Neil Warman of HML examines how funding is driving strategic change throughout the mortgage industry and how obtaining it is only the first hurdle when deciding how to operate in the
There has been a lot of talk about funding in recent months which is no surprise as, let's face it, there can't be any lending without it. Different types of lenders have varying requirements following the downturn in the economy, and each faces a distinct set of challenges. The decisions they have to make span much further than putting a tick in the box of 'funding in place' and in this piece I'm going to talk through some of the broader considerations lenders, new or existing, face today.
The existing players
Let's start with the oldest sector of the lending market. Building societies have been amongst the hardest hit in the
The specialist lending community, previously the rising star of the UK mortgage market, has also been hard hit and many of the new brands that had come to prominence in recent years have now subsided or, in many cases, been wiped out. As well as taking some of the flair out of the market, this has hit the intermediary community particularly hard and created problems for mortgage advisers that have been well documented in the press.
It's certainly been tough for the smaller players on a number of fronts. Despite the introduction of the authorities' support schemes, such as The Bank of England's special liquidity scheme (SLS), they have been of little benefit to the smaller lenders as they are not accessible to these companies who so desperately need them. This, combined with their lack of access to economies of scale has left them vulnerable. In the case of building societies there has been renewed talk of the opportunity of sharing certain key services in a bid to manage costs more effectively and sustain certain business activities, such as specialist products. We have been involved in a number of these discussions and continue to talk to the building society community about how such arrangements could work.
The overall impact has been a concentration of the remaining lending activity amongst the largest lenders in the industry - those for whom access to funding is more easily available. That's not to say these institutions have not had their challenges too of course, and the pressure to raise retail savings deposits in order to repair and improve capital as well as to be able to offer new lending has been further complicated by the low interest rate environment.
The problems of the retail banks have been well documented in recent months following the near collapse of a number of high-street banks and the resulting government intervention has been widely discussed. We have seen lending by these banks focus on low risk borrower profiles, with a minimal appetite for high loan-to-value loans or anything more than conservative income multiples.
The non-standard elements of the lending market have been all but eradicated. Adverse mortgages now make up a tiny proportion of total lending and self certification is being withdrawn by a number of lenders in anticipation of regulatory change.
Lenders are understandably wary of risk, and as a result are becoming ever choosier about where the money goes. This risk aversion has culminated in the Financial Services Authority’s Mortgage Market Review (MMR), which will precede a much discussed increase in regulation for the lending market. The MMR has led to increased aversion in general to ‘toxic lending’ and also put focus on diversified business models that may lead to higher capital requirements and put the focus on driving down costs.
The resulting increased regulatory intervention has raised some fundamental questions about the role of the financial industry within the wider economy. There is always a need for some risk, not least to act as a barrier to entry, but also to encourage a dynamic and innovative economy. However, this more stringent regulation has meant that funding is harder to acquire.
The new entrants
As is always the case in times of adversity, there are some opportunities opening up and these are being eyed by a number of organisations including well known household name retail brands. Such well-known and trusted companies are undoubtedly well placed to do well with customers as the heritage and familiarity attached to them will be a major asset that can be drawn upon when marketing the products on offer. Having a strong brand and funding in place won't necessarily make these new entrants a commercial success though, and they have a lot to think about, for example: How much lending do they want to do? How will they match this to the potentially sky high demand they are capable of generating? What will be the impact on their overall brand/customer experience of them entering into a new product area where they have no track record or experience?
The key consideration for these big brands is around infrastructure. Anyone looking to be a successful lender will need to ensure they have the appropriate technology, operational capability and risk management systems in place. For an established financial operation the chances are they will have these. For different types of lenders, including supermarkets and other 'new lenders', they will need to be built, bought or outsourced to ensure they are implemented.
The learning curve for setting up a new lender is a steep one, and outsourcing is likely to be the preferred route in most cases. In recent times, outsourcing has emerged as a major trend within the lending market and the facilities exist in the market to help new lenders launch. Before the credit crisis, lenders had begun to look more strategically at outsourcing as a value creator rather than as a pure cost reduction exercise, and then as the downturn worsened, the strategy became more one of keeping costs down to survive. Who gets funding and when they get it will likely have a major impact on the development of the outsourced mortgage servicing market in the coming months. Our discussions around the market certainly suggest this to be the case.
An outsourced business strategy can provide a variable cost base, which is obviously attractive for lenders facing fluctuating or quickly rising business volumes. The economic background of recent times has also seen a rise in specialist lenders coming into the market, who do not have the infrastructure to manage their books themselves so quickly or efficiently; plus there is a rise in bank and building society mergers with their own challenges in terms of managing the integration of current and legacy systems and back office functions.
The innovators
From our own perspective as the largest provider of outsourced mortgage servicing in the
One such example has been a relationship we have established with a hedge fund that was seeking to purchase mortgage assets from existing lenders. Although it was an FSA regulated entity the firm was unable to take over the legal title on the loans as it did not have the Part 4 lending permissions. This is not a legal requirement, but lenders who are selling assets are unwilling to sell to an investor without this in place. By using an authorised entity from within our own business as part of the transaction, we were able to demonstrate the customers will continue to be treated fairly under the lender's policies and TCF approach. This arrangement meant that the lender selling the mortgage assets was happy, and the buyer of the assets was able to service them on an existing platform, which came with the reassurance of robust compliance procedures. HML was obviously happy because we obtained a new client, and the whole transaction was completed in a transparent fashion with the full awareness of the regulator.
The Treasury has recently issued a consultation paper on mortgage regulation in which it is talking about potentially regulating the transfer of mortgage portfolios. This would involve the introduction of a new FSA permission for 'managing a regulatory contract'. This could place a new angle on this sector of the market and could lead to a requirement for investors such as hedge funds to gain a new FSA authorisation in order to engage in this activity.
There is an interesting role to be played by cash-rich investors such as property funds as the market starts to pick up. There are tentative signs emerging from the market hinting at a recovery in the wholesale funding sector but this is unlikely to see a spectacular return in the near future. Cash rich investors are looking for deals on assets they can buy below market value so they can make a profit from them. This is placing an increasing volume of mortgage assets within the control of this sector and making it an increasingly prominent group.
The future
There seems to be some early jostling for position in the lending market at present. Market share has not been a hot topic in 2009 but the dynamics have changed a lot and lenders such as HSBC have been grabbing chunks of the market. As the other major lenders start to map out their strategy a trend we have noted at HML is a marked increase in interest in outsourcing. Some of the existing lenders, particularly those who have been involved in mergers or consolidation, are looking to resolve issues around multiple legacy platforms by outsourcing to a third party servicer's systems and processes. This allows the lenders to focus on their current and future business and get to market more quickly, which they will need to do if they are to avoid falling further behind in the market share stakes.
We started this article talking about funding so it is only right we return to that topic at the close. As we have discussed throughout this piece, funding is vital to the lending industry but there is a lot more to think about than this when trying to weigh up the future of the market. There are many strategic decisions to be made by the organisations that will play in the lending arena in the future. It certainly promises to be an interesting next 12 months for all involved in the market. I'm looking forward to seeing how things play out and reflecting on a year of development when we look back in 12 months’ time.
Neil Warman is chief commercial and finance officer at financial outsourcing provider HML
Date: 12th, January, 2010
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