up, pushing brokers out, taking advantage of the customer interaction and selling the ancillary products.
“There’s a great opportunity,” he says, “but it doesn’t involve brokers, or it shouldn’t.
“We were doing £120bn through the branches five years ago, in a market of £360bn. It’s just absurd that brokers even exist today. If I were at HBOS or Lloyds group, I would be squeezing the broker market. Firstly, you do not pay fees. HSBC is dealing with the broker market. We all know that. It is not paying a penny for it.”
Mike Jones begs to differ.
“I’m naturally going to give a slightly contrary view and I say that as a lifer at Lloyds group,” he states. “While brokers will hate dual pricing, it allows us to trade differently in different markets. In that environment, the brokers are a healthy and attractive source of business for us. I can’t speak for the economics of the different channels, but it’s a good place to be.
“I don’t look at the world of four or five years ago and think it’s going to repeat itself, but it’s clear the capacity in the market sits on the broker side. In the world post-MMR, it is going to be hard and slow to grow.”
The retrospective challenge of regulation
“It is the retrospective stuff that is the real challenge,” says Bob Young. “You’re having to second guess what might happen in four or five years’ time.
“Exactly right,” says Ian Cornelius. “The concern is that while the FSA has the right intentions, from a lender perspective if there is any uncertainty in five years’ time about what it is doing today and how that might be judged during an Arrow visit, it’s not surprising that it will be over conservative in its approach. It is not because the FSA is saying you should not do it at all. The FSA will probably be puzzled that lenders are being over conservative, but that is why.”
So does innovation become a thing of the past?
“Not for niches,” says Young.
Ward argues we are going to see more innovation.
“It got driven out of the market because everyone was on a bandwagon trying to compete,” he says, but he saw opportunities for innovation by bespoke players.
In contrast Bolton sees innovation coming from large players.
“You’ve a great opportunity,” he says to Mike Jones. “The market is yours, it’s Santander’s, it is HSBC’s. Everybody else will just be picking crumbs off the floor.”