There are some institutions in the mortgage market, and particularly in the building society sector, that seem to have been an unchanged part of the landscape for as long as anyone can remember.
Despite each ebb and flow of the tide, they remain in place and unchanged, going about their business while other sectors bubble away in a continual state of flux. The packaging sector is one which has been in perpetual motion over the last few years and its ability to evolve and develop its offering has been key to it remaining an integral part of the mortgage world.
Events over recent months in the financial markets have again thrown up a huge challenge for the packaging sector and there are undoubtedly problems ahead for many firms as they deal with the current credit crunch.
How big these problems turn out to be will in a large part depend on how well businesses have been managed during the recent boom times and for those who have failed to be prudent there will be plenty of time ahead for regret.
No desire
Wholesale funding has become more difficult and expensive to secure and for lenders looking to securitise, investor appetite has disappeared. Like a well-fed snake there is simply no desire for more and it will take time for investors to digest their big-ticket purchases over recent years and regain confidence in the market.
In turn, many lenders are reluctant to push volumes against such a backdrop and are tightening up on their criteria while pushing out their margins in an effort to make their book of business as attractive as possible for investors in the future.
In basic terms, this simply means there are less products available for borrowers and those offering the biggest risk to lenders are finding it hardest to secure the finance they need.
How hard this will hit packagers is a moot point, but some feel business volumes in certain product lines will fall by as much as 50 per cent. David Burrows, managing director of Secured Loan Services, says: “I think first mortgage packagers face something between a 25 per cent and 40 per cent drop in income and this will not be through a lack of enquiries, but because lenders will just not have the appetite to lend.”
This is a hefty drop in income for any firm to absorb and it looks certain that mortgage packagers are going to have to take some fast and decisive action about how they move forward.
As Burrows comments: “There will be difficult times for some firms and some of them will struggle. Their biggest bill will be staff, as packaging is very labour intensive even with the automation available.”
Difficult to call
It is obviously difficult to know what sort of moves each and every packager will make when it comes to cutting their cost base and there will be a number of considerations to take on board before any decisions are made.
Many packagers have invested heavily in IT as they seek to improve the service offered to both intermediaries and lenders. Improving its ability to integrate quickly and easily with multiple parties is going to be an important part of the sector’s development and for those winning the race there are some significant commercial advantages to be had.
Indeed much of the work that is being done by Origo in relation to generating IT standards for the mortgage industry that can be used by players across the board has been driven by investment from packaging firms and the monies involved are by no means small change.
However, despite the importance of developing market standards and internal trading platforms over which partners can conduct their business, it is likely most company boards will seek to cut back on their IT spending in the coming months.
Along with other marketing and promotional campaigns, it seems that unless things can be justified as essential spending they are going to be put on hold.
As John Rice, managing director of the Regulatory Alliance of Mortgage Packagers, explains: “What is most likely is that a lot of spending plans get put on hold around things like IT where there will be a good deal of caution about spending money that does not need to be spent.”
It will take time to see just how far back budgets have to be pruned and Rice adds: “In another month we will have a much clearer picture of the problem and so at the moment caution is going to be key.”
On top of the caution and cut backs, Rice also believes there will be some redundancies across the sector. “It is difficult to know but I would think you could easily see 10 per cent or 15 per cent of staff disappearing if boards think it is going to be a long haul to get back into a profitable position.”
Close-knit community
One positive for staff is that the packaging industry has long had a reputation of being a close-knit community with many firms operating very much like family businesses. As such, there has never been a hiring and firing culture in place and any decision to make staff redundant will not be taken lightly. Unfortunately this may not be enough to protect them from harsh commercial realities if business continues to prove difficult.
Key factors
The key factor is going to be in how long managements believe trading conditions will remain difficult and volumes stay depressed. Most expect to see things ease significantly over the next three months and although 2008 will not represent anything quite so dramatic as a new dawn, it will certainly be a fresh start offering more opportunities than the tail end of this year.
Certainly this is how Vic Jannels views the situation and the managing director of All Types of Mortgages and chairman of the Professional Mortgage Packagers Alliance (PMPA), comments: “I think it is going to last for two or three months and I think we will see more normality in the early part of next year. People who have managed their businesses properly should be able to weather the storm for such a period.”
