Memorandum by the Intermediary Mortgage
Lenders Association (CRED 08)
INTRODUCTION
1. The Committee announced this brief inquiry
on 14 October, requesting evidence by 31 October. The focus is
on three specific areas:
— Achievement of the Government's house-building
targets, both for market and for social housing.
— The financial viability and ongoing
business of housing associations.
— Measures to help existing and prospective
homeowners affected by the credit crunch.
2. IMLA is pleased to be able to respond.
IMLA is a member driven lender trade body focussed upon intermediary
based mortgage lending. Some 70% of UK mortgages are sold through
intermediaries and IMLA members are active in supporting this
market. Its 28 members include specialist lenders, banks and building
societies and its product coverage includes sub-prime, self certificated
and buy to let mortgages. Given this our main focus in this response
will be on the third of these issues.
3. This submission has been prepared by
Peter Williams Executive Director of IMLA in consultation with
IMLA Directors. The limited consultation reflects the tight timescale.
HOUSING SUPPLY
4. In our view the Government has rightly
been seeking to address the underlying long term demand and supply
position in England. The output of new homes relative to the increase
in population and households has been inadequate for some years
and not least in Southern England. This has contributed significantly
to increased affordability pressures and the difficulties first
time buyers have had in entering the market. Both borrowers and
lenders have had to adapt to this—bigger deposits and tighter
household budgets for the former and increased lending terms and
more mortgage innovation by the latter. However it is worth noting
that the proportion of 100% mortgages remained low compared to
the late 1980s housing boom (currently close to 0 and before the
credit crunch 2-3%).
5. The current downturn is clearly impacting
upon housing supply. Although there was a total increase of around
200,000 homes in England in 2007 it is likely that the output
in 2008 will be well below 100,000. This is below the government's
estimate of the 240,000 homes per annum that are required over
the medium to long term to help ease affordability pressures.
The credit crunch has thus impacted upon supply and made the achievement
of the supply targets more challenging. Much, of course, turns
on the depth and length of the downturn and that is still subject
to speculation.
6. Offsetting this is the reduction in demand.
Consumer confidence has fallen and it is already clear that the
demand for mortgages has gone down. There is some evidence to
suggest inward migration to the UK is falling and there will be
more outmigration. This is significant because increased immigration
was a material factor in higher household numbers and the estimated
demand for new homes.
7. Falling house prices may temporarily
assist some households but this re-adjustment will not solve long
term affordability problems, not least because reductions are
currently being matched by tightening credit conditions.
8. The government has moved to support continued
housing output through its £200 million scheme for buying
homes from developers and through backing HomeBuy Direct (a joint
shared equity scheme with developers). It has also opened up bidding
for social housing grant to the private sector. However it is
clear from house-builders that though this support is welcome
it will not prevent a serious contraction in output and the impact
of that will be felt widely. Section 106 schemes, through which
house-builders secure planning permission and also contribute
to affordable housing objectives, are being curtailed. Around
60% of social housing output in 2007 was on Section 106 sites.
With a contraction in development overall, and in Section 106
applications in particular, an important source of supply and
cross subsidy for the social housing sector (including low cost
home ownership) is lost. The implications of this are considerable
both in terms of the numbers of new affordable homes being built
and the impact it has on the financial viability of the associations
involved.
9. In the short term and outside of Section
106 schemes the programme for building new social homes for rent
will continue though associations will increasingly be constrained
unless grant levels are increased. Private finance for these schemes
has also been impacted by the credit crunch with funding costs
increasing and the funds available reducing. We return to this
issue in the next section.
10. Low cost home ownership (LCHO) is also
part of the social housing output and an important part of affordable
housing supply. Again output is falling and there is some evidence
to suggest there are fewer lenders prepared to offer high % advances
to borrowers seeking to part-buy such homes. LCHO sales have been
falling reflecting both mortgaging difficulties and a reduction
in demand. Some associations now have a stock of unsold LCHO homes.
This puts an increased financial burden on the associations and
in some cases will require action to allow "changes of use"
to either social or market renting.
11. In recent years the proportion of new
homes being built as flats has increased significantly reflecting
the push for higher densities and increased output. A proportion
of these new homes have been bought as investment properties in
the Buy to Let sector.
12. Currently Buy to Let lending has been
substantially reduced partly because of overall credit conditions
but also because a number of the main lenders are non-banks and
they are part of a sector which has not been supported via either
the government's recapitalisation scheme or the Bank of England's
special liquidity scheme. We return to this point later.
13. The recently published Rugg and Rhodes
Review of the Private Rented sector has aired the possibility
of increased regulation for this sector. Clearly at a time when
home ownership levels are falling, the private rented sector assumes
greater importance. Any increased regulation will have to be approached
with considerable care given this situation.
