If you believe the rumours and speculation buzzing around at the moment, there could be up to 10 new lenders about to burst onto the UK intermediary mortgage market during 2006. If this is the case, what impact are they likely to have? After all, the UK mortgage market is not only oversupplied but is also going through a bit of a flat spot at the moment. Gross mortgage advances, having peaked at £291 billion in 2004, fell to £280 billion last year and are forecast by the CML to fall still further to £275 billion during 2006 and 2007.
All of these new lenders will target their services at the specialist lender market and will distribute their products via intermediaries. They will not be B2C or mainsteam lenders. If we assume intermediaries are responsible for 60 per cent of all new lending, there is a potential broker market of £165 billion. Even if a new lender targets £500 million of lending in its first year, which is an ambitious target for a new start company, that still represents only a 0.3 per cent market share. 10 new lenders would therefore account for only 3 per cent of the market – or to put it another way, all 10 together would generate about the same volume of business that Bristol & West writes in a year. This is not insignificant, especially in a static market like the one we are currently in, but neither is it going to cause a major upset overnight.
Watching the competitors
Although lenders such as HBOS and Nationwide won’t be quaking in their boots at the prospect of a few new lenders, they will be watching developments vary carefully for two good reasons.
Firstly, the new players of yesteryear are some of the big players of today. GMAC-RFC is an obvious example. It writes more than £6 billion of new business a year and is officially a top 10 lender, only one place behind Alliance & Leicester and well ahead of established names such as Britannia, Portman and Bristol & West. If you look a little further down the league table, you also see a number of other ‘new’ lenders (by which I mean new entrants in the last decade or so) such as Standard Life Bank, Kensington Mortgages and Mortgages plc growing rapidly. From small acorns large oaks grow.
Secondly, and perhaps more importantly, new lenders have acted as catalysts for change, particularly in recognising the importance of brokers. Indeed, it was back in the 1980s when centralised lenders such as National Home Loans and The Mortgage Corporation first provided a service designed specifically for the intermediary community.
Prior to that, lenders had a very ambivalent attitude towards brokers and the intermediary mortgage market did not exist in the way in which it does today. Procuration fees were not paid to brokers until specialist intermediary lenders introduced them in the late 1980s and early 90s.
Think of almost any of the specialist lending facilities currently available and their origins can be traced back to a new lender: self-certification, buy-to-let, non-conforming and sub-prime lending – the list goes on. Traditional lenders have often been slow to respond to new developments and have been happy to be imitators rather than innovators in the mortgage market.
Tough environment
However, you can be sure that existing lenders will not simply roll over and make way for new players to enter the market. Establishing a new lender in a rapidly growing market is certainly not as difficult as trying to launch a new lender in a flat market. The UK mortgage market is a tough environment for any lender to compete in and at a time when lenders are desperately trying to increase market share in a static market, they will fight hard to defend their ground. Existing lenders also have a few trump cards up their sleeves: well-established relationships with key distributors, strong balance sheets and funding lines which enable them to enter into pricing wars if pushed to do so, and respected, tried and tested brands which brokers and borrowers will need some persuading to abandon.
However, none of these factors have acted to stem the flow of new entrants into the market. In the recent past we have seen names such as Freedom Lending, Victoria Mortgages, Affinity and Heritable Bank enter the market to name but a few. At the moment, the industry is eagerly waiting to see how new players such as Deutsche Bank’s db mortgages, the Oakwood Group and Morgan Stanley (which recently purchased the branded mortgage arranger, Advantage Home Loans) intend setting out their stalls.
Media hype?
Much media hype is pointing towards a ‘big bang’ launch for the Oakwood Group, which has recruited a large and expensive breakaway management team from HBOS subsidiary BM Solutions. Based on the previous track records of the individuals concerned, they have not been afraid to take on markets and seem eager to do so again, but they will find life as a new lender altogether tougher and riskier than it was in the past. Lenders such as HBOS and GMAC-RFC are not going to roll over and let new players steal their market share. They will fight hard to defend their territory.
BM Solutions has its own balance sheet capacity and budgets which most marketing managers can only dream about. A new lending operation will be dependant on whole loan sales and securitisation as it will not have its own balance sheet capacity, and budgets will be tight. Launching a new lender is an expensive business and regulation has raised the entry barrier even higher in recent years. Pressure is also on new lenders to return profits to their shareholders sooner rather than later, which means keeping tight control over costs. ‘Big bang’ launches therefore represent a high-risk strategy. If a lender gets it right the rewards are great, but if they misjudge the market, the consequences can be disastrous.
Delivering success
To state the obvious, success is totally dependant on delivering to brokers what they want in terms of products, service and proc fees. Reputations and track records are all very well but if the basic proposition is wide of the mark then brokers will not buy. The danger with a ‘big bang’ launch is that a lender fails to generate the projected volumes of business on which its profitability projections were based, and costs end up being too high in relation to income. Alternatively, the proposition ends up being far more attractive than initially anticipated and the mortgage processing centre, which is new and untested, fails to cope with the volume of new business.
Either of these scenarios is a new lenders nightmare and hitting projected business targets is very difficult to judge in the early years. An alternative strategy, and one which has been adopted by Freedom Lending, is a more ‘softly softly’ approach in which the initial focus is put on processing and administrative infrastructure and then, when they have proven to be robust, marketing activity is geared up accordingly. Our view is that by adopting such a strategy promises are not broken – either to shareholders or intermediaries.
This type of approach has also allowed us to be fleet of foot in terms of product development. We have been able to develop our product range over time in response to feedback from brokers and distribution partners. We haven’t had to pin our colours to the mast upfront in the blind hope that we have correctly guessed the market.
Product strategies
New lenders therefore need to consider their product strategies very carefully especially if they have no balance sheet capacity of their own and are dependant on securitisation and whole loan sales. Securitisation does, to an extent, drive product design as investment banks have very specific views about what is and is not acceptable within a pool of securitiseable mortgages. Investment banks understand the bond markets very well, but sometimes have peculiar views about the mortgage market. Investment bankers are not necessarily mortgage bankers.
For example, loans which are deemed to be at risk of early redemption by borrowers are not favoured. Borrowers may not like overhanging redemption penalties, but investment banks do. Lenders which are wholly-owned by investment banks will inevitably have their hands tied to a certain extent in terms of product design and development as their parents will only want what they consider to be investment grade assets.
Lenders that are not corporately owned have the choice of either securitising or selling tranches of assets. Mortgages which are not attractive to investment banks may well be suitable for whole loan sales to other lending institutions. Products have to be designed with one eye on the mortgage market to ensure they meet broker and consumer needs, and one eye on the financial markets to ensure they will be an attractive purchase for another financial institution. The lender which can crack the problems facing first-time buyers will have a huge market opportunity in front of them.
The challenges facing new entrants are considerable. Existing lenders understand the threat they pose and will defend their market share vigorously. The margin for error is getting ever smaller and new lenders cannot afford to make too many mistakes. It’ll be interesting to see, at the end of 2006, who the winners and losers will be. My guess is that there will be entries under both categories.
Colin Snowdon is managing director of Freedom Lending
