The BoE has taken the market’s crutch – but is it ready to stand on its own feet?

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If you remove a crutch from a patient prematurely, it is likely they will fall to the floor with an almighty thud. 

When the Funding for Lending Scheme was introduced in the summer of 2012, that is how many described it: a crutch, a drug – along with a multitude of other metaphors – for a market that needed hooking up to life support.

And now, as we found out last week, from the end of January the Bank of England will pull away the crutch that was meant to prop up mortgage lending.

Banks and building societies will no longer be eligible for cheap funding from the Bank for any new mortgage lending they do come February.

The big question though is whether the Bank’s governor Mark Carney has chosen the right time to remove the artificial support.

Has it made a difference?

No matter what figures you care to look at, it is clear the FLS has achieved what it set out to do.

The most obvious effect has been on mortgage rates, which have fallen by over 1 per cent on average. While this was never the primary intention of the FLS, it has clearly made homeownership more affordable and has boosted demand for finance.

According to the Council of Mortgage Lenders, the average two-year fixed rate fell from 3.68 per cent in the third quarter of 2012 to 2.56 per cent a year later, while the average five-year fix fell from 4.12 per cent to 3.36 per cent over the same period.

Average price of two- and five-year fixed rates since Q1 2012
    Avg two-year fixes Avg five-year fixes
2012 Q1 3.36% 4.18%
  Q2 3.69% 4.29%
  Q3 3.68% 4.12%
  Q4 3.42% 3.93%
2013 Q1 2.98% 3.65%
  Q2 2.73% 3.49%
  Q3 2.56% 3.36%

The improvement in the number of approvals since the scheme launched is even more stark.

Yes, some of this can be attributed to the Help to Buy scheme but there is no doubt the FLS has played a significant part.

If you look at the second and third quarters of 2012 there were a total of 38,469 and 35,506 approvals, respectively.

Fast forward a year and these figures jump a respective 20.4 per cent and 37 per cent to 46,334 and 48,647.

Gross lending, too, has rocketed since the launch of FLS. In October, lenders advanced £17.6bn to mortgage borrowers, a staggering 37 per cent increase on the previous October – and the highest monthly total in five years.

And while net lending was relatively poor (in negative territory in fact) for the first six months of the scheme, it too has made a dramatic improvement, reaching its largest quarterly total in Q3 since the scheme launched 16 months ago – £5.8bn. This means net lending has reached £3.6bn since the scheme’s launch.

Falling mortgage rates and increased access to finance has led to a surge in house prices in certain parts of the country – notably London and the South East – although clearly not all areas have fared equally.

Data from Nationwide shows the average UK house price has risen 6 per cent in the fifteen months to November, while London house prices are growing at about 10 per cent a year and are now well above their 2007 peak.

House prices

Steady on its feet

While parts of the country have yet to fully recover, clearly the the mortgage market has gained considerable traction in the last 16 months. 

For me, all of the data shows the Bank was right to pull FLS before the market overheats.

The market needs to get back to funding mortgage lending the way it used to: through savings, covered bonds and securitisation, the later having experienced a patchy recovery since the credit crunch.

Since the heady days of 2007 the number of new UK residential mortgage-backed securitisations has tailed off dramatically. Standard & Poor’s says there were 57 and 52 issues in 2007 and 2008, respectively, but this fell to just 11 in 2009 before recovering to 26 last year.

This year there have only been 11 new issues (to November) but this has been because of how cheaply banks and building societies have been able to fund mortgage lending through the FLS.

Now this market support mechanism has been taken away we will undoubtedly see banks re-enter the wholesale markets and, hopefully, the number of new issues will grow.

Further, there are signs that investors have regained some of their appetite to invest in mortgage debt, which can be seen by recent non-prime issues from non-bank lenders Precise Mortgages and Paragon Mortgages.

Just a few years ago, investors would not go anywhere near mortgage debt unless it came from one of the big boys – potentially a sign that the wholesale markets are beginning to thaw.

Number of UK RMBS transactions 2007-13
  Number of UK RMBS transactions
2007 57
2008 52
2009 11
2010 20
2011 22
2012 26
Year to date 2013 (November) 11

So lending is increasing, house prices are heading in the right direction in many parts of the country (Nationwide says all 12 regions registered year-on-year increases in the third quarter) and there are positive noises coming from the debt markets.

But what will happen once the FLS is pulled?

The truth is we can’t be certain but brokers are confident it will not represent a disaster for transaction levels and have predicted 2014 will be a strong year for both gross lending and approvals.

However, we are likely to see mortgage rates increase over the coming months as the BoE weans lenders off cheap central bank funding. The extent of these increases though will depend on how much lenders will have to pay for their funding in the wholesale markets and through retail deposits.

But brokers have told us to expect increases of up to 0.75 per cent by the middle of next year.

Is this a bad thing?

Not necessarily. Borrowers have had access to the cheapest mortgage rates the UK has ever seen recently and an increase of 75 basis points will be unlikely to deter consumers from taking out mortgage finance, especially as demand has improved substantially. And historically rates will still be low even if you add another 75 basis points.

While we can expect increases to mortgage rates – especially when the Bank of England decides to raise base rate – all of the signs suggest the mortgage market has made enough of a recovery to stand – and hopefully thrive – without the help of its crutch.

Paul Thomas is deputy editor of Money Marketing sister title Mortgage Strategy – you can follow him on Twitter here