14. The Government should be commended for
its continued drive to increase housing output and through that
to help reduce affordability pressures. Having set out to secure
a significant and long lasting increase in house-building there
is obviously concern now it is clear that objective cannot be
met in the short term (over the next three years). It is still
too early to say how this will work out over the medium to long
term. The reduction in demand and fewer households will offset
the shortfall to a degree but it is likely there will be increased
demand for social housing and for market renting. It will be essential
to carry forward current work on improving the planning system
and regional coordination so that when the upturn begins England
will not be faced by a sudden spike in house prices.
HOUSING ASSOCIATIONS
15. The housing association sector has grown
significantly in recent years reflecting increased grant funding,
continued access to substantial private finance at very favourable
terms and a steady stream of stock transfers from local authorities.
The credit crunch is impacting upon the sector in a number of
ways but it remains fundamentally strong in terms of both assets
and capacity.
16. Mention has already been made of the
downward pressure on development programmes with associations
cutting back on new LCHO schemes and the flow through to reduced
cross subsidy for social renting. It has recently been suggested
that the development model in use in recent years by large and
medium sized associations—cross subsidy— is now broken
and must be replaced by one based around higher grant rates and
with a focus on social renting.
17. The credit crunch has impacted directly
on the development process in the way described above. In recent
years associations have also developed a partnership approach
with developers, sharing risk and profits. However such joint
ventures must now be approached with caution given the vulnerable
financial position of some developers.
18. Perhaps less obvious has been the contraction
in the market for funding social housing. Over the last five years
the strong competition between lenders has driven both the margin
on lending to associations very low (0.25 basis points above LIBOR/Base
rate) but also the terms of that lending had become less demanding
in terms of cover ratios and covenants. The upshot of this and
in advance of the credit crunch a number of lenders had withdrawn
from active participation in this market (worth around £40
billion and with eight to nine major players).
19. With the onset of the credit crunch
in 2007 the number of active lenders to the sector fell further
and the terms of lending were tightened. In recent months there
have been only three major lenders still active in the sector
funding new business though most lenders have continued to consider
support for their best customers. However as the financial squeeze
has continued so even those three lenders have reached their lending
capacity limits for 2008 with the upshot that very little new
lending is taking place.
20. This clearly poses problems although
it is important to note three key facts:
— There are significant loan commitments
outstanding so that much of the planned programme of development
for 2009-10 and 2010-11 is already funded. Terms may be re-negotiated
but there is a degree of certainty.
— Given the rise in rates and the tightening
of terms there is some evidence that a number of the lenders who
had withdrawn from the market are beginning to consider lending
again.
— Bond based financing is an alternative
to debt from lenders. With low margins it has proved difficult
in recent years for bond finance to compete but with "better"
margins this is now possible and there has been a recent bond
issue although the investment market has since closed again.
21. As this suggests the funding market
is quite volatile. Logically long term lending to "low risk"
associations (state regulated, grant supported and backed by housing
benefit) is attractive but the fact is the return is quite low.
In the current environment where lenders need to rebuild their
balance sheets and undertake business that is as profitable as
possible there are now other opportunities for relatively safe
lending but with higher returns. We have moved from a surplus
of funds to a shortage of funds and lenders can be choosier.
22. In 2007 an English association became
insolvent and the banks involved triggered the moratorium arrangements
under the 1996 Housing Act. This event heightened lender awareness
of the risks associated with lending to this sector. It is now
clear that lenders are tightening their assessments of associations
looking more closely at governance and finance and that they have
begun to discriminate between them in terms of pricing and terms.
23. We can thus observe a reduction in funds
and a tightening of terms and pricing. This will put additional
pressures on budgets and viability at the association level and
up the case for increased grant funding. Given the 2008 Housing
and Regeneration Act and the current changes in the investment
and regulation regimes with the creation of the Homes and Communities
Agency and the Tenant Services Authority the government will need
to keep a close eye on the association sector, the effectiveness
of the new regulation and investment regimes and funding levels.
Associations are vital to continued supply and although government
is keen to encourage a diversity of provision the reality is that
this sector is in overall terms strong and capable. The government
has invested heavily in it over the last decade and a half and
should now be ready both to draw upon it but also to support it
in order to secure its own goals.
MEASURES TO
HELP EXISTING
AND PROSPECTIVE
HOME BUYERS
24. IMLA has noted the measures the government
has taken to help existing and prospective home buyers. These
include:
— Increased funding for advice agencies.
— Improvements to the Income Support
for Mortgage Interest regime (for one year a higher £175k
mortgage limit and a reduction in the waiting time to 13 weeks
from 39 weeks—but entitlement to ISMI will be for two years
only for those on the job seekers allowance).
— A funded mortgage rescue scheme aimed
at 6,000 most vulnerable households.
