Disaster for many companies is usually envisaged as taking the form of an act of God, such as flood, fire or hurricane – the sort of events one cannot prepare for or expect in any real sense of the word. Yet, disaster can appear in another guise for firms in the property sector, namely, a housing market crash that sees house prices plummeting by say 30 per cent.
The mere thought of this scenario would make any housing professional, or indeed home owner, break out in a cold sweat. All the same, it is worth considering how your business would cope in such a situation if only for the simple fact that one should always be prepared for any eventuality. Taking on the uncanny likeness of an ostrich will certainly not stand anyone in good stead.
Of course, we have witnessed such a crash in relatively recent times when the early 1990s saw the UK drop into an almighty recession, with high unemployment, high interest rates and a property market that tanked. Yet, a return to these troubled times of not so long ago is deemed unlikely by many, considering we now live in a very different economic landscape. The stability of the economy is helped by current high employment rates and the transfer of interest rate decisions from the government to the Bank of England’s Monetary Policy Committe.
No one is predicting an imminent housing crash – except, perhaps, the Daily Mail – but what if the worst was to happen? How would financial firms cope, and be expected to cope, in such circumstances?
A regulatory standpoint
From a regulatory point of view, it is only lenders who have to answer to the Financial Services Authority (FSA) specifically and are required to have measures in place to cope. In light of a market crash, brokers are not actually seen as such a concern for the FSA because they are not deposit takers. With the FSA’s focus on consumers and how they would be adversely affected, it is lenders that must actively stress-test their mortgage books against scenarios, such as the previous recession.
Robin Gordon-Walker, spokesman for the FSA, says: “Lenders are required to always have enough capital and assets to withstand difficulties such as repossessions, arrears and also non-secured debt. It boils down to having a buffer to see you safely through signs that are a lot less benign than now. The regulator has got to be a bit of a pessimist and look for rocks ahead. We believe lenders should do stress-testing in a prominent way to see what would happen if there was a downturn in property valuations and increase in rates.”
Of course, all companies are answerable to their customers on some level and Roger Morris, managing director of em-, believes accountability is more of a key issue than ever before. He explains: “Every company needs to have very strong contingency plans for any disasters that may happen, no matter which industry they are in. Plans need to be tailored according to the company as contingencies for each company will depend on its business and its stakeholders. Companies within the financial services industry often have to have more detailed contingency plans than most though, so packagers, lenders and brokers all need to be aware of this.”
Morris adds: “The key to a successful disaster recovery plan is to ensure your customer only feels minimal levels of disruption and is kept informed, which is particularly important for packagers.”
An open dialogue
Certainly, maintaining an open dialogue with clients during times of duress is vital for brokers. Advising a client at such times as to how to handle a downturn in the market is ultimately one of the most important facets of being an intermediary in the financial services industry.
Martin Wade, director of Mortgage Options, believes broker focus has got to be on affordability, ensuring the extension of terms, switching customers to interest only deals and ensuring debt, such as credit cards, is paid off in the most efficient way.
He adds that educating clients is also crucial to helping them. “People have got to live within their means and not look at their house as their only way of funding their retirement. Brokers have to get through to customers to view their home as a home, not an asset. All of us have been accused of viewing our house as an investment and not a home at some point, but it’s not why we buy.
“The defence for the market is that there is more demand than supply, fuelled by people putting off getting married, the rise of the single household and a lot of immigration. While demand outstrips supply, prices will all go up. H
owever, over-consumption is always a threat to the economy and changing politics can also have an effect. If you ask anyone, the concern of a correction in the housing market is in everyone’s mind.”
When it comes to brokers preparing for such an eventuality, Ray Boulger, senior technical manager for John Charcol, states it can be difficult. He says that a business cannot be run on a plan that there will be a crash without compromising growth, as maintaining that flexibility would not allow for long-term plans to be made.
He continues: “If you have a crash on any scale, such as a downturn in prices of 25 to 30 per cent, you would see a huge difference in the way the mortgage market operated. The volume of business would fall quite sharply, people would not be moving and so more inclined to remortgage. From a broker’s perspective, they would have to plan for a significant reduction in gross lending and give up fixed and variable costs like staff incomes and bonuses. But you can’t run a business like this.
“Brokers should plan for growth if they see it, but, if they see trouble on the horizon, they should put in place measures to cut back on costs, such as being cautious with big capital commitments or cutting back if a large part of your costs are salaries or bonus payments. It’s unpleasant for the staff, but one of your biggest costs would be reduced as a result.”
