New lenders attending our HML-sponsored round table earlier this month believe that opportunity knocks in the mortgage market and they hope to play a vital role in the industry going forward. By John Murray
The theme of the round table and dinner is new lenders – and with good reason. Ever since the fall of Northern Rock and the demise of the specialist lenders, there has been speculation about the role new entrants might play in the market.
Brian Brodie, chief executive of HML, says he would like to have a conversation about the future as he’s had enough of talking about the past. The others around the table, which include representatives from four new lenders, say ’Amen’ to that. They are Charles Haresnape, managing director of residential mortgages at Aldermore, which is currently active in the market; Stuart Sinclair, chief executive officer of US-backed Home and Savings Bank; David Dyer, corporate development director of Virgin Money; and Tom Wood, finance director of NBNK Investments – all hoping to create a new banking force.
But while the names of some of these institutions may be new, the collective experience of the UK mortgage market around the table suggests that whatever they’re going to say about the future will be informed by the past.
They’ve all enjoyed senior roles in the industry, including Brodie and the remaining guests – Garth Emrich, director of financial services at Ernst & Young, and Julian Wells, HML’s marketing director.
FUTURE OF BANKING
I respect Brodie’s wish to focus on the future but am anxious they talk about some sort of historical perspective and explore what might be different about the new lenders this time.
There have been only three waves of new entrants since building societies began in the 1750s and each one has had massive consequences.
In fact, the building societies’ state-sanctioned monopoly of the mortgage market did not end until the 1980s, when Margaret Thatcher’s government freed the clearing banks to compete for business, which they did in a big way.
At the beginning of 1982, building societies had a virtual monopoly of new mortgage business but by the year end the banks were writing more than 40% of all new mortgage lending. For the first time ever, home buyers could obtain a mortgage on demand.
The banks were attracted into the market by big margins and by the idea of emulating the mutuals, which funded their lending using cheap deposits obtained through the retail savings market. It didn’t quite work out like that and they soon relaxed their competitive position and were replaced by a second wave of new entrants, the centralised lenders who had a different business model.
These took advantage of cheap wholesale funds and, without branch networks, used intermediaries or went direct as their route to market. Again, they had a big impact but their business model proved vulnerable when wholesale money rates hardened, in the same way as non-conforming lenders’ dependency on securitised lending proved fatal in recent times.
The non-conforming lenders represented the third wave of new lenders. They were a response to an insatiable investor appetite for mortgage-backed securities and to more uncertain UK working patterns. By 2000, jobs for life were already a thing of the past, and contract and flexible working patterns were the new order of the day.
So I am interested to find out if the people around the table see themselves as part of a new wave that will have a big or lasting impact on the market. If so, can they see themselves making up for the shortfall in mortgage lending created by tough new capital and liquidity requirements and the disappearance of the non-conforming sector?
But we start with the savings market and Haresnape asking Brodie if HML processes savings as well as mortgages. The answer is yes.
“First, because it gives us a bit of balance to our portfolio and the things that we do but second, I think it has become more important to clients we want to start to originate with,” says Brodie. “And it’s going to become even more important over the course of the next few years.”
As the conversation develops, it is easy to see why. Dyer says Virgin will fund its mortgage lending primarily by retail deposits.
“Not least because, unless a significant acquisition or something like that comes our way, we’re not in a position to go to the wholesale market like more established players,” he says. “So we’ll start with deposits. We’ll grow into securitisation or wholesale and other means that are available to us.”
BRANCHES IN THE 21ST CENTURY
Haresnape is interested in the role that branches might play and the differences between the new lenders around the table in that respect.
“We have a centralised operation,” he says. “You guys have previously expressed an interest in branch-based businesses so that is a different model for kick-off, isn’t it?”
Dyer says Virgin thinks branches will play a part. Sinclair says there are lots of savvy investors in the UK who don’t need branches to buy a one to five-year term bond.
“On the other hand, there are lots of equity providers in private equity who think that if you don’t have branches, it’s not real,” he adds.
“Therefore, you’re going to struggle when it’s time for an initial public offering or do a trade sale if you do not have some physical manifestation of what you represent.”
