The latest Bank of England credit conditions survey showed some encouraging signs of improvement in mortgage market conditions and lender confidence in the third quarter, with firms reporting the biggest increase in overall loan availability since the survey began in 2007.
Some of the more positive findings in the survey were attributed to the early effects of the funding for lending scheme, on which the Bank also published data last week.
But that was followed by weaker lending numbers for August from the Bank earlier this week.
And the August figures led some commentators to an early judgement that the FLS had got off to a disappointing start – even though the Bank said it would be "unrealistic" to expect to see the effects of the FLS so soon.
In this article, we reflect on whether better times may be returning – and whether the FLS may suffer the effects of hype about what it can achieve.
The credit conditions survey
The mortgage market remains in a fragile state, but some of the findings of the recent credit conditions survey showed some signs of a more upbeat mood among some lenders. On the supply of mortgage credit, firms reported that in the last three months:
"The overall availability of secured credit to households had increased significantly, in contrast to the previous survey expectation of no change."
The survey added: "A further significant increase was expected over the next three months, with the funding for lending scheme cited as an important contributing factor."
It also said: "Lenders commented that the funding for lending scheme should help improve the availability of secured credit to households. One element of the increase in availability was an expected tightening of spreads on secured lending to households over the next three months."
With the FLS having only been launched at the beginning of August, it is probably too soon to draw any conclusions at this stage about its likely effects. But the credit conditions survey reported that lenders expected an increase in mortgage availability "to borrowers spread across loan-to-value ratios."
And the increase in credit availability in the preceding quarter was reported to be concentrated on higher LTV borrowers, in part reflecting changes in lenders’ affordability and increased availability to first-time buyers.
Looking back on conditions over the last year, the survey said that "wholesale funding conditions have been reported to be acting as a significant drag on credit availability."
But the third quarter of this year saw a change, with wholesale funding contributing positively to market conditions.
Are better times returning - or is the FLS suffering the effects of hype?
The dysfunctional wholesale funding market has severely constrained the supply of mortgages since the onset of the credit crunch, with conditions deteriorating further in the last year in response to fears about the impact of the euro crisis on all types of financial institution.
The improvement in market conditions for the third quarter was therefore unexpected, and may reflect a wider belief that the European Central Bank has at last acted decisively to ease sovereign debt problems. The survey warns, however, that conditions in wholesale funding are not expected to improve further in the fourth quarter.
Reasons for improvement
A number of reasons for improvement in market conditions emerged from the credit conditions survey. Some lenders reported a desire to build market share – an aspiration that, in itself, may indicate improved confidence. The desire to build market share was "expected to contribute positively towards credit availability" in the fourth quarter, the survey said.
Lenders predicted that demand for house purchase loans would increase modestly in the fourth quarter, building on an improvement in demand for prime lending reported by lenders in the third quarter. Over the last three months, however, demand in the buy-to-let sector had fallen slightly.
Credit quality is also holding up, the survey said, with lenders reporting that the default rate on secured loans fell slightly in the last quarter, with losses given default remaining broadly unchanged. Both are expected to remain stable for the rest of the year.
Funding for Lending data
The day before it brought out the credit conditions survey, the Bank of England published the first list of firms participating in the FLS initiative, a scheme intended to increase the availability of credit to firms and individuals across the economy.
Thirteen firms were included in the list, but one of the most encouraging features was the range of lenders – large and small, with a healthy mix of banks and building societies. Although the FLS is not open to all lenders (non deposit-taking lenders are excluded, for example), publication of the list confirms that participation in the scheme is diverse and broadly inclusive.
Five of the six largest mortgage lenders are signed up to the scheme, and the other participants are five small or medium-sized building societies and three smaller banks. The size of individual loan portfolios of the participating firms extends from £11 million to £443 billion, with the base stock of loans of all 13 participants totalling £1.2 trillion.
Measuring success
Funding for lending has been carefully constructed to encourage an expansion of lending, with firms that increase net lending entitled to draw on the scheme at lower rates.
With the amount firms are permitted to borrow under the scheme capped at 5% of their loan portfolio (plus any increase in loan portfolio over the reference period), the FLS has the capacity to create more than £60 billion of additional funding if each of the 13 current participants draws the maximum permitted.
That would amount to three-quarters of the total provision of £80 billion the Bank has set aside for the scheme. But the final outcome remains uncertain: more firms may sign up for the scheme, but some participants may not draw on the FLS to borrow the maximum 5% of their outstanding loan portfolio.
From now on, however, the Bank will monitor progress and publish quarterly data on net lending by participating firms, cumulative net lending and amounts drawn under scheme, with a split between business and mortgage lenders.
In publishing the first data about firms signed up to the scheme, the Bank reiterated that the FLS "aims to encourage more lending in the UK than would have been the case in the absence of the scheme."
When the scheme was launched earlier this summer, Bank staff judged that lending, at an aggregate level, had been "more likely to decline than increase over the subsequent 18 months."
Firms were reducing some areas of lending activity, the Bank said, "consistent with the continued adjustment of their business models in the wake of the financial crisis." It added that "while such adjustments should continue, the FLS should encourage those banks that were planning to reduce their lending to households and companies in aggregate to expand their core lending, such that the total is cut back by less than would otherwise have been the case."
The Bank also estimated at the launch of the FLS that quoted rates on new mortgages had risen by around 50 basis points since the preceding summer, and believed that conditions would continue to exert upward pressure on rates. Now, however, responses to the credit conditions survey show that lenders are expecting spreads to tighten in the next three months.
The Bank’s assessment reflects our own view of the scheme’s potential, and how its success might be measured. In our press release in response to the launch of FLS in July, we said: "The scheme is designed to enable access to cheaper funding than might otherwise be available to banks and building societies to support lending growth…in aggregate, the scheme is likely to act as a positive influence on both the flow and the cost of new lending for customers to support growth in the economy."
Individual lenders taking part in the scheme have responded to it positively. In the summer, the Royal Bank of Scotland announced that it was planning to use the FLS to offer attractive terms "to small and medium enterprises and cut costs for first-time property buyers".
The firm linked a cut in first-time buyer lending rates to "direct support for the FLS" and said it had received more than 2,800 applications for loans totalling £400 million in value.
Earlier this month, another lender, Lloyds Banking Group, announced an initial drawdown of £1billion under the scheme, and said it would help provide an increase in lending to first-time buyers, manufacturers and small businesses.
Conclusion
Initial support for the FLS has been positive, but it is still too early to judge its full potential impact on the mortgage market. An encouragingly broad range of lenders have already signed up the scheme, and some firms have linked it to the introduction of attractive rates for borrowers, whether as individuals or businesses. The Bank will continue to publish data about the impact of the FLS, but some lenders may opt not to draw on the scheme and non-bank lenders are not eligible to join it.
Like the Newbuy scheme, which has made a modest but positive contribution in its first six months, the FLS is part of a raft of government measures, many of which seek to incentivise behaviour through a series of guarantees. Pressures on public finances leave little room for manoeuvre for the authorities, but there are encouraging signs that the cumulative effects of a range of initiatives are having a positive effect currently on lender confidence and activity.
