Looking in the murky compliance crystal ball at some of the new ‘opportunities’ (risk is a dirty word, even in the compliance world) floating in the astral ether, I decided to forgo another comment on Home Information Packs (HIPs) or article on how simplification of the Mortgage Code Of Business (MCOB) will make our lives easier in favour of a little regulatory ‘issue’ the lenders are losing sleep over, but probably isn’t on the radar of the broker or packager – Basel 2. Basel 2 is not an obscure and little-publicised round in the World Cup, but is a little bit of Europe that is going to change the financial burdens on banks and building societies at the end of 2006.
At the moment the FSA requires a bank or building society to set aside capital to cover the risk in its mortgage book on a level basis; i.e. the type of product has little impact on the capital requirement. However, at the end of 2006, banks and building societies will have to calculate capital holding requirements by reference to three things: the level of credit risk in their book, operational risk; and the level of market risk.
The lenders with ‘good’ quality loan portfolios could see a decrease in the level of capital requirement. Larger lenders will be able to use a ‘ratings’ basis for calculation of capital requirements but the smaller lenders will need to use a ‘standardised’ approach that requires them to analyse the mortgage books. All of this means increased bank and building society lending costs in setting up system to collect data and calculate capital requirements, only two years after the significant cost implications of mortgage regulation.
Margins in trouble?
I can see you all yawning now and losing the will to live, if you’ve got this far. After all, it’s a lender problem, so why should I, as a broker, introducer, intermediary network or packager be interested?
Well, let’s think about it this way. If capital holding requirements are based on capital risk (we’ll forget about the other two for now), what sort of capital requirement is a bank or building society with a book consisting of high loan-to-value (LTV) loans, adverse credit rated borrowers, self-certified personal status borrowers, etc, going to require? It seems to me that there will be a significant hike in capital requirements and capital holdings cost money in lost lending opportunity.
Even the larger high-street lenders now have non-conforming books that will impact on capital requirements. Add the cost of capital holding to the cost of implementation of the Basel Accord and systems to collect data and calculate capital, and it doesn’t take an ageing compliance consultant like me to tell you margins in lenders will be squeezed further than they are now.
Price hikes?
Does it take too much imagination to see that a smaller bank or building society just might find it impossible to meet the capital requirements, without a significant hike in product price? Even the larger lenders might lose some appetite for risk. If you are a bank or building society looking to reduce capital costs after December 2006, what are your options? There are probably two principal solutions. Firstly, stop lending on higher risk products so that the risk profile of your book decreases over time and/or securitise and sell off the higher risk balances on your book.
This has two potential affects on the market and you, the intermediary. If banks and building societies stop marketing higher risk mortgage products, your client’s choice reduces as the market shrinks. If you are a specialist lender, which securitises all mortgage balances off your book, will the extra securitisation issues from the banks and building societies seeking to shrink their books’ risk profile have an adverse affect on the price in the market, i.e. will supply exceed demand.
However, there is also an opportunity here for the specialist lenders. One solution I haven’t mentioned is for the banks and building societies to white-label products manufactured by the specialist lenders. Risk stays off their books but they keep a toe in the market. A bit of a win-win here perhaps for the Unitys and Infinitys of the mortgage world?
Being Mr Doom Laden Compliance Officer, and adding into my prognosis the Financial Services Authority’s (FSA) concerns over self-certification of income, I might venture to suggest that we could see the price of higher risk mortgages rising to meet the increased capital costs and a supply shortage due to fewer lenders in the non-conforming and specialist market. It would be nice to think that lower risk mortgages might fall in price, but then, I still believe in Father Christmas.