— The recently announced Pre-Action
Protocol which sets out the steps lenders must have taken before
a court will consider agreeing a possession order.
— A one year stamp duty holiday for
homes under £175k.
— £300 million of funding to support
HomeBuy Direct a shared equity scheme with home builders.
25. All of these measures have some merit
although IMLA would question a number of them. In addition with
a shrinking mortgage market and a home ownership market in transition
there are questions as to the scale and scope of the interventions.
Certainly by comparison with the USA the UK government interventions
remain limited.
26. The extensions to the ISMI scheme are
important and helpful but the scheme still remains restrictive.
In the last housing market downturn research revealed only 25%
of those in mortgage difficulties got access to ISMI—reflecting
its focus on those out of work (rather than reduced work) and
with very limited savings and income (full entitlement is for
those with less than £3,000 savings). The £175k limit
will limit usage and of course payments are based on a defined
standard rate rather than actual payments. For borrowers in the
non prime market with mortgages priced off LIBOR there will be
a considerable gap between the standard rate on which their ISMI
payments are based and the actual rate they are due to pay. Finally,
we note the Department of Work and Pensions has proposed limiting
access to the scheme to two years for those on the job seekers
allowance. We are unaware of any impact assessment of this restriction
and given a possibly sustained recession we would question its
appropriateness.
27. The new measures around low cost home
ownership both in terms of entering and staying in the sector
are welcome in certain respects but they further complicate what
is already a confusing landscape of products and programmes. Sadly
government's efforts to simplify this market have failed and it
is now becoming more complex by the month making it ever hard
for borrowers to choose and others to advise.
28. The CLG mortgage rescue scheme is currently
being developed. It offers home owners in difficulty a range of
options including sales of equity stakes through to becoming tenants.
These options are helpful and IMLA is fully supportive of them
(one of our members has seconded a member of staff to assist its
development). The scheme is understandably aimed at the most vulnerable
but in our view that it is too restrictive in both scope and scale.
Possessions in 2008 may reach 40,000. As this begins to suggest
the scheme could find there will be many applicants who will not
be eligible and that the scheme will be very bureaucratic given
its narrow focus. In the last recession the government set up
a mortgage rescue scheme aimed at helping some 20,000 households.
In the event some 1,800 were assisted and most of these were via
one scheme operated by the Bradford and Bingley Building Society.
29. IMLA has suggested a market based scheme
would be far more effective using routes already in place with
lenders through asset management companies and potentially providing
an equivalent of the Business Expansion scheme type arrangements
that were in place in the early 1990s. These provided incentives
to acquire and hold property and allow former home owners to remain
as tenants. This could be structured to avoid the abuse that is
evident in the sale and leaseback market and reach far more owners
in difficulty.
30. In the USA the government is providing
support to help home owners in difficulty restructure their mortgages
and to remain in their homes. In our view the priority should
be to prevent home owners getting into difficulty rather than
dealing with the consequences and here we would highlight the
difficulties many "non prime" borrowers will be facing
now and in the coming months.
31. The "non-prime" market in
the UK is small in comparison with the USA (though different definitions
are used) but it is still significant with perhaps 10-15% of borrowers
in 2007 in this category. Prior to the Credit Crunch non-prime
borrowers included Right to Buy applicants, divorcees, foreign
nationals and those with weaker credit histories as well as the
self employed. This market developed on the back of the application
of sophisticated credit assessment techniques and has been central
both to the sustained growth of home ownership and the continued
health of the "prime" home ownership market. Around
80% of non-prime borrowers would have relatively "minor"
credit problems (eg, a county court judgement for unpaid debts
or limited arrears on a loan).
32. Any borrower getting into difficulty
in the "prime" market has been able to remortgage into
the non-prime sector—paying a premium but securing a mortgage
and thus sustaining their home ownership (somewhere over 100,000
borrowers have migrated to non-prime from prime each year). The
lenders into this market consisted both of major banks and building
societies but also a number of specialist lenders typically funded
via the wholesale markets and securitisation.
33. Over the last 12 months the number of
lenders to this market segment has contracted sharply. There are
now very few sub prime mortgages available in the market and almost
none at the more extreme end of the debt problem spectrum (up
to three to four county court judgements and none in last three
months etc). Clearly part of the reason for this is lenders have
reduced their appetite for risk as well as reflecting the fact
that the appetite to buy such mortgages in any subsequent securitisation
has fallen sharply.
34. However it is also important not to
lose sight of the effects of the government's current rules around
its recapitalisation scheme and the Bank of England's limitations
on the special liquidity scheme both of which have been aimed
at helping ensure the solvency and liquidity of the firms involved.
As mentioned earlier the non-prime market has been developed in
part by specialist lenders, non-banks, to use the correct terminology.
