The global financial markets have taken something of a battering in recent months, headed by the non-conforming crisis affecting the US market.
US lender Countrywide Financial recently laid off 12,000 staff and predicted that business levels would drop by 25 per cent in the coming 12 months, while American Home Mortgage (AHMC) filed for bankruptcy in August, citing market turmoil as the reason for their closure.
The problems in the US stem from the differences in the economies, with the US market dominated by an over-supply of housing and a different approach to mortgage lending. Until the recent crisis it was commonplace for borrowers to be able to obtain 100 per cent self-cert offerings, with so-called ‘ninja’ loans – no income, no job or assets, also valid, up to 98 per cent loan-to-value (LTV) exacerbating the crisis.
The regulatory situation is much weaker in the US and the crisis has forced a number of lenders into administration and also led to increased tension in the wider financial market, resulting in a ‘global credit crunch’.
The White House was also forced into action, with President Bush introducing tax breaks for home owners struggling to meet mortgage repayments, and launching a programme of limited federal aid for refinancing to stem the non-conforming crisis. He also moved to quell growing discontent with the US financial services sector, and in an effort to reassure borrowers indicated that the US economy was strong. “Recent disturbances in the non-conforming mortgage industry are modest, modest in relation to the size of our economy,” he said.
However, it has been closer to home that much of the uncertainty has come from.
An adverse impact
Despite many market analysts suggesting that the US market drop would not impact the UK market, it has become clear over recent weeks that the UK sector has been adversely impacted, with Northern Rock the most high profile ‘casualty’ so far.
While most lenders have reined in their product offerings and re-adjusted their products, particularly in the non-conforming sector, others have stepped back from the market all together. Lenders have re-adjusted their products and criteria on a weekly, if not daily basis, reining in the LTVs, tweaking the rates and restricting the borrower criteria to promote a more stringent lending procedure in the face of increased market adversity.
Market opportunities
Over the past 12 months, many lenders realised the growing opportunity within specialist sectors – namely buy-to-let and non-conforming. With statistics indicating that borrowers who, through financial defaults, debts or bankruptcy are forced to choose a non-conforming product are continuing to increase, it came as no surprise to see lenders, including recent entrants db mortgages and Alliance & Leicester (A&L), enter the fray in 2006.
Statistics from the Council of Mortgage Lenders (CML) backed up this statement, reporting that the number of mortgages in arrears of three months or more at the end of June 2007 rose to an estimated 125,100.
The number of properties taken into possession in the first six months of 2007 rose by nearly 18 per cent compared with the previous half-year, and nearly 30 per cent compared with the first half of 2006, the CML stated, which equated to around one in 840 mortgages ending in possession in the first half of 2007. As a result, it was no surprise that lenders began dipping their toes into the non-conforming sector.
While the previous 12 months had perhaps seen lenders cautious in their approach, following formal regulation of the mortgage market by the Financial Services Authority, the 12 months that followed led to a market diversification, particularly among lenders. Lenders realised that the prime market could not generate enough of an income stream and began to look at opportunities in other sectors, mainly near-prime and buy-to-let.
However at the time, established lenders in the non-conforming field, including Kensington Mortgages, stressed the need for lenders not to entertain the idea of a ‘quick buck’, suggesting that those operating in the non-conforming sector had to be in it for the long haul.
This seems to have come back to bite Northern Rock, which had to obtain emergency funding from the Bank of England, and it is only now in the market conditions we are currently experiencing that the UK sector has undergone a ‘mini-crisis’, with Bill Dudgeon, managing director at db mortgages, suggesting that the UK market was ‘currently in intensive care.’
A rock and a hard place
Due to its lending strategy, Northern Rock has felt the pinch more than most. While most lending institutions rely on customers making deposits into savings accounts to help their balance sheets, the Northern Rock strategy places a large emphasis on its mortgage business.
Unlike other banks, Northern Rock raises most of its money by borrowing from other financial institutions – a strategy that has become harder following the global crunch, with Northern Rock unable to obtain funding from US institutions. Indeed, speculation has hinted that potential bidders for the organisation from other lenders and banks had found funding to acquire the lender difficult in the current financial climate.
In a statement, Adam J Applegarth, chief executive of Northern Rock, admitted that the non-conforming crisis had led the lender to reassess its strategy and place in the market. He said: “We are seeing extreme conditions in global liquidity, which have impacted on world markets. As a result, we have taken prudent action to rein back our lending until markets normalise. Against that background it is inevitable, albeit disappointing, that our profits will be affected. We remain focused on prime lending in the UK mortgage market and our credit quality remains robust.
