The Financial Conduct Authority released its highly anticipated proposals for the second charge mortgage market last week.
To some, what is contained in the document comes as little surprise. For others it has been a wake-up call as to what the new regulator has planned for the sector.
There have long been rumblings in the market as to what rules the FCA might impose around advice and affordability and many of these were confirmed last week.
Once firms had digested the nuts and bolts of the paper, they were then faced with the FCA and KPMG’s cost analysis.
The bodies estimate the bill to the industry will run into the millions and cost individual firms thousands to implement.
On top of this, they estimates the new rules around affordability will lead to a 20% reduction in volumes.
Whilst the industry may welcome the new regulations and the better outcome they will produce for consumers – they will undoubtedly change the face of the second charge market forever and those firms wishing to still offer seconds may need to re-think their business model.
Loan Introducer has dissected the main points of the FCA’s consultation paper and takes a look at what they will mean for the industry.
The FCA’s consultation paper lays out plans not just for how second charge mortgages will sit within the Mortgage Conduct of Business rules (MCOB) but also how the market will comply with the European Mortgage Credit Directive (MCD).
The regulator is proposing that from March 21 2016, second charge mortgages will fall under the definition of a regulated mortgage contract, so most MCOB provisions will apply.
The regulator however is extending the implementation timetable for certain areas, such as advised sales.
Fiona Hoyle, head of consumer finance at the Finance and Leasing Association, says the timetable might prove testing.
She says: “Increased regulatory costs and a tight implementation timetable will present real challenges for the market.”
But she adds: “Allowing firms more time to transfer into the full MCOB regime should help prevent severe market disruption.”
The paper highlights several areas where the regulator feels the industry has placed consumers at risk in the past, such as:
– Firms not making consumers aware of the consequences of taking out a secured loan (e.g. that they might lose their home).
– Carrying out poor affordability assessments (e.g. some firms have assessed loans as affordable solely on the basis that a consumer’s monthly outgoings will decrease if they consolidate debts – rather than assessing whether they can afford to repay).
-And charging very high fees, particularly when a consumer is in payment difficulty.
By transferring the industry across to the MCOB rules, the FCA hopes to put an end to such practices.
The biggest change for the market under the new rules will undoubtedly be the need for all sales to be carried out on an advised basis.
As in the mortgage market, all sales where there is dialogue with the customer will need be advised. A non-advised sale will only be permitted where advice is given over the internet or via a postal application, where there is no interaction.
Sales to high net worth customers, mortgage professionals and business loans will also be allowed to be carried out on a non-advised basis.
This will mean that all staff selling second charges will need to obtain a Level 3 Certificate in Mortgage Advice and Practice (CeMAP) qualification by 21 September 2018.
This will also give second charge brokers the necessary qualifications to offer first charge mortgages.
This will be a huge and costly undertaking for firms in the seconds market.
Robert Sinclair, chief executive of the Association of Mortgage Intermediaries and the Association of Finance Brokers, says: “The biggest shift for the industry is going to be moving into an advised market where staff need to be exam qualified – this will be the biggest single change for the market.”
The other big change will be the relationship between the broker and master broker.
Sinclair says: “There can only be one person responsible for the advice and that person is the person who talks to the customer. So either the master broker will only be able to give business-to-business information to facilitate a broker, or the customer will need to be passed in full to the master broker who will carry out the advice – it will change how the sales process works.”
Under the directive rules, all prospective borrowers will also need to be given a European Standardised Information Sheet (ESIS) by March 21 2019. The ESIS will give customers product information and inform them of the new seven day right of reflection period that the MCD introduces. Additionally it will need to describe the Annual Percentage Rate of Change and what would happen to monthly payments should interest rates rise to the highest level seen in the past 20 years.
Perhaps the most positive piece of news from the proposals for the sector is that mortgage brokers will need to reference a second charge mortgage when a borrower is looking to raise more funds. However, there is no obligation for the seller to assess whether the second charge would be more appropriate. The same rule will apply for seconds firms who will need to acknowledge to the customer that a further advance, remortgage or unsecured loan may be the best option.
