31 October, 2014
The Financial Conduct Authority’s proposals for the second charge mortgage market contained their fair share of headline grabbers.
One detail of the paper which has been debated over the last few weeks is the regulator’s estimate that the new affordability measures will result in a £100m loss in business for the sector.
While some commentators have warned that this is a conservative estimate and the actual cost will be higher, others claim the figure is irrelevant given the amount of business that is likely to be generated from other areas of the proposals – such as the need for mortgage brokers to make customers aware of second charges.
So where has the FCA got the £100m figure from and is it a true estimate of what firms should prepare themselves for?
Calculating the Cost
In its proposals the FCA estimates that based on lending volumes in 2013 the new affordability measures will result in reduced lending of about 20% – 23%, roughly £100m.
However it also states: “Given unaffordable lending in the market appears to have materially decreased since the cut-off point for our analysis (2011) and because many firms, particularly larger players, have already adopted practices which go significantly towards meeting our responsible lending proposals, we expect the actual reduction in volume to be materially smaller than these 20-23% (and £100m) estimates.”
As part of KPMG’s separate cost analysis into what the new measures will cost, it questioned six active lenders, six active brokers, two dormant lenders and one industry association.
When asked what change in volume they expected as a consequence of the package of rules proposed for second charge firms (much wider than only the responsible lending proposals) 57% said they expected a reduction in volume. Of this proportion 14% said this fall in volumes would be less than 10%, 21% said the fall would be between 11-20%, and 21% said the fall would be greater than 20%. 36% in total said the proposals would have no significant impact on volume and 7% said they expected a small increase in volume.
The research also notes that: “Any impact of responsible lending proposals will not be equivalent across firms but dependent on differences in behaviour.
“The data submitted to us by our sample indicate that one medium sized firm continues to have materially higher arrear rates relative to the market. This indicates poorer underwriting standards (which our responsible lending proposals would address), and suggests reduction in lending volumes and revenues as a consequence of the proposed responsible lending rules are likely to be concentrated more in this firm.”
As the FCA highlights, the decrease in lending will not be the same for each firm.
It is impossible to say what the true impact of the proposals will be until they are implemented – but can what happened in the first-charge mortgage market with the MMR offer any guidance for the seconds’ market?
The regulator first estimated that its MMR reforms would result in just a 2% reduction in lending volumes in a subdued market and 10% in boom times.
This was generally seen as an underestimate of what impact the new rules would have. In the months preceding its implementation in April 2014 there was a slight drop in mortgage lending, however during May 2014 the number of loans to first-time buyers was actually 19% higher than in May 2013. While both the number and value of loans to home movers was up 9% by volume and 21% in value compared to May 2013
The Council of Mortgage Lenders noted that the impact of the MMR had been “subtle, rather than dramatic.”
During the MMR’s implementation however, the first-charge market benefitted from several schemes such as Help to Buy and Funding for Lending. The MMR was also five years in the making, giving lenders ample time to introduce some of the proposals early on and avoid a sudden drop in lending.
The second charge industry on the other hand does not have the luxury of a five-year period to implement the rules and some firms may wait until the final rules are confirmed in 2015 before applying any changes.
A number of modifications were made to the MMR rules throughout the five year period, which resulted in some lenders being over cautious with their criteria changes.
Simon Stern, business development director at Prestige Finance, says there has been significant engagement with the industry through the working groups to ensure they don’t end up going back and forth in the way they did with the MMR.
He says: “We also have to bear in mind that because of the European Mortgage Credit Directive which comes in to affect in March 2016, the industry is already on a tight timetable.
“It is too early to know whether they will result in a £100m drop in business and anybody who says otherwise is clutching at straws. We are hoping that volumes will increase as more brokers explain to their clients the benefits of a second mortgage.”
The proposal which states mortgage brokers must make their client aware of a second charge if they are looking to raise extra funds has been seen as a silver lining by many in the industry, so could this counteract a possible £100m drop in business?
