The inexorable rise of the new lender and TPMA

So we have recovered. It seems that most commentators believe that the UK economy is back on a safer footing (despite some notable risks and potential headwinds) and as the wider economic environment continues to improve the UK mortgage market is, broadly speaking, on the up.

2014 saw regulatory issues dominate. The introduction of the Mortgage Market Review (MMR) in April 2014 and the anticipated increase in the Bank of England (BoE) base rate during 2015 were expected to slow growth levels in mortgage approvals during 2015. However, restrictions to credit imposed by lenders in the wake of the credit crisis have loosened somewhat over the last two years and this has driven double digit annual increases in house prices, increased gross mortgage lending and kept the number of housing transactions increasing steadily too. With interest rate rises seemingly deferred until late 2015 or early 2016 and the overall economic outlook improving housing demand does look likely to continue this steady upward progress which should keep the market as a whole on an upward curve.

That is why I sat down with great interest recently to read ‘2015 Financial Services M&A Selected Opportunities: New Rules, New Players, New Game.’ While I’m willing to concede it’s not likely to make bestseller lists anytime soon for those of us in the loans industry the report (published by Deloitte) did make for a riveting read. Broadly speaking it looks at the emerging M&A trends across financial services particularly the impact of The Asset Quality Review and Stress Tests as well as M&A in reinsurance, consumer finance, third party mortgage administration, fin tech, European life insurance and asset finance. The report seems to confirm what many of us working in the UK loans industry have predicted for quite some time. In response to the improved macroeconomic picture and continued growth in the UK loans sector (and the mortgage market in particular) we are likely to see more new entrants to the mortgage market over the course of 2015.

New Entrants

The result, as we have been predicting at Target Group, will be more investment institutions trying to pick up the baton when it comes to ‘specialist lending’ and additional wholesale funding into the market via these institutions will increase. As more and more of these firms seek better investment returns globally, the UK loans market with its potentially enticing and relatively safe investment returns does seem to be an attractive way to deploy capital. However, it is not a simple market to gain exposure to. Becoming a challenger bank or a specialist lender rightly has a number of practical and regulatory barriers that mean this isn’t an easy process. Which begs the question, what is the best way to get yourself in the game quickly and efficiently while meeting all your regulatory obligations and having an infrastructure ready to support your new enterprise? Clearly, for those with money to spend acquisition is a sensible method and for those keen to get involved there are some willing sellers out there in the shape of existing lenders.

Many of those existing lenders are looking to free up capital on their balance sheets by shedding ‘non-core’ loan portfolios. These firms are a prime target for the new kids on the block. Several existing players in the market are willing to shed these ‘non-core assets’ and free up precious capital for re-deployment elsewhere to attract higher returns and offer new propositions to new customers. Many of these firms may have had an unhappy experience with ‘specialist lending’ following the financial crisis and found themselves troubled by the downturn in fortunes of the sector post 2008. However, despite the increased heat several of them will have felt over this period it would be wrong to describe any current deals as fire sales. Most of those that had to sell in distress have already struck deals and already exited the market. The distressed era seems to be over and the bid offer spread on these books of business is back up to what might reasonably be called ‘par.’

So if its not necessity motivating these sales what are the main drivers? For many it’s the ability to re-deploy capital out of ‘slow’ non-core areas of the business and into ‘fast growth’ areas. Whether they use the capital to shore up balance sheets or to invest in a new strategic direction it is clear that sellers are now making hard headed decisions about the future growth and direction of their businesses rather desperately trying to raise funds quickly to cover liabilities. Equally there are significant benefits and strong strategic rationale for the buyers as well. They aren’t only acquiring portfolios but also a ready made customer base. This clearly creates cross-selling opportunities and the opportunity to re-market products in the future should they so wish. Going from no exposure whatsoever in a market to a healthy number of ready-made customers does present opportunities and it is a welcome by-product of what is essentially a process of buying a customer base.

Will borrowers beware?

So how will these new specialist entrants be received by their new customers? Is the market big enough to support a raft of new lending? Will new entrants be welcomed or shunned in favour of more established high street names? Well according to research we at Target Group recently conducted with YouGov there seems to be a good base level of demand and we would expect that to increase as time wears on. We surveyed 2,000 UK adults about their mortgage habits and preferences and like the Deloitte report the results made for interesting reading. Our findings revealed that many borrowers tend to, rightly, have a perception that big established banks and brands are safe havens for their savings and current account. Often this desire for security extends to their views of their mortgage. Intuitively borrowers do tend to hold a greater level of trust in the all pervasive and established names. Almost half of those we surveyed (49%) said that they would be uncomfortable getting a mortgage from a ‘new entrant’ in the market and of that 49% almost three quarters (74%) said that they would be worried that a new lender may not be financially stable in the long-term. All in all that does seem to be pretty damning and conclusive. However, look a little closer and you will see that is not the case. Perhaps more interestingly almost a third of those we surveyed (29%) said they would be comfortable getting a mortgage from a new lender. With almost a third of UK consumers saying they are happy to borrow from new entrants, if they price their products effectively, offer innovation and good efficient service there is no reason they shouldn’t be able to gain significant market share and maybe increase those numbers over time.

So with demand for credit increasing, the size of the loans market increasing as a result and our data showing many consumers are willing to be ‘brand agnostic’ when it comes to selecting a lender it does indicate there is plenty of room in the market for new entrants. As a result we can expect these acquisitions to act as a catalyst for greater competition and more lending capital to emerge in various shapes and sizes. The hope therefore is that a healthier market for lenders and borrowers will emerge as a result.

Focus on what you are good at

So far so good, however, there will be practical challenges that many of these new entrants will have to contend with. A good number will not possess the capabilities or the expertise to overcome several of the challenges posed by their new industry and will need to outsource non core capabilities to maximise efficiency and stay on top of compliance requirements. As it stands in there is £1.2trn worth of mortgage assets under management in the UK alone and until recently 5% of that number is under third party administration (the Capita Co-Op tie up probably adds c1.5%). It does seem inevitable that the number will increase as more and more firms enter the fray and seek help dealing with aspects of their business that are considered non-core. Add to this the fact that specialist borrower profiles tend to be regarded as higher risk and therefore need a greater level of continuous servicing and regulatory oversight and the case for an increase the amount of outsourcing does seem inevitable. That is even before we begin to consider the idea that changing borrower needs in the coming years may well drive greater product innovation that will demand a larger level of service in areas such as equity release.

With all that in mind the decision in November 2014 by The Co-Operative Bank to select Capita as the preferred bidder to service its £23bn mortgage book over the next 10 years could be seen as just the start of a significant increase in third party administration across the board. Many new lenders simply won’t have the origination, servicing or process capabilities or indeed the infrastructure in place to cope with some of the demands of their new market. Outsourcers are able to offer simple solutions when it comes to staff, expertise, systems, processes and technology. Of course this influx of potential new business into third party mortgage administrators is welcome news for all of us that ply our trade in that way. However, we must not rest on our laurels and my hope is that it will also drive change in our industry too. Gone are the days when outsourcers could just be a body shop. Our industry needs to work in a more bespoke way to meet the individual challenges faced by each lender. This can be anything from taking legal title on behalf of portfolio owner right down to loan servicing, systems support and providing business and market analytics. It is clear that there is a momentum starting to build in the loans market and the fact that more and more firms want to commit funds to it is an encouraging sign. These are exciting times for all in the industry and my sincere hope is that greater competition will drive greater choice and with it greater product innovation for the borrower. If we do that we will build a better balanced, healthier and ultimately a more sustainable loans market in the UK.

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