Sinclair however says in reality this may change very little.
He says: “Brokers will need to disclose to the borrower the range of options in the market but can do this by saying: ‘I only do X and Y, if you want to go for another option you will have to go elsewhere – do you want to proceed with me now?’
“It will be no different to where we are now in all honesty,” he says.
Sinclair does however believe it will be good for the industry in the wider sense as it may encourage more lenders to offer second charges and more second charge brokers to offer first charge mortgages.
“I can’t understand why someone would hold a mortgage permission and only do seconds,” he says.
As part of the requirement to carry out sales on an advised basis lenders will ultimately be responsible for checking the affordability of the loans, as is the case in the first charge market. But brokers will be expected to carry out a vetting process.
Simon Carr, director of secured lending at Precise Mortgages, says it already carries out robust affordability assessments in line with the FCA rules, but not all lenders are the same.
He says: “The affordability rules will be a challenge for some lenders and volumes will no doubt be affected as a result of them implementing more robust calculations,”
But he adds: “The opportunities regulation presents, such as mortgage brokers having to reference secured loans, I believe are much stronger than any risk to businesses the rule may pose.”
The FCA’s own analysis shows that if its proposed affordability rules had been in place between 2009-11, between 10% and 17% of consumers would not have been able to obtain a loan and between 22% and 30% would have been lent less.
During the boom period (2005-08) it estimates that close to 46% of borrowers would have been impacted and around 9% of borrowers would not have been able to borrow through a second charge, while around 37% would have been lent less.
The FCA does acknowledge however that a number of firms have already applied its affordability measures and thus the true scale of borrowers impacted may be lower than its estimates.
Under the rules firms will need to check the loan is affordable against:
•The consumer’s verified income
•Their credit commitments and basic living costs (‘basic essential expenditure’, including utility bills, basic food and essential travel; and ‘basic quality of living costs’ which can only be reduced with difficulty such as clothing, household goods and basic recreation)
•Any known changes to income and expenditure expected in the future.
Within this, firms will also have to consider the effect of future interest rate rises – unless the loan is fixed for five years or more.
Firms will be required to consider the expected interest rate environment for at least five years and base their estimates on externally published sources such as the Bank of England and the Financial Policy Committee.
Interest-rate stress tests will also need to assume a minimum interest rate increase of 1% over the five-year period, even where the market expects interest rates to fall, or rise by less than 1% over that period.
Lenders will need to stress test affordability against the first charge mortgage, meaning firms will need to obtain the borrower’s outstanding balance and current interest rate from the borrower’s mortgage statement.
Philip George, managing director of secured lending at Shawbrook Bank, says this is something it already does.
“We are already assessing income and expenditure as part of our affordability calculations on our secured business and applying a stress rate to the first and second charge interest rate so the requirement by the FCA will not mean a material change.”
But this will not be the case for all lenders.
Sinclair says: “What’s disappointing is that when the FCA talked about a proportionate regime, I think people thought it might be a less rigorous regime. What we have is a proportionate regime that is more rigorous than MCOB in certain parts.
“The proposals about stress testing around an existing mortgage will present some challenges for the industry.”
Fees and Charges
One of the areas that the regulator has concerns over is the use of excessive fees, particularly when a borrower is in financial difficulty.
In light of this it is proposing a ban on rolled-up fees, unless this has been requested by the borrower or if it is in their best interests to do so, for example if they do not have funds upfront to pay the fees.
The paper states: “We are aware that it is common practice in the second charge market for fees and charges to be automatically rolled-up. In some cases this can be in a customer’s best interests. However, if the customer does have funds available to pay these fees, then it may be in their interest to do so – to avoid paying interest on them for the duration of the loan.”
Second charge firms will also need to apply MCOB 12.3 to early repayment charges (ERCs), which states that the fee must be ‘a reasonable pre-estimate’ of the costs a lender will incur as a result of the contract being terminated. Under MCOB 12.3 firms are also not allowed to use the ‘Rule of 78’.
