When the Financial Services Authority took charge of the mortgage market in 2004, a number of firms decided it was too much work for too little reward and exited the industry. So will it be a case of history repeating itself for the second charge market?
The Financial Conduct Authority takes over regulation of the second charge mortgage market on 1 April this year, a move which will result in a more costly and more time consuming set of regulations for the sector.
Little is expected to change for brokers and lenders on 1 April, but by April 2016 the FCA hopes that all second charge firms will be fully authorised under a new regime.
With a number of small brokers and lenders operating in the market – will FCA regulation spell the end for some of these firms, or could the formation of second charge networks be the key to survival?
Although the FCA has yet to release details of its plans for the second charge industry, it released its consultation paper – CP13/14 into its proposed fees for the consumer credit industry in October last year.
Within, it proposes that application fees will range from £600 to £15,000, with annual fees of between £500 and £1,000 for firms. It is not clear yet as to where second charge firms will sit in these brackets but the consultation gives the sector an idea as to how much their fees are likely to go up under the new regulator.
For the larger firms, such costs will not necessarily be an issue, but for smaller ones the costs will be felt.
Tim Wheeldon, managing director of Fluent Money, says it will not just be the cost that acts as a stumbling block for many firms but the extra compliance requirements.
“For the small brokers who are doing a couple of deals a month, the cost of the licencing in the first place is going to be high,” he says. “And as we move further into the same regulations as the mortgage market, firms are going to need some kind of compliance department and we have never had that before in the second charge marketplace,” he says.
Robert Sinclair, chief executive of the Association of Mortgage Intermediaries and Association of Finance Brokers, is confident the proposed fees will be changed but also says that if second charge brokers eventually fall under the Mortgage Conduct of Business rules, they will end up paying the same fees as mortgage brokers, which are even higher than what is being proposed for the consumer credit industry.
“The consultation on fees is not a closed book yet,” he says. “I think the fees have to be lowered otherwise they risk strangling the market.”
“The costs are a significant uplift on anything we have seen in the past and I’m not sure the FCA has justified the increases it is talking about.
Ultimately second charge mortgages will be part of the mortgage world and not consumer credit – the problem for second charge brokers is that they will come under the mortgage broker regime, where the minimum fees are even higher than the proposed ones.
But I think most second charges businesses are robust enough that they should be ok in that arena,” Sinclair says.
Paul Crewe, director of Smart Money Loans, agrees with Sinclair.
“Those of us who have come this far through the teeth of a recession are not going to be deflected by the CCL charges,” he says. “But it is unfortunate that in effect this is a double charge, because we all have paid money for a licence and why that could not be fully transferable has not been properly explained,” he adds.
Barney Drake, director at the Y3S Group, believes it will be the extra paperwork and record keeping firms face that will create the tipping point.
“With the increase in scrutiny moving from OFT to the FCA, there will be drop outs,” he says. “FCA regulation will change the whole dynamic of packing a secured loan. In the next few years, packaging a secured loan will be the same as packaging a mortgage,” he adds.
“Back in the origin of mortgage regulation in 2004 there was a huge drop out – about a third of brokers, because of the increased workload for the same amount, or even less money. As credit brokers we will have to evidence everything – why we chose a certain rate at the time and justify our decision,” he says.
The extra compliance and regulatory costs do not just pose a risk to small brokerages, but second charge lenders are also likely to feel the pinch.
The second charge industry is home to a number of smaller privately funded lenders who often have limited funds. This lending model however may not work as easily under the FCA as it does under the OFT.
“Lenders are going to need deep pockets or they are going to struggle because whilst the regulator requirement for a lender under the OFT is considerable, under the FCA I can imagine it will be huge,” says Wheeldon.
“I can’t see many people having enough money to comply properly with the FCA’s framework and still only have a small amount to lend. One of the issues that all brokers are going to face when they enter regulation is why they have picked their lender and whether they are FCA complaint.
“I think we will see some of the smaller lenders disappearing, being bought or amalgamating. It is so much of an unknown right now – but I would expect a repositioning of the market,” he adds.
One idea that is being touted around as a solution to a potential broker exodus is that of a secured loan network. Y3S is currently working on plans to offer such a service, which would involve a secured loan broker packaging the deal but it being submitted to a lender under Y3S’s licence.
“There are currently around 85 secured loan packagers in the UK and a lot of these only produce a handful of completions each month – FCA regulation might act as a deterrent for a number of these firms,” says Drake.
This is why, he says, Y3S is developing the UK’s first secured loan network. Members of the network will gain access to miLoanQuoter – to help them quote secured loans, refer cases out of normal criteria, request underwriting assistance and create loan documents. The packaged case will then be sent to Y3S who will carry out the necessary checks before sending the application to the bank for completion, under its own licence.
Drake says it is still undetermined as to what licence or permissions the brokers will need under the new regulations, but it could be a case of them acting as appointed representatives under the Y3S brand.
It is requesting that brokers do a minimum of three cases per month, with the broker keeping the fee and Y3S keeping the commission.
Drake says it is not trying to attract wannabe second charge brokers, but is being developed for those that currently package second charge loans.
Wheeldon says a second charge mortgage network may struggle because of the dynamics of the second charge market.
“If you are an AR of a mortgage network, the lenders understand that if something goes wrong it’s partially down to you and also down to the mortgage broker. In our market there is more of a direct link between the secured loan broker and the lender and they would be looking to us,” he says.
“So unless lenders in the second market adopt more of a mentality to those in the mortgage market I think a network would possibly struggle – are networks prepared to take on all of the regulatory responsibility for somebody who is passing them the occasional deal?
“If you are working with a number of small brokers the network would have to have absolute faith in everything they do to put their regulatory licence on the line,” he says.
Simon Stern, director of Prestige Finance, says he is intrigued by the idea of a secured loan network but would need to see the finer details.
“Y3S have seen an opportunity and good luck to them in providing the compliance support that the brokers will need to have,” he says.
“From a lending point of view we will have to look at the responsibility and who we are responsible for. You have to work with the broker, there’s no point saying ‘that’s the broker’s responsibility’, because ultimately it is the lending company that is putting the money at risk.
“All of the reputable lenders have got systems and controls in place to cover any issues that may arise but the market is going to get tougher for some of the smaller brokers and my concern is that some of them may have some issues with compliance, which is where y3s might be able to offer a service,” he adds.
History repeating itself
History, especially in the financial markets, tends to have a habit of repeating itself, and if the mortgage market is anything to go by FCA regulation is sure to bring about substantial changes to the structure of the second charge market.
The extra costs and paperwork involved will no doubt lead to a market that favours larger firms. A network model may provide some help for second charge brokers who are struggling with compliance, but until the FCA specifies its rules for the sector it will remain unclear as to whether these brokers will also have to pay annual costs or they can work under an AR model.
The market however has reached a point where it is established enough to continue even with the exit of some smaller firms. And as the second charge market becomes more aligned with the first charge market that will hopefully lead to more business enquiries and higher business volumes being written.
There is no doubt that FCA regulation will bring change to second charge firms, but hopefully this will not be to the detriment of the market.