There is a demand for specialist lending but there is also a need for innovation in the various part of the market that the’ non-prime’ label covers.
The latest Mortgage Finance Gazette Lunch Club in association with Target Group was held at Michelin star chef Jason Atherton’s City Social restaurant on the 24th floor of Tower 42 with impressive views over London.
Guests came from an array of areas within the mortgage industry to discuss product innovation and choice in the non-prime mortgage market.
David Tweedy, market relations director at Target Group, started the discussion with a few observations of the specialist mortgage market. He referred to a speech made by Linda Woodhall, the Financial Conduct Authority’s director of mortgage and consumer lending, at the Mortgage Finance Gazette Conference in March. She stated: “There is a need for change and innovation to cater for a very different mortgage market than the one that existed in 2007.”
And he quoted Patrick Bamford, director – mortgage insurance Europe at Genworth Financial, who recently wrote: “Innovation means very different things to different people.”
David Tweedy noted that both of these statements are very true. There is a lot happening in the mortgage market and there is certainly scope for innovation. He posed some questions and observations.
Now that the General Election is over, how will the new government impact on the mortgage and housing markets?
The general consensus is that interest rates will stay low with any increase likely to be about a year away.
There are challenges in regulation both from the UK regulator in terms of conduct, capital and the prudential side of the business, as well as the European Mortgage Credit Directive, the UK’s participation in Europe and how Europe impacts on the UK.
The big banks are doing their job for the mainstream market but there’s a whole bunch of sectors within the mortgage markets where clearly innovation is required. These include first-time buyers and the unique challenges around affordability and deposits. There are so-called last-time buyers, such as people who can’t move either because they have an interest-only mortgage, or adverse credit – now an underserved sector compared with pre-credit crunch when there were many non-prime players.
The buy-to-let market goes from strength to strength. What sort of impact will the new pension freedoms have? Is putting all your eggs into the property basket the right long-term strategy?
Equity release is a fast growing market with a lot of innovation coming out of that sector. The self-employed is an area where some specialist lenders are making a strong play; but for certain types of self-employed people it can be hard to get a mortgage from a mainstream bank. Self build is a small but growing sector.
Right to Buy is back in the news with the government extending the scheme to housing associations. How will the industry support Right to Buy borrowers with mortgage options?
The high net worths are another interesting but niche market. Tweedy doesn’t see the big four or five banks playing in the niche markets so that leaves room for the challenger banks, wholesale funded lenders and the smaller building societies playing in local and regional markets. So the big question is: How is this market going to continue to serve all that demand around the edges of the prime mainstream mortgage market? Is this where we are going to see innovation?
Over to the floor
It was noted that there isn’t a one size fits all to cover all those specialist areas and lenders have preferred markets they want to play in.
Simon Read, managing director – lending, Magellan: We work in niche, credit repair, residential lending and are one of a handful of lenders that have come to the market over the last five years. There is interest from other parties that would like to go into this market but it’s difficult as a new lender. On the flip side, more lenders are coming into the buy-to-let sector where the hurdles are maybe not as high as on the adverse, residential side.
Matthew Wyles, distribution director, Castle Trust: Is regulation helping to address consumer needs? Is the incoming supply of lenders skewed towards segments of the market that are less regulated and is that a measure of the success of mortgage regulation in the UK?
Simon Read: The FCA worked with us to bring our model to the market. It was our proposition but they were involved. In 2006/2007 credit repair was a multi-billion pound market. Risk being the key reason for moving away from it.
We distribute through intermediaries only but intermediaries themselves haven’t quite jumped on the bandwagon as much as we would have perhaps hoped. I think part of that is their anti-risk stance, being part of networks – they see both a regulatory risk and reputational risk.
We deal with the networks and they want to make sure it is a safe market for their intermediaries to play in. We are hoping that we have opened a door and hope to be the leader in that area. There are other lenders filling a niche such as the building societies – complex prime is the buzz phrase where the high street banks don’t really want to play. There haven’t been too many specialist lenders but that market has definitely been moving forward over the last 12 to 18 months.
Increasing numbers of existing mortgage holders who have come to the end of their introductory deal are now on a higher SVR, struggling to remortgage due to the new affordability checks. These groups have been termed ‘mortgage prisoners’ or mortgage misfits.
Paul Winter, chief executive, Ipswich Building Society: I think that lenders are using regulation as an excuse. Mainstream lenders aren’t doing some of the things they could do. We have made a lot of noise about mortgage misfits in the market and we are trying to persuade the FCA to change its interpretation of the European Mortgage Credit Directive. I still find it astonishing that lenders don’t want to lend to existing borrowers or offer them reasonable remortgage products – bits of the market aren’t being served. The quality of the borrowers around the transitional arrangements can be superb.
Mortgage misfits include the self-employed, contractors are a significant part of the market, people over the age of 50 and those who may have had a bit of an issue but nothing major, i.e. not repossession or bankruptcy but a missed bill here and there. People can pass affordability, and our tests on affordability are probably more rigorous than many, but it needs people to look at individual circumstances.
