Lenders have been expressing an increased interest in title insurance in recent months as the US sub-prime crisis impacts on the UK mortgage market. Christian Bearman explains
The sub-prime mortgage crisis in the United States has set in motion a remarkable chain of events in the global financial markets. In a matter of just a few months, the global credit markets have gone from being the best markets in the last 20 years, where the level of debt rose to unparalleled levels, to the worst in the last 20 years, where banks will not lend to each other – even on a short-term basis.
The impact of the US crisis here in the UK has been far quicker and more pronounced than most people originally expected. During the summer, leading investment banking analysts were putting out research reports arguing that the UK market would not suffer ‘contagion’ from the US sub-prime situation. Yet, in only a matter of weeks, the market saw Victoria Mortgages forced into administration as its funding lines were withdrawn, and Northern Rock turn to the Bank of England for emergency financial support. The resulting consumer panic forced the Bank to take the exceptional step of promising to protect Northern Rock savers’ deposits in a bid to restore consumer confidence in the UK banking system.
The dramatic fall in the value of collateralised debt instruments (CDOs), underpinned in most cases by residential mortgage-backed securities (RMBS), has culminated in a ‘liquidity crunch’. Although recent analysis suggests that there is the necessary liquidity in the market system for it to function, the actual allocation of this liquidity is now being restrained in a manner not seen for several decades.
Confidence in the debt markets has been severely dented and it is likely that the credit markets will remain in a state of paralysis for some time to come. A global reassessment of the price of risk is now under way and most analysts believe it will take many months before the credit markets return to some semblance of normality while some believe the worse is still to come. US Treasury Secretary Henry Paulson has been quoted as saying that “the crisis of confidence in credit markets is likely to last longer than any of the financial shocks of the past two decades”. The last time the UK banking system experienced a similar crisis when the secondary banking market was hit in 1973, the impact lasted two years.
Funding
One of the biggest areas affected in the UK has been the securitisation markets where complex debt instruments underpinned by residential mortgage assets are packaged and sold to investors. The securitisation market in the UK has effectively shut down. There is currently very little investor appetite for securitisations, particularly those involving second charges or at the heavy adverse end of the credit spectrum, and several deals have been pulled altogether, although some institutions have been rumoured to be thinking of testing the market in the early part of the last quarter of the year.
It is clear that whole-loan sales (from lender to another lender) have also been impacted, with some deals now being priced below par value. This market paralysis has hit the off-balance sheet lenders the most, as they rely on the capital markets to buy their securitisations so as to be able not only to make a margin on the business they originate, but more importantly, to raise fresh funds to lend. Without selling first, they cannot raise fresh funds to lend, so their lending grinds to a halt altogether.
In general, sub-prime lenders in the UK have reacted in a number of ways: pulling products out of the market; tightening lending criteria; pulling out of particular sectors of the market, such as first-time buyers, self-certification, and right to buy; raising interest rates and reducing intermediary fees. The impact of these actions has seen a dramatic cut-back in the volume of their lending, with some stopping lending altogether and others going into administration. With official figures not yet published as to the impact in terms of total sub-prime lending, one only has to look at the US for some guidance to see that the share of sub-prime new lending as a percentage of total new advances has shrunk from 20.4 per cent to 6.3 per cent in August, a near 70 per cent reduction.
Increasing uptake
The heightened awareness of risk and the need to assign this risk has resulted in a marked increase in the purchase of title insurance throughout the lending community. Off-balance sheet lenders are seeking to make their portfolios as attractive as possible in advance of the securitisation market re-opening and so are looking to assign risk by title insuring these portfolios, including both remortgages and sale and purchases. Equally, smaller to medium-sized lenders who operate a more traditional business model are looking to protect their reserves and their investors or members, and are also looking to assign risk through title insurance.
There is also evidence that as the primary capital markets have dried up, some middle-tier players are reverting more to the wholesale market, with title insurance again coming to the fore as a means of protecting their investment. As a result, in the second quarter of the year, London & European experienced a 40 per cent increase in sales of its lender title insurance policies and interest has noticeably spread across different sectors of the market.