The name of the game
As for lenders, stress-testing is the name of the game. Clive Briault, managing director of retail markets at the FSA, told members of the British Bankers’ Association last November that retail banks must be prepared for ‘the potential storms ahead’. He stated banks should use the FSA’s ‘considered reference points’ for assessing the impact of a downturn – those being an average reduction of 40 per cent in property prices and a 35 per cent downturn repossession rate.
Indeed, lenders are wise to plan for such drastic figures, as Bob Sturges, director of communications for Money Partners notes. He says signs of financial stress among parts of the population are already visible. “This is only likely to deepen if interest rates continue to rise. But even if they don’t, they are unlikely to fall back significantly over the next 12 to18 months. This alone will ensure that consumers who have borrowed heavily against relatively modest incomes and assets will continue to feel the pinch.
“Lenders will ultimately be impacted, albeit to varying degrees. Those most at risk are likely to be specialist lenders whose mortgage portfolios are skewed towards heavier adverse, high loan-to-value (LTV) loans. Credit performance among this group is almost certain to worsen in line with deteriorating indebtedness performance in the wider consumer credit world.”
However, Sturges feels this situation does not necessarily dictate the fall of potentially exposed lenders. He explains: “Early and targeted account management can help ensure many problem cases are salvaged from a possible repossession situation. Brokers can also play a vital role by researching the market for possible remortgage routes. Granted, these may reduce as lenders become more cautious, but are unlikely to disappear altogether.
“A far better strategy is for lenders to take a methodical and proactive approach to risk assessment. This supposes regular stress-testing of portfolios to measure performance across a range of economic scenarios; product and criteria re-engineering to alter higher-risk deals; and, if required, a realignment of distribution channels.”
Gus Park, director of intermediary sales at Bradford & Bingley, adds: “The truth is lenders spend an enormous amount of time and energy thinking about what can go wrong. Lending is about managing risk. All our development work and work with the FSA is on identifying scenarios and macro-economic scenarios and how it will affect us. Security for lenders is always critical. The real issue for lenders to worry about is borrowers that might be in financial difficulty might have no incentive to keep up repayments. This is why LTVs are so important to lenders and why we are so careful when lending at high ratios.”
Park continues: “There were hard lessons learnt in the 1990s and lenders have become more sophisticated in how they lend. The chances of that kind of recession are very low and the fact that no one expects a return to mass unemployment should help the market ride it out.
“For the most part, the industry is better equipped. But if a recession did happen again it would hurt and a lot of risk analysis does look at scenarios from the less positive to the disastrous. Part of our responsibility as a lender is giving significant thought to these scenarios and having enough capital as a bank to deal with it.”
Yet, Sturges sees one area of concern in the continuing appetite among investors for securitised mortgage and secured loan assets. He says: “The success of securitisation to date has been one of the principal factors behind the growth of specialist lending. Any serious weakening in investor demand, which is likely if securitisations start to perform worse than expected, would jeopardise this important sector’s future and ability to innovate.
“The good news is that investors remain as hungry as ever for well executed and well managed securitisations. But lenders and funders would do well to remember that this is a reaction based on hard facts and analysis, and not on sentiment or goodwill.”
As for Park, he believes one side of the market that will fare better than any other in a crash is buy-to-let. He explains: “There is reason to believe the rental market would remain viable in falling house prices. What most buy-to-let investors would do is to ride it out. As long as the demand was there, it is in their best interests to hold on and wait for house prices to recover. I’m not saying it would definitely be stable. The fundamental point is that tenant demand would fall, but people still need a place to live. As long as demand for rental property holds up, there is no reason for buy-to-let to fall.”
No room for complacency
However, the industry’s greatest enemy in remaining strong is complacency. As Sturges says: “History teaches us that financial upheaval on an institutional scale takes us by surprise. The savage recession of the early 1990s and the dotcom collapse in 2001 occurred relatively suddenly, and few, if any, so-called experts called it right ahead of either event.”
Yet, he remains optimistic about the future of the mortgage market in general and the specialist sector in particular. “Lenders are getting better at risk assessment and managing risk. A robust macro-economic environment will continue to underpin high employment and a strong housing market. This, in turn, should limit serious consumer indebtedness problems to a minority – albeit a large one – of the total borrowing population.”
The prospect of a housing market crash is unpalatable at best and downright frightening at worst. Nevertheless, understanding how one’s business would cope at such times is vital, as is keeping both eyes open for economic warning signs. Lenders’ stress-testing is a necessary step to ensuring the survival of their business and brokers would do well to follow suit and understand what would happen to their business if push came to shove.