Given the good years the industry has recently enjoyed, there may be little sympathy for those who have not put money to one side or financially strengthened their position over recent years to guard against such a downturn.
Indeed the feeling is very much that through the next six months, we will see the market redefine itself and the strongest firms emerge as much more efficient entities which are well placed to take advantage of the improving environment.
Rice comments: “Long term, I think the current climate is extremely good news for the packaging market.”
Restructuring the chain
Rice believes there will be a restructuring of the price chain to redress the balance of the extremely cheap deals customer were getting in the past. Massive oversupply meant the market was falling over itself to give everything they could to customers and he thinks it got to a point, particularly in the non-conforming arena, where rates were too close to the prime sector.
As Rice says: “It simply was not sensible.” However for those who can weather the storm, there are better times ahead and he goes on: “I think the structure of the pricing will be better when we come out of this and I think the structure of the market will also be better and those that come out of the other side unscathed will be in a terrific position. Long term it is good news, although short term it is going to be painful.”
It is not only going to be pricing that changes and many packagers are looking to forge closer links to their lending partners at a time when they most need it.
Jannels says members of the PMPA have already taken the time to write to lenders about a different approach to pricing and that talks on a number of initiatives are already being arranged.
Principally he says the problems for lenders is in knowing that a particular tranche of money will deliver them a certain return. Jannels believes the only way to do this is for lenders to offer the products and pricing upfront and then leave the distributor to sell the mortgages.
In recent years the problem has been that in such a competitive mortgage market it has been impossible for lenders to put this sort of restriction on their distributors, but now the landscape has changed Jannels believes such a move could work well.
He says: “In today’s market rate is no longer important. Rate is not the key and it is product availability that matters. A product might be 15 basis points off song but the fact it is available is what matters.”
Discussion
Not everyone agrees and although this is certainly going to be an option that comes up for discussion it is unlikely to become the market norm over the coming months.
David Copland, deputy managing director at Pink, is one who does not see this as the correct model for the future.
He says: “Pre-pricing would be difficult. We have a panel of around 55 lenders from which brokers can choose and we can’t guarantee volume. If the market moves against a lender it would become difficult.”
However where Copland and Jannels do agree is in the need for packagers to be working across a number of product lines and not just relying on adverse business for their entire revenue.
“Operating across different business lines is crucial,” says Copland. “Packaging should not just be adverse, but also things like self-cert and buy-to-let. It is important to have relationships with lenders to work across all of the niche areas.”
For those who do not, it is now going to be difficult to try and set something up in such difficult circumstances and this is something that many firms will be considering for the future.
Copland also points to the mortgage network run by Pink as another revenue stream, although for other packagers running smaller network operations, it is likely a number will not survive the difficulties ahead.
In explaining why this may be the case, Burrows says: “Some of the packagers have set up networks. Not necessarily to make any money but more to guarantee packaging volume and they were happy to take a loss on the network while the packaging was guaranteed. But if that drops off significantly then suddenly the network does not look very viable. I think we may see some networks being dropped or discontinued.”
Mergers in store?
In such a market acquisition and merger rumours are rife and there are already talks taking place about possible sales according to Rice, although he feels it may take a little bit of time before announcements are made publicly to the wider market.
However what will perhaps be most interesting is to see how firms go about acquiring the business they want from others in the market. Will they take the time to go through an acquisition and pay out for a business that is suffering a severe drop in volume and then have to go to the trouble of merging back office and management set-ups?
Burrows thinks this is not the way many aggressive packagers will go and feels they will be much more direct. “I can’t see a lot of packagers looking to take over other firms as they would need fairly deep pockets to do that and by taking one or two of the key people they could pick up most of the business anyway. What would you want to buy a business that is struggling with a 40 per cent drop in income?”
Once again it seems the packager deck of cards is about to go through a severe reshuffle and there will be a number of firms who fail to come out of the other side intact. However for those that do, business partnerships look set to be stronger and with a much fairer set of trading conditions expected in 2008 most will quickly look to make up for the losses they have endured in the Q4 2007.
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