Slowdown in lending
The impact of higher official interest rates and tighter credit conditions has had an immediate effect on borrowing numbers. Mortgage approvals in August fell to 109,000, the lowest figure since 2005. August mortgage approvals were down nearly 10 per cent year-on-year, whereas only 12 months ago they were up 20 per cent year-on-year. Lending to individuals, which has been racing ahead at double-digit growth, has now slowed to 9.9 per cent, the lowest since 2001. Housing equity withdrawal, where homeowners withdraw to finance their spending, fell to its lowest level since 2002, at £10 billion, which represents only 4.5 per cent of householders’ income.
The Royal Institution of Chartered Surveyors (RICS) UK Housing Market Survey in August revealed that house prices turned negative for the first time since October 2005. According to the RICS, new buyer enquiries declined for the ninth consecutive month with potential buyers remaining cautious as the effect of interest rate rises filters through. In August, four of the most-followed calculators of house prices – the Halifax, Nationwide, Hometrack and Land Registry – all said there were signs that demand in the housing market had slowed.
Repossessions
Returning to the issue of security of assets, when the capital markets start to recover, the nature and structure of deals are likely to change, especially in relation to the warranties required in the transactions of non-standard lenders. The impact of rising possession rates on the business models of off-balance sheet lenders will also undoubtedly be scrutinised yet further and questions posed as to the security of their portfolios.
Much has been made in the national press of the increasing number of properties taken into possession in the UK; these have risen by 40 per cent in the last three months and in the US foreclosures have risen by 96 per cent in the last 12 months. The number of properties taken into possession in the UK for the first six months of this year rose by nearly 18 per cent compared with the previous half-year, and nearly 30 per cent compared with the first half of 2006. The increase in mortgage payments that 800,000 homebuyers are going to face between now and December as their fixed-rate deals come to an end could well start to push the numbers of possessions up further.
At the beginning of September, the Citizens’ Advice Bureau (CAB) reported that consumer enquiries about debt rose by 20 per cent in England and Wales last year to a record high of 1.7 million. It is currently handling almost 7,000 debt enquiries a day; 40 per cent of these were for credit card and unsecured loan troubles, and the CAB has experienced a 33 per cent rise in the number of people struggling to pay utility bills. This is worrying evidence that a large number of people are paying the price of enjoying the credit boom and are now overwhelmed by debt, and so their ability to cope with a hike in their mortgage repayment of up to £200 is questionable.
Should possession actions continue to rise, it is likely that title insurance will be viewed as a given by many lenders in order to add a much needed layer of security to their portfolios – and perhaps one that could ultimately be demanded by the rating agencies, who are now actively engaged in investigating the benefits of the title cover over recent months as further upgrades to their rating models.
Buy-to-let market
Rising interest rates could also have a detrimental impact on the flourishing buy-to-let market. Confidence is strong in this sector as landlords are benefiting from the inability of would-be first-time buyers to get a foot on the property ladder as a result of the rises in both property prices and interest rates. Loans for buy-to-let and extensions to existing mortgages rose to their highest ever level in July according to the Council of Mortgage Lenders. A recent survey of landlords by Paragon revealed that investors expected to increase the size of their portfolios over the next year by 5 per cent.
However, there is evidence that more heavily leveraged landlords may be feeling the pinch from higher interest rates, according to a recent survey by RICS. Landlords are experiencing higher borrowing costs and some may find it more of a struggle to get funding as lenders become more discriminating – particularly at the riskier end of the market. Wise investors think ahead and have funds set aside for difficult situations – but many have rushed into the market anticipating easy money as house prices boomed. If interest rates continue to rise and landlords fail to secure the rental income they need to cover their borrowings as competition for rental accommodation increases, this could well push up possession actions in this sector. Once again, title insurance could provide additional security for lenders operating in the buy-to-let market and this appears to have registered with a number of lenders and investors in this sector where the number of inquiries regarding title insurance has risen dramatically in recent months.
The UK mortgage market is entering a period of uncertainty and there will undoubtedly be more casualties in the future as the aftershocks reverberate through the broader economy. Only time will tell how the industry copes and how consumers and government react, but it is likely that the current challenging conditions will prevail well into 2008.
In this climate, the continued application of title insurance to both prime and non-standard mortgage portfolios will be imperative if lenders are to assign risk effectively. Title insurers need to continue to review their product offerings to offer lenders much needed support over the coming months. For those lenders who manage their risks, refine their operating models and hold their nerve, the longer-term picture still remains attractive. The UK mortgage market will survive this period of instability and will undoubtedly emerge to continue to thrive as one of the most dynamic markets in the world.
Christian Bearman is a director at London & European
Date: 5th, December, 2007
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