Nigel Stockton, financial services director, Countrywide: Most of the major lenders are now giving intermediaries access to underwriters. At the heart of this is the big six – Lloyds Banking Group, Santander, HSBC, Nationwide, Barclays and RBS. These organisations get the market share and profits without having to deal with more complex cases and if you are in those organisations why would you? These lenders have no intention of relaxing risk criteria.
You have the likes of Magellan, Shawbrook, Aldermore and others that can make a bit more margin on a smaller book.
Matthew Wyles: There is a big opportunity for skilful lenders who can dodge around the ankles of the big guys. Actually, they are just creating a franchise for alternative lenders.
Nigel Stockton: There is a blurring of definitions. If a borrower wants a sub 50 per cent interest-only is that non-prime? There are three or four people out of every 10 where their cases need some work [by an intermediary or lender] to get to a position where they can take out a mortgage.
Matthew Wyles: Is the intermediary market willing to engage with more complex cases? Is there an anxiety amongst intermediaries and additional regulatory risk associated with complexity?
Nigel Stockton: It depends who you talk to. There is a nervousness about taking on extra risk among intermediaries as there is with lenders. The big intermediaries can’t afford reputational risk in the same way big banks can’t so there is a reticence to extend into that. Equally, for small DAs (directly authorised) and the likes of Brightstar, who are a shining beacon of what can be done by specialising in this space, can do very well.
The specialist wholesale broker, which used to be known as a packager, aggregates more complex demand. Examples are Brightstar and Solent.
Nigel Stockton: The conduct risk issue would mean that a broker might not feel confident that he can properly address the case. You can see equity release handoffs, contractor handoffs, secured second charge and bridging handoffs. The mainstream broker is quite happy to get involved with Help to Buy, first-time buyers, home movers, buy-to-let. Moving outside of that, brokers can split commission and pass the case onto a specialist wholesale broker; the broker is helping the client by doing that.
Simon Read: In the majority of cases when you’re using an aggregator it’s a help rather than being seen as offloading the advice process. The advice still very much sits, in 90 per cent of cases, with the original intermediary and the aggregator will advise on the best option.
Vanessa Owen, head of retirement solutions at LV=: Reliance on proc fees is one of the things stifling innovation in the equity release market because advice fees are the norm. It is accepted that there is a cost for the advice process, the sourcing, ensuring the person knows what they are getting into. You can’t expect someone to do that for 30 basis points, therefore we have a completely different remuneration model in the equity release space. Generally a lender will provide a proc fee and the adviser also charges for their advice. Most equity release customers will visit their broker three or four times before a decision is made. There is a lot of research involved, the whole fact-finding process which includes the customer’s family.
Andrea Rozario, chief corporate officer, Bower Retirement Services: Equity release is labour-intensive for the adviser. It still has a reputational issue hanging over it and there is generally a trust issue within financial services. It would be difficult for advisers to move away from taking commission and just charging a fee. I think we can warrant the fee because there is so much extra work that goes into advising a client compared to a normal mortgage. One of the problems we are facing is that there are not enough advisers in the industry. Why would an adviser come into this industry when they are not particularly well respected, there is a reputational worry in financial services with the likes of PPI claims.
Vanessa Owen: The amount you are charged for PI (professional indemnity insurance) compared to the number of complaints to the financial ombudsman – hardly any – is disproportionate; yet you pay three or four times higher premiums in PI than if you’re doing standard mortgages.
Andrea Rozario: There is less risk in equity release than any other part of the financial services industry. It has been cleaned up over the last 20 years. The safeguards we have in place outstrip any of the safeguards in place for any other product.
The conversation went back to regulation and distribution and the specialist elements within that. Vanessa Owen pointed out that regulation is creating distribution silos. That may not be the intention of regulation but that is a reality.
Vanessa Owen: We have an opportunity in equity release with the retirement review and we have to start talking about people’s debt and their retirement planning at the same time. But one is under investment regulation and RDR, one is under mortgage regulation and MMR and then you’ve got consumer credit too. Trying to have that holistic conversation in the current regulatory environment is virtually impossible.
Simon Read: I don’t agree with that. We do a little bit of lending beyond state retirement age if people are still working. The regulator gave us some pretty good ideas on how to make that work in a risk based credit area and they are aware that there is a need and they are pushing for more innovation in this corner.
Vanessa Owen: We have had very fruitful conversations with the FCA in various aspects of the retirement space in terms of access to advice – quite innovative conversations. The challenge is how to bring distributors to a point where they feel comfortable – at the moment there is no incentive for brokers.
Paul Smee, director general, Council of Mortgage Lenders: The industry thinks in silos and the regulator thinks in silos. One of the catalysts for improvement in equity release will be a great realisation that it ties in with interest-only and end of term – and you have to find a better way of transitioning between the two. The big challenge we are going to have with the new government is getting shared ownership models to work better. There is a need for the industry to respond to that more flexibly than it sometimes does.