For the second charge back book (that is loans made before 21 March 2016), the government has proposed that these will remain subject to the early settlement provisions in the CCA. Under the CCA, firms may defer the settlement date for one month (for loans over 12 months in duration) and calculate the settlement date to a point 28 days ahead of any notice given by the customer.
Under the new rules, firms will also be prohibited from imposing excessive pre and post-contractual charges on customers.
In its paper, the FCA estimates that two-thirds of second charge loans are taken out for the purpose of debt consolidation.
It wants to see lenders take reasonable steps to ensure the debts to be consolidated are repaid, or include them in the affordability assessment as if they were not repaid.
It states: “Our understanding is that the predominant current market practice is for second charge lenders to make out cheques to creditors, to be forwarded by the customer to the creditor.
“This would be one way in which second charge lenders could meet this proposed requirement, and therefore we do not consider that it would be burdensome.”
Arrears and Repossessions
The FCA says evidence from consumer groups suggests that the levels of fees for those in payment difficulties can be high in the seconds market and in the past such fees have been a key driver of profit for some second charge firms.
It is proposing to implement article 28 of the MCD, which requires member states to ensure that arrears charges are a reflection of the costs to the creditor arising from the consumer’s default and to not apply excessive charges.
MCOB 12.4 will also prevent firms from charging fees that are a percentage of the loan balance, or monthly fees where the customer is maintaining an agreed payment plan.
The FCA will also be apply MCOB 13 in its entirety to second charge firms and their back book. MCOB 13 outlines robust forbearance measures lenders must follow for those in payment difficulties.
One positive for the industry is that the FCA has decided to postpone inflicting capital requirements on second charge lenders.
First charge non-bank lenders, administrators and intermediaries are subject to prudential requirements under the FCA.
But the FCA says it wants to gauge a clearer picture of how the market is operating under the new regulations before imposing such requirements, so it will revisit the issue again in March 2017.
In the meantime, there are plenty of costs associated with the new regulations for lenders and brokers to evaluate. It will not come as a surprise to firms that the cost of imposing a new regulatory regime will be expensive, but the estimates from the FCA and KPMG may threaten the existence of some businesses.
George says: “It is likely that a number of brokers will exit the market which in turn will reduce the availability of secured lending to consumers.”
The FCA is of similar thinking.
It says: “Smaller firms (because of narrower profit margins) and in particular firms with worse post-lending outcomes may be at some risk of exit, though the ability to pass through costs through higher prices may temper this.”
KPMG, who the FCA commissioned to carry out a cost analysis of the new regulations estimates that the ESIS-based disclosure required by the MCD will be the largest cost for the industry, with one-off costs approximately £5.3m for active lenders and approximately £1 million for intermediaries.
Ongoing annual costs are estimated to be approximately £1.9m for lenders and £1m for intermediaries.
The costs associated with the implementation of other MCD requirements through existing MCOB requirements would be one-off costs at approximately £1.4m for active lenders and £0.7m for intermediaries. They further estimate ongoing cost of approximately £1.2m for active lenders.
On top of this it estimates one-off costs associated with the implementation of the FCA’s mortgage regime to be approximately £1.4m for active lenders and £100,000 for intermediaries.
However, its findings show that 75% of firms have already moved completely or mostly towards income and expenditure based affordability assessments and 54% are now applying variants of interest rate stress tests, which means some firms have already shouldered some of the associated costs.
The new regulations will mark one of the biggest changes the industry has ever encountered and while the end result will inevitably lead to better outcomes for consumers and a more aligned first and second charge market, it is not going to be an easy task for some firms to adapt to and afford the new way of doing things.
Sinclair says: “Behind the scenes we have always known this is where second charge regulation would end up and a number of firms will decide not to proceed into this market as a result. Brokers and lenders will need to decide what their business models are going to be going forward. Whether the rules are positive or negative for the industry – we won’t know until we get there.”