With 14p on wine, 4p on beer and 55p on gin (that’s 11 shillings, my gran would say), it’s hardly surprising Alistair Darling’s cunning plan to fix the mortgage industry attracted little attention in the papers the day after.
In fact his speech was low on detail, limiting itself to a vague undertaking to “bring together” investors, lenders, the Treasury, Bank of England and Financial Services Authority in finding ways to “stengthen these funding markets further”. Strengthen further may not be the words some people would have used.
Even the Treasury’s concurrently published Housing Finance Review: analysis and proposals, although containing much interesting information and many worthy proposals, offered little in the way of short-term solutions to the current situation.
A key proposal was to encourage the development of a ‘gold standard’ mortgage market as a means of kick-starting the residential mortgage backed securities market and give a wider range of investors confidence in UK mortgages as a safe form of collateral for such asset classes.
The Treasury is at pains to emphasise that it favours a “market initiative” – and indeed most of the industry would not disagree that the best solutions are likely to be market-led, albeit with support as needed from the Treasury, Bank of England and FSA.
However, the problem is current, and the government’s timetable is for an initial response to the chancellor in the summer and more specific proposals at the Pre-Budget Report in the autumn.
Even if the concept is sound, there will be no fix – at least via this initiative – anytime soon.
The gold-standard concept raises other considerations. For one, this looks like something ratings agencies already do – analysing pools of mortgage assets and assessing their risk profile to the investor based on ratings from AAA downwards.
At this point, we might point out that there has been no major deterioration in the credit quality of UK mortgage assets. The reluctance of investors to buy is driven by a loss of confidence following events in the US market rather than specific bad arrears experience in the UK.
Concerns have been expressed that this could lead to a two-tier mortgage industry, with lower risk loans commanding finer pricing while those for some homeowners become more expensive or indeed unaffordable.
But since we are in a situation where self-cert and sub-prime mortgages are tougher to find, arguably the gold standard would only formalise what the market is already doing of its own accord.
Of course, the risk of a pool of mortgage assets does not just depend on the appraised creditworthiness of each loan at the outset – circumstances change. People who were good risks when they took out the loan may lose their jobs, get divorced or separated, fall ill or over-extend themselves financially. Maintaining an ongoing high quality risk profile of a mortgage depends to a significant extent on how it is serviced. A ‘gold standard’ portfolio of mortgages may not stay that way if it is not administered efficiently. And, indeed, a silver or bronze level asset may perform better from a credit perspective if it is more effectively managed.
It is not a question of assessing the risk characteristics of mortgages at origination, turning away the lower quality borrowers (or at least making them pay through the nose so they can’t afford the loan) and letting them be.
To maintain the integrity of mortgage assets requires proven infrastructure over the full term of the loans which can extend well into the future.
This requires best-in-class cash collection, credit management and arrears processes, which are achieved through a combination of procedures, technology and training.
Effective mortgage servicing re-quires a proactive approach in contacting customers whose monthly pay- ments are overdue, strong negotiation skills to agree how much will be paid and when, and tenacity to ensure payment is made.
One of the concerns of investors in structured collateralised investment products has been the lack of transparency of the bundled assets within them. A key objective of the gold standard rating will be to restore investors’ confidence in the underlying mortgage-backed assetsBut they will also need to be satisfied with the structure of the financing, the quality of the ongoing servicing and the regular reporting that flows from that.
This is particularly critical in a slower property market in which arrears may rise further, when the servicing function will need to work harder to ensure borrowers are able to continue to makemortgage payments and remain in their homes.
Speed is of the essence, and identifying customers who are in difficulty quickly, opening lines of communication, reinforcing with them the need to continue to pay their mortgages in order to protect their homes, all play a key role in managing risk.
So what do we make of Darling’s bright idea? To be fair, any initiative that helps restore confidence in the market is worth a second look, and it is positive to see the government taking a more proactive approach to the current difficulties in the market. Our view is that the working group will need to consider the whole life of a mortgage, from cradle to grave – in the same way as we all do.
Many industry observers have expressed concerns that this initiative will take far too long to produce results – and government working groups usually take far longer than intended. The fact is, it seems unlikely that the gold standard will see the light of day before 2009 at the earliest – and the market needs some relief now.