Paul Winter: The reputation of financial services is a key point that was made earlier. We’ve talked about what intermediaries and lenders want, but what do customers want? Dare I suggest that one of the reasons we are getting innovation in the building societies is that we have a very different view of what we are in business for. I think the industry needs to look at itself and ask what are financial services for? Do we want to help people live the sort of life they want rather than make money out of them? The problem is that innovation seems to be circled by people who want a quick buck and that is the reason why consumers don’t trust financial services.
Andrea Rozario: There is also confusion amongst customers, especially around retirement planning. Where do you turn to get proper advice? How do you work your way through so many different options and choices so that you feel confident you have made the right decisions? I don’t think there is any one port of call a customer can go to and feel confident that they are getting the right information. It is only those that are really able to afford to pay for advice at the top end that don’t have the same concerns as the vast majority of people.
Matthew Wyles: There are a lot of people who want to help their children onto the property ladder. One of our key missions at Castle Trust is what we call the intergenerational transfer market. What homeowners don’t want to do is pay a conventional mortgage because they have just got to the end of having done that. The fact is people are living longer and staying fitter longer and not moving into residential care at the age they used to. We need to find new mechanisms for the younger generation to get their hands on the capital they need to become homeowners in their own right – and that is a need that did not exist 20 years ago.
Andrea Rozario: One of the problems for younger people is student loans so they they’ve already got a large debt before they even think about taking on a mortgage.
Matthew Wyles: We have lots of fit and healthy 60, 70, 80-year-olds who want to help the generation below them or even the generation below that. We need to find mechanisms to help do that rather than just saying you’re too old.
Regulation has resulted in lenders clamping down on interest-only mortgages and they are now a tiny part of the market but the consensus in the room was that they can be a good product.
Matthew Wyles: The economics of borrowing from your mortgage lender are vastly more compelling than the economics of renting from a landlord. I’m sorry to say it but regulation means the customer has to choose renting rather than buying on an interest-only basis. With interest-only you never repay a cent, you have capital gains tax, you have much greater safety of tenure – what is so toxic about interest-only mortgages?
Paul Smee: The problem for lenders is that you’re bringing in the next generation. If the borrower’s son turns up and says ‘why didn’t you get my mum to pay off her interest-only mortgage before she died then I would have the property now and I would have been willing to put up the capital to pay it off’ – that is the sort of situation that lenders want to avoid. They also want to avoid the situation where you get somebody in old age who is possibly mentally impaired, ceases to pay the mortgage and then gets repossessed. It’s that sort of complexity that drives a lot of lender behaviour.
Simon Read: Regulation does have to put the boundaries in place because unfortunately we are in a world where consumers want something now. When self cert was around people over egged their income so they could get a four bedroom property rather than a three bed.
Matthew Wyles: I used to run a portfolio of self cert mortgages, which had a slightly higher default rate, but 97 per cent of them never experienced arrears; so we have to deny 97 per cent of people their rights to protect at the very most 3 per cent of defaulters.
Paul Winter: We still do interest-only, at any age, but it depends on the customer, what they are trying to do and what their strategy is; and we have no problem with the regulator.
Vanessa Owen: We do equity release safely and recognise that there are risks but we manage those risks. Just because you have a concern about reputational risk doesn’t mean you shouldn’t do this stuff. I’m afraid the banks in my view just simply backed away from it because it’s easier that way. Opportunities
James Snow, group sales director at Target Group: There is an opportunity for the specialist. We are seeing a huge amount of capital wanting to get to the market. We are currently launching a process for two new lenders with innovative products that are around the periphery of mainstream market. What the mainstream lenders are backing away from is providing a huge opportunity for new lenders to come into the market with good ideas and products.
I think regulation tends to catch up with innovation. For example, the regulator is catching up with the growing peer-to-peer market and that market is moving faster than the regulator. I don’t think innovation is stifled; there are some great products out there and there will always be new lenders coming to market. When it gets to scale what then happens is that the mainstream lenders start to buy into it, they either acquire or copy and I see that trend continuing.
There is obviously demand for all types of specialist lending although the size of that demand is unknown and unmeasured. Mainstream lenders don’t want to deal with it, which leaves a gap that new lenders can fill as well as smaller players such as the challenger banks and regional building societies.
The financial advice industry is professional, brokers are qualified and customer focussed. Most mortgage intermediaries are generalist catering mainly for mainstream business and unlikely to move into more specialist areas such as equity release. That is left to the specialist advisers and wholesale aggregators.
Supply is not a constraint. The industry is flexible enough and creative enough to match up supply particularly now that the wholesale funding markets are back.
Regulation is a double edged sword: it has brought discipline, control and value to the industry but at the same time can constrain it.
We need to somehow break down the silos within the industry and creating joined up thinking, but that is easier said than done.
Lending into retirement will be a big issue going forward and work has already started on tackling that through, for example, the CML’s new task force, and a retirement review.
There is opportunity for growth within the various specialist sectors and room for new lenders, which we are already seeing this year in the buy-to-let and secured loans space.