The gloom of the Summer is spreading. Torrential rain, floods and now a credit crunch cast a pall over sentiment. Is a brighter outlook dawning or are we set for a tough Autumn? Even the mighty Halifax, king of the UK mortgage market, has been struggling. So what does the pricing crystal ball presage for the future? Are leaner times ahead or will the land of milk and honey return?
When I originally agreed to write this piece my thoughts were of an impending price war. Halifax had significantly underperformed its market share in the first half of the year and new chief executive, Andy Hornby, had promised analysts that the situation would not be allowed to continue. One thing for sure is that having made such a promise he couldn’t afford not to deliver on it. Failure was not an option and this remains the case. Cigarette packet calculations suggest that in order to catch up, Halifax needs to take at least a third and possibly half the market available. What’s more, that business needs to complete this year and against slowing housing market activity this can only mean one thing – a dose of remortgages.
Early signs
Early signs of this approach became apparent in late Spring/early Summer. Stories spread of Halifax reviewing agreements with bulk conveyancers. The initial request was to double capacity, then to treble capacity and then to increase it week by week. The engine had been primed, the starter button pressed and the business readied to ensure the promise was met. We saw a clunking fist move from 11 to 10 Downing Street and the mortgage market equivalent swung into action. Application levels climbed, proposed volumes were exceeded and the plan was well in train. In normal circumstances, such a move would have led to reactions from competitors defending their positions. Rumours abounded that Abbey would respond and needed to defend its share. Would Northern Rock sit on its hands having exceeded share but disappointed on profits in the first half, or seek to maintain momentum? A price war seemed likely in the prime remortgage market – then from across the Atlantic came growing gloom concerning non-conforming lending.
US effect
We have all read the stories – no income, no job, no equity. Negative amortisation loans – a new thing from America. Well not new actually – back in the good old days of 12 to 15 per cent interest rates, they were called deferred interest loans. What has been the effect? Well, investors in residential mortgage-backed securities have finally twigged that asset quality is important and that a booming economy and increased house prices won’t last forever and continue to bail the investors out. In the US, arrears levels are rising, house prices are falling and rating agencies are the villains for not spotting the deterioration sooner or not understanding the original risk.
The net result of this growing realisation has been the well documented unwillingness of investors to buy securitised debt where it is seen to have any material risk attached to it. So in addition to non-conforming mortgage securitisations in the US, many highly leveraged take-over deals are now stuck and the contagion has spread across the pond. The result is lenders unable to release the cash locked up in the deals and increased demand for short-term cash as a result. As demand increased so have short-term rates and thus the market faces two issues. The first, a rise in funding costs. The second, a market unwilling or willing only at a much increased price to take debt securitisations.
Mortgage predictions
So what does the crystal ball say about mortgage prices? Clearly we have two competing effects. Halifax needs to rebuild share and other lenders need to defend their position as a result. The cost of funds has increased for all lenders – though those funded partially through retail saving have some degree of protection as the cost of retail funds has, for the first time in years, fallen below the cost of wholesale funds. The upshot is that prices will increase for borrowers – however some will fare better than others. The day of the prime borrower will again dawn and competition will remain strong in the low loan-to-value prime remortgage market. These customers will see the lowest increases. The non-conforming borrower will bear the brunt and large increases in price coupled with policy tightening are already emerging.
Traditional lenders have the opportunity to rebuild share against businesses struggling to fund their growth. The air seems redolent of the mid-1990s and the retreat of centralised lenders. The crystal ball predicts an Indian Summer for traditional balance sheet lenders and a stormy Autumn for non-balance sheet lenders.