Coming into Scope
Robert Sinclair, chief executive of the Association of Mortgage Intermediaries and the Association of Finance Brokers, says the FCA may not be ‘too far away in its estimate’ of a £100m drop in business.
Speaking about whether mortgage brokers will help recoup some of this loss, he says: “It will all depend on whether first-charge brokers bring second charges into scope. It will not be automatic, mortgage brokers will have to make a decision as to whether they include seconds and at the moment there is no certainty either way.
“Brokers will not even be obliged to say that a second charge may be better- just that it exists. They could just say, ‘A second charge may be more appropriate but I don’t offer that service– are you happy to proceed with a remortgage?’
“Some people in the seconds industry have made a mistake in thinking that mortgage brokers need to include it in their scope – they don’t. The second charge industry would very much like it to be in their scope but I’m not sure the first charge industry will want it that way.”
Steve Walker, managing director of Promise Solutions, is confident mortgage brokers will include seconds in their scope.
He says: “I believe brokers need to adopt a consistent and fair approach in dealing with their clients and only offering a secured loan as an after-thought doesn’t do this. Brokers could fully opt out of offering secured loans but that diminishes their ability to properly service their client’s needs and will result in brokers losing income and clients.”
Ray Boulger, senior technical director at John Charcol says any good mortgage broker should already be considering second charges and those who aren’t should act now, instead of waiting until 2016.
He says: “There are regulatory obligations that every mortgage broker must abide with and then there are other things a broker needs to do beyond the regulatory requirements to make sure they are giving their client a good service and the best options. One of those is to consider a second charge where the borrower wants to increase their borrowing.”
He says there are a surprisingly large number of brokers who are not doing that and will probably only start doing it when the regulator says they should, which Boulger says is a dangerous position for firms to take.
“With the way ambulance chasers work these days it would not be beyond the realm of possibility that you could get one of them coming on board in a situation where a second charge would have been the best option for a client and pursuing a firm for that – even if it wasn’t a regulatory requirement. First charge firms should start recommending second charges now rather than wait for it to become mandatory, which probably won’t happen until 2016,” he adds.
Paul Crewe, director of Smart Money, says it has already seen more brokers looking at second charges as a result of the proposal and high street lenders tightening their criteria in the wake of MMR.
He says: “But to see whether there will be an overall increases in business, we need to see whether the second charge lenders follow the pattern of their first charge cousins. My feeling is that they will not be panicked into the drastic changes we have seen in firsts. Second charge lending will take its place as a realistic alternative to remortgaging and we will see business in the sector climb after MCD is bedded in properly.”
Implementing the Rules
Alistair Ewing, director of Blimey Loans, also says in theory the ruling should bring the sector more business as brokers will have to talk about secured loans.
But he says: “There is a potential negative because the regulations could make it too onerous for some clients who currently qualify for specialist loans but may not when the rules change.”
Tim Wheeldon, joint managing director of Fluent Money, believes a lot will depend on how lenders implement the affordability rules.
Second charge lenders are smaller in size than the first charge lenders and cannot afford to make mistakes when it comes to granting loans, he says.
Wheeldon says: “Second charge lenders do not want arrears and I believe they will find more innovative ways to carry out affordability assessments than some lenders in the first charge market have. They will find a way to still only lend to customers who can afford it but not ask the silly questions such as how often do you eat steak for dinner?”
The FCA has admitted in its own estimates that the £100m figure is unlikely to be the true cost of what implementing the new measures will be and with lenders have already imposed some of the more stringent measures since the financial crisis.
This will not be the case for all firms though and those operating in the non-mainstream of specialist sectors may see a steeper drop off in business than those in the mainstream market. One proposal which could undoubtedly help replace this lost business is that of referrals from mortgage brokers and it will be the job of those within the industry to make sure mortgage brokers are aware of the importance of second charges before 2016.