"The support of the Bank of England through this facility reflects a recognition that Northern Rock is solvent, exceeds its regulatory capital requirement and has a good quality loan book. In these extreme times we are pleased to have a high quality asset base and remain confident in the excellence of our strong customer franchise, our efficient business platform and our well-known brand.”
Following this move consumers moved quickly to withdraw their money out of the organisation, at a speculated rate of £10,000 per second. Over the weekend, it was predicted that Northern Rock had seen borrowers take out an estimated two billion pounds, despite the lender, the FSA and the government reiterating to borrowers that their money is safe.
Callum McCarthy, chairman of the FSA, said: “The FSA’s judgement on Northern Rock is that we believe it is solvent, meets all capital requirements and has a good quality loan book. We are clear it should continue to be open for business.
“More generally, it is important to remember that the UK banking industry has entered this period of severe market turbulence after several years of very strong market conditions which have helped it build up healthy balance sheets and strong capital positions.
“The FSA remains confident about the industry's ability to withstand current market pressures. We are in constant dialogue with firms to ensure that they are vigilant with regard to potential risks and continue to carefully monitor developments.”
McCarthy added: “To be absolutely clear, if we believed that Northern Rock was not solvent, we would not have allowed it to remain open for business. It is open for business and it can continue to receive deposits and allow customers to make withdrawals.”
Michael Coogan, director-general at the CML, added: “The Bank of England would not have provided the loan to Northern Rock if it had concerns about the quality of the lender’s own business.
“All lenders are facing funding pressure at the moment, and what they need is a return to more normal market conditions as quickly as possible. We welcome the Bank’s intervention and confirmation that it is keeping a close eye on the situation.”
However, despite the government, the lender and the regulator all calling for calm, the last time that a bank required ‘bailing out’ from the Bank of England was 1973, and it is to be expected that consumers will fear the worst.
Indeed in a BBC Newsnight programme, a number of Northern Rock borrowers suggested that they did not believe the government, following years of ‘spin.’ While Gordon Brown has undoubtedly made moves away from the ‘spin era’ of Blair and Alastair Campbell, many remain wary of government pledges.
Lies, damn lies, and statistics
Despite Chancellor Alastair Darling calling for calm, it is clear that many consumers simply do not believe the government. This is perhaps the most worrying aspect of the affair, and the government will have to act fast to restore faith.
While the previous decade has seen economic growth, spearheaded by Gordon Brown’s tenure as Chancellor, his move to Prime Minister has coincided with the ‘worst financial crisis in a generation’ according to some.
Lending strategies and the role of the FSA are undoubtedly under scrutiny as a result of this ‘credit crunch’ and has suggested that it plans to make changes to the current bank deposits rulings.
FSA chief executive, Hector Sants, admits the plans in place need to be re-examined in light of recent market changes. “There have been a number of factors affecting confidence, but it is clear that investors are aware of the limitations of the scheme and, in the light of events, it would be right to look at it again.”
For borrowers, it is clear that a certain amount of concern is gripping the market – with Northern Rock forced to open its doors earlier to cope with the demand – and the industry must do the best it can to quell this concern.
However with pragmatism key to many borrowers outlook, it came as no surprise to see other lenders seeing drops in their share prices. While Northern Rock was the most severely hit, with shares at one point down 40 per cent, A&L and Bradford & Bingley also experienced marked drops, although all of the lenders concerned reported a subsequent re-adjustment of share prices, with A&L shares dropping by over 30 per cent, before realigning itself.
An A&L spokesperson also confirmed that it had seen no increase in branch activity and did not expect its business model to be overly stretched, because of the different lending model it has in place. Although A&L relies on mortgages for a proportion of their business, the strategy in place differs from the Northern Rock plan.
A statement by Bradford & Bingley also moved to allay fears over its lending policy, despite the lender experiencing a fall in share prices of over 10 per cent. A B&B spokesperson, said: “We are a well-funded company with a broad funding base of retail savings allied to a cost-effective secured funding programme. Earlier this Summer we pre-funded by completing a £2.5 billion master trust securitisation and a £2.5 billion covered bond issuance.”
Quick to ask questions
In the market environment it is clear that the government, the regulator and lenders will all be under fire for their strategies. Conservative leader, David Cameron, has been very quick to question the government’s strategy and commitment to the financial sector, and consumers have expressed their own worries over the market, which will undoubtedly remain for some time.
The government needs to ensure that it keeps the public fully informed of the moves being made, and the FSA may, as a result of recent market movement, become a more prominent figure for consumers.
It is up to the industry to learn from this recent turbulence, and make sure the ripples that have been caused by the market tumoil do not have a lasting effect on what has been one of the most stable economies in the world.
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