So is a branch network more of an investor requirement than an operational necessity?
“I think it can be an investor or emotional requirement and I would perhaps say that this is stronger than the customer requirement,” says Sinclair. “However, there’s a type of customer who you won’t trigger interest from unless you have at least some kind of network.”
Wood agrees with him.
“Banks need to rebuild their capital and are very risk-averse and I think that in five years the situation may be the same,” he says. “There is a dearth of mortgages for people aged 35 and below, even on average earnings.”
So will there be a swing to private rented accommodation?
Sinclair thinks there may be. He guesses that there’s a swathe of young people who could comfortably service a mortgage but will never have one.
“They will be denied one,” he says. “You can take the view that this is fine because property is not an asset class that you want to be in for the next 50 years, but that dream of ownership will be hard won for my children’s generation.”
Sinclair wonders if we are facing a world where a dwindling number of people will qualify for a mortgage.
“Compared to our youth, the addressable market is not going to be big,” he says. “I think last year new lending amounted to just £130bn, so perhaps everyone needs to get re-orientated to that sort of volume.”
Dyer is more optimistic.
“Capital will also have to adjust its expectations as everyone works out what Basel III really means.”
He suggests that the ’no risk’ mantra will move on and the risk-weighted view of mortgages versus other potential slices of business will change. But I’m still curious about the idea of a new equilibrium for the mortgage market and the challenge that lower volumes presents. Sinclair says he’s not sure what the mixture of supply and demand in that equilibrium will be, but the number of people who seem to be eligible now for mortgages is drastically down on what it was three years ago.
And Haresnape wonders whether it’s a supply rather than a demand-side problem.
Sinclair senses it’s a supply-side issue, which leads Haresnape to think that the market might recover as the supply side becomes more confident.
On that basis, it doesn’t look as if our new entrants will satisfy any pent-up demand for mortgages.
“I think everyone around the table will be thrilled to provide even – I will make up a number – £8bn a year in our third year of operation,” says Sinclair. “So we are not going to move the needle in terms of the outcome.”
Returning to where we’ll all be in five years’ time, Haresnape says the market will be starting to lift off again. Wood takes a different perspective in respect of the same point.
“The fascinating thing is if you take credit cycles, the cycle from the housing market slump in the late 1980s that finished in the early 1990s was 15 to 16 years to 2007,” he says.
“The average credit cycle is seven years. So one scenario could be that if you go back to the last crash and said 2008 was the nadir, seven years on is five years from now, broadly. Therefore on a normal seven-year credit cycle basis, you should be OK.”
But Emrich thinks Wood has overlooked a shift of the world’s wealth eastwards and for him, that means that in five years’ time the West will still be deleveraging.
Haresnape is still in the positive camp. Wood believes it will be a different world to the one we left behind – he doesn’t think we’ll be back to the froth witnessed in 2005/06. Brodie isn’t sure.
“The human race is fantastic at one thing and one thing only – that’s forgetting its past,” he says.
Wood is still reflecting on what might break the impasse that is making the ability to lend so difficult.
“It comes back to the question of where is the balance between facilitating lending for economic growth and not facilitating lending,” he says.
“There’s an economic theory that says if the required capital holdings for banks rises above a certain point, an investor would question whether they’d invest capital in that bank because of the perceived return. If the capital requirement gets to a point where economic return is more challenged, logic would say the capital wouldn’t flow to support the banks.
“If the capital is not in the banks, logic says the banks can’t lend as much. So you get into the question of where you strike the balance between capital required to manage it, the ’too big to fail’ question, avoiding future taxpayer support and the ability of the banks to lend.
“It’s a complex but relatively simple question,” Wood adds. “If everybody has to hold more capital, investors have to recalibrate their expectation of return. If you don’t do that, logic would say they’d stay away until they feel they can generate a return that feels commensurate with what they want.”
I can’t help wondering if these people wouldn’t be entering the mortgage market if they weren’t confident about the future. It’s self-fulfilling but, as Emrich says, “I imagine that most of the optimism round the table is based on the fact that the incumbent players have their own problems to deal with”.