Borrowers have been left bemused by several lenders’ decision to hike their SVRs in spite of the low base rate. Halifax, the Royal Bank of Scotland, Bank of Ireland and the Co-operative Bank have all been forced to increase SVRs in some form.
Customers often erroneously believe an SVR tracks the base rate and so rises are merely a chance for banks to grab some extra money. This may be a contributing factor but there are four key reasons why lenders have hiked SVRs and they are all related to the cost of funding.
First, the banking crisis means banks are now seen as far riskier and less likely to attract investment and outside capital.
Second, the eurozone crisis is increasing the risks to banks by making some of its biggest debtors shaky.
Third, the regulatory environment after the crash means banks need to store huge amounts of liquid capital to buffer against any future shocks.
Finally, banks want cash to rebuild their balance sheets despite four years of brutal write-downs from dodgy loans.
All these factors are ongoing. They squeeze the availability of money and lead to a rise in funding for lenders that they have taken on for a long time. Mortgage rates have been creeping up to reflect this trend as a dysfunctional wholesale market and a fiercely competitive retail market push up costs.
The relative stability of LIBOR and the Bank of England base rate are no longer seen as the best indicators of mortgage rates. In such an environment, John Heron, chairman of the Intermediary Mortgage Lenders Association, believes the base rate is irrelevant to rates and is down to underlying funding costs.
“First, most mortgages in the UK are funded through retail deposits,” he says. “Attracting new deposits is expensive and it is a competitive market that is driving up the cost of funds.”
The second issue is continuing volatility in the wholesale funding markets.
“There is a cocktail of reasons for the instability,” he says. “There is the usual level of volatility, ranging from recovery from the financial crisis to the reaction of governments and regulators. Their responses have compounded the situation as financial institutions across the globe are being asked to hold more capital, which makes lending more expensive. There is added volatility over the uncertainty in the eurozone in particular.”
Halifax charges extra
Banks such as Halifax have taken enough pain from these rising costs and have decided to pass some of it on to consumers.
The former building society was the highest-profile mover on SVRs when it increased its rate from 3.5% to 3.99% on May 1, affecting 850,000 customers. For a customer with a £100,000 mortgage balance and 15 years remaining on their term, it amounts to a £24.30 monthly increase.
Across all the affected banks, Which? estimates that customers will pay a combined £300m more in mortgage repayments as a result of the increases.
Halifax puts the blame entirely on the rising cost of retail and wholesale funding, saying it is significantly higher than the long-term average. Announcing the changes in March, it said the average retail deposit rate has shot up from an average of 1.18% under the base rate in 2007 to 1.27% over the base rate.
“This demonstrates the increased cost that banks must pay to attract retail deposits,” Halifax states. “Longer term funding costs are particularly high. In addition, the cost of raising money in the senior unsecured and securitisation markets has increased.
“For example, in 2006 the cost to the group of issuing a four- year securitisation bond was three-month LIBOR plus 0.11%. In July 2011, it issued a four-year securitisation bond at the cost of three month LIBOR plus 1.45%. In February 2012, this increased to three-month LIBOR plus 1.75% for a three-year bond.”
Industry consultant Mehrdad Yousefi believes banks have endured a major increase in funding costs without changes over the past 18 months.
“The cost of funding has gone up sharply – around 300% in the past 18 months – so it’s a logical step for banks to raise their SVRs.” he says.
“For UK banks, the cost of raising funding on the money markets, depending on credit ratings, is anywhere from 3.5% to 5%. For smaller banks, funding can cost as much as 6% as they seek out retail deposits.”
Yousefi believes that banks have tried their best not to pass on costs, hoping the storm would pass, but it has not.
“It could be argued that UK banks should have put up SVRs last year but they have been patient and tried not to pass on the extra costs to consumers,” he says. “They were hoping the situation would correct itself but now they realise they are in it for the long haul, so they are passing on part of the increased cost of funds.
“If cost of funds has gone up 300% and SVRs have increased by 0.5% or 0.25%, then that is not too much of a burden,” Yousefi adds. “It may be a burden for around 10% of consumers who are finding it difficult to meet mortgage payments, but maybe they should not have been lent money in the first place if they are finding it difficult to service their existing mortgage at this interest rate.” The cost of funding is clearly higher and with turmoil in the eurozone, there is no sign of a respite in the increases, which are ultimately passed on to consumers.
In the Bank of England’s quarterly inflation report, published in May, governor Sir Mervyn King warned that uncertainty in the Eurozone is badly affecting funding costs.
“The direct and indirect exposures of UK banks to the euro-area periphery have affected funding costs as the challenges of tackling the indebtedness and lack of competitiveness in those countries have intensified,” he says. “The economy will continue to face strong headwinds over the forecast period. Underlying concerns about balance sheets, especially in the financial sector, with its exposure to the euro-area, mean that the path of recovery is likely to be slow and uncertain.”
The eurozone crisis and the exposure to shaky sovereign debt in countries such as Greece, Portugal and Spain are a major concern for UK banks.
Another driving force behind higher mortgage rates is the deleveraging of balance sheets and the disposal of assets.
Stephen Hester, chief executive officer of RBS, has made it his mission to reduce the size of his bank’s assets after his predecessor Fred Goodwin’s acquisition spree.
Meanwhile, Lloyds Banking Group and Santander have both indicated that they want to reduce their share of the UK mortgage market.
Indeed, Lloyds group has already reduced its market share from just under 40% when the HBOS and Lloyds TSB merger took place in September 2008, to 27% now in a smaller market and has ambitions to hit 25%.
As well as selling assets and having little appetite to expand share or grow volumes, banks are dealing with regulatory costs and the build up of capital buffers against future crises.
Brussels, London and Basel accords are all demanding higher levels of capital to guard against future crises, and this is directing money away from lending.
Tony Ward, chief executive of Home Funding, believes the rise in SVRs is a direct result of deleveraging at the major banks.
“We have banks trying to rebuild capital basis as they have to build up their capital buffers and have big debt refinancing obligations coming through,” he says. “They either have to grow equity capital, hold on to reserves and not distribute it, or shrink their assets – or a bit of everything.”
Ward believes no organisation wants to try to raise equity and attract investors in such a dour market, so instead they are selling assets and storing capital.
“SVRs are rising for two reasons,” he says. “First, it dampens demand for loans, so you can lend less, which subsequently helps deleveraging. And second, it increases margins, which can help to build up reserves to boost capital.
“The increases are down to both of these factors but it is more about the former than the latter. They don’t want to be too competitive, which can also be seen through stricter credit criteria, with the use of scorecards going up significantly.
“Where banks used to have red, amber and green customers and look at the ambers, now they are using scorecards that are not interested in ambers,” he adds.
“Criteria will be narrower and prices higher as banks try to ration business.”
Deleveraging is one of the many headwinds flying in the face of the mortgage market. The wholesale markets are in a treacherous state and turmoil in the eurozone is shaking the continent’s banking system to its core.
When combined with capital requirements and a slow economic recovery from the global financial crisis,the result has been a rise in the cost of funding.
Lack of finance in the money markets drives competition in the savings market and altogether it has been pushing up the cost of SVRs.