These firms are fully regulated by the FSA and comply with the
rules of the Mortgage Conduct of Business regime. These firms
are funded via a varying mix of balance sheet support from a parent
body, whole loans sales (ie, the firm originates mortgages, packages
them up and sells them down to other lenders) and securitisation
(where loans are originated, packaged up and sold to investors).
35. With the effective closure of the securitisation
and whole loan sales markets over the last 12 months these specialist
lenders have been forced to curtail lending. Some have gone out
of business, others are simply doing no new business and managing
their existing mortgage books. This has meant that existing borrowers
of non-prime mortgages are finding it difficult to remortgage
unless they have significantly improved their credit standing.
Any borrower coming to the end of their current mortgage will
move instead to the lender's reversion rate which may be significantly
higher.
36. The current interventions in the banking
system are directed at deposit taking institutions. This is understandable
and most welcome given the need to protect savers and overall
confidence. However, unlike in the USA, non-banks have been excluded
from accessing the scheme and this impacts both upon the competitive
landscape and their capacity to support and sustain a range of
home buyers. The failure to address the plight of these borrowers
and lenders is a great weakness and one which does pose significant
additional problems going forward.
37. The intervention has distorted the market,
denying non-banks access to sources of funding. This leaves them
unable to refinance and reduce interest rates for their existing
borrowers. It will inevitably lead to greater financial difficulties
and ultimately repossessions. As a result, some of the most vulnerable
borrowers coming off fixed rates are faced with high reversionary
rates, and are unable to re-mortgage due to the reduced number
of non-bank lenders.
38. IMLA's view is that urgent attention
needs to be given to this market and that non-banks should be
allowed to sell high grade assets into the special liquidity scheme
(thus easing their capacity to lend/remortgage) and that where
appropriate they should also become eligible for capital support.
39. Much is made of the need for a flexible
mortgage market. The non-prime and non-bank sector has been part
of that flexibility. The future mortgage market in the UK may
look very unlike the one we see today given possible regulatory
and structural responses to the downturn. However it is vital
that government helps manage the transition between the market
we had until recently and the one we will have in the future not
least for the several hundred of thousands of borrowers in the
non-prime market and who in some respects might be judged more
vulnerable to the downturn. Moreover we must not lose sight of
those who would have been "prime" but because of tightening
credit conditions are now excluded from that market.
40. The mortgage market in 2008 has seen
a much reduced volume of loans, a contraction in terms of the
number of products, a tightening in terms of loan conditions and
in some segments of the market a sharp increase in costs (eg,
any LIBOR linked lending). At present our expectations for 2009
are that the market will continue to contract unless it is possible
to increase the flows of mortgage finance. The outcome of the
Crosby Review is important here and this should be published by
the time this evidence is given. Our hope is that the report may
set out ways of improving and restarting the securitisation market.
41. Given the difficulties it should be
no surprise to see an increase in mortgage arrears and possessions
though these remain low both in historic terms compared to the
last recession and in relation to the total number of mortgages.
There may be 40,000 repossessions in 2008 compared to 75,500 in
1991 and although up on 2007 (26,200) this will still represent
significantly less than 0.5% of all mortgages. At present our
expectation is that the number will increase in 2009 though much
turns on the impact of the pre-action protocol and other measures
the government has taken alongside any further cuts in interest
rates and the actions of lenders who have increased their support
to home owners in a variety of ways.
42. IMLA is of the view that increasing
the flow of funds for the mortgage market is a pressing priority
as well as improving ISMI through further changes to eligibility,
the size of the mortgage covered and the standard rate. In the
previous recession mortgage interest tax relief helped dampen
the impact of high interest rates. With LIBOR still around 1.5%
above base rate cost pressures continue albeit we now expect base
rate to be cut significantly.
43. Sustainability is thus important alongside
access to home ownership. Clearly entering home ownership will
be more restricted in the future given a smaller mortgage market
and tighter terms. Consideration has to be given to further developing
intermediate schemes such as shared equity and to reforming the
current arrangements which are complex and confusing. In our view
government needs to give urgent attention to this matter.
CONCLUDING REMARKS
44. The credit crunch has had a severe impact
upon the UK's housing and mortgage markets and the consequences
are still working their way through the system. The severity of
the impact is evidenced in the way it has undermined the business
models used by house-builders, housing associations and lenders
and on which policy has been built. Both market approaches and
policy will need reconsidering in the light of this but it is
still too early to say how fundamentally these must be redrawn
and what the best options are going forward. The government will
need to work closely with all these parties to ensure we build
the most appropriate framework going forward. IMLA is ready to
play its part in that and not least reflecting its special skills
in relation to the intermediary and specialist mortgage markets
and the non-banking sector.
October 2008
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