CML news & views

The lending industry – and its regulator – must learn the lessons from the past in order to ensure that the mortgage market of the future is properly regulated, the CML said today.  

In a wide-ranging speech to today’s mortgage sector conference hosted by the Financial Services Authority (FSA), we put the case for regulation focusing on key areas of potential consumer detriment, better supervision of firms by the regulator and the restoration of a sustainable mortgage market. 

The speech reflected initial feedback from lenders on the key regulatory issues we need to address.

It reinforced our view that the recently published Turner Review presented a thoughtful description of the global banking crisis and the breadth of issues to be addressed in the UK and internationally. The mortgage market is a small but crucial part of the jigsaw.

In making adjustments to the regulatory system, it will be important to unbundle broader, systemic banking issues relating to capital, accounting, liquidity and other matters from the review focusing specifically on mortgage lending.

We know from talking to lenders that the industry recognises a need for change. But we also believe that the mortgage conduct of business (MCOB) rules overseen by the FSA have largely fulfilled their purpose and do not need substantive amendment.  We need to avoid change for the sake of it. But looking again at how the rules and principles are applied and supervised by the FSA might achieve a better overall result for consumers.

Some key questions 

As the Turner review suggests, it is important that there is a proper analysis of areas of real consumer detriment – and what caused them. What we need is careful scrutiny of real problems in the mortgage market, not knee-jerk reaction to ill-informed perceptions. Our speech sought to identify a series of key questions for the debate about the shape of regulation, including:

• Will the existing regulatory structure ensure that, in future, mortgages balance risk and price appropriately for the lender, and are suitable and affordable for consumers? If not, what do we need to change, and why?
• Has the growth of remortgaging been a good thing (that is, a healthy indication of consumers switching effectively between providers) or has it been driven by a combination of churning by intermediaries, matched by serial re-financing by some borrowers?
• Does the increase in mortgage arrears and possessions in the last 18 months show that lenders have lent irresponsibly in the past, that customers have over-extended themselves by borrowing irresponsibly, that lenders are taking possession too quickly and not treating their customers fairly now, or that higher unemployment is creating more payment problems, as might be expected in any economic cycle?
• Have consumers taken sufficient responsibility for their own actions or relied too much on poor quality advice?
• Has the government been right to promote a culture of home-ownership in its desire to create an asset-owning democracy in the UK, or has this simply led to more marginal borrowers taking out loans that proved unaffordable when those customers were confronted with a financial shock?
• What sources of funding will be available to meet consumer demand for mortgages in the future, and what can the FSA do to help, rather than hinder, market activity? Will mortgage rationing continue? And should the FSA be seeking to re-open the market to improve economic prospects, and not close the door to interested lenders by its prudential attitude?

A starting point

We endorse the FSA’s view – set out in its business plan – that it should review the value chain, extending from lenders through intermediaries to consumers. There needs to be an acceptance of responsibility across the board, including by:

• lenders, some of whom have mispriced some mortgage products, relaxed credit standards or relied too heavily on the securitisation market;
• intermediaries, whose behaviour may have worsened the outcome for some consumers and who may need to accept changes to their future obligations and in the structure of their sector; and
• borrowers, some of whom may have borrowed irresponsibly and may need other forms of protection, if they are not adequately protected by lenders’ affordability models or by the quality of advice they receive from intermediaries. “But,” the speech asked, “how do we introduce protection for the few without reducing the choice of the many?” And how can we do this without undermining the potential innovation and other benefits of competition that most consumers want to maintain?

Running in tandem with the debate now under way about the future shape of regulation in the UK is another one about regulation in Europe. “It is therefore absolutely vital that what the FSA does in this UK review runs with the grain on international issues, both in banking supervision more generally as well as mortgage regulation specifically,” today’s speech said.

Better regulatory supervision

We have already begun a process of consulting widely with members and, so far, four main themes have emerged. But we are only at the start of the process, and consultation with lenders will continue. So, the views expressed in our speech today are not our final word, but a first contribution. The first theme already clearly identified by lenders, however – and one which the FSA acknowledges – is a failure of regulatory supervision.

“The quality of supervisors needs to be improved,” the speech said. “The types of dialogue which supervisors and firms have are mixed, and we are some way from a relationship of mutual trust and understanding. 

“A regulator seeking to instil fear will fail again. What we need to have, but we do not yet consistently have in place, is proper informed debates between firms and supervisors, and appropriate prudential requirements to match business models and risks.”

The role of intermediaries

The second theme emerging from our consultation revolves around mortgage distribution and the role of intermediaries. We have seen some of the problems created by customer churn, product and commission bias, the misrepresentation of borrowers’ income and poor quality advice. 

We believe that larger intermediary firms are less likely to exhibit this kind of behaviour, and there is a need to look at a combination of enhanced intermediary authorisation, higher capital and professional insurance requirements for firms, more rigorous training and qualification standards for advisers, and a review of remuneration in the sector. “Market expectations suggest that the majority of future business will continue to come from mortgage intermediaries, so this is something we cannot leave to chance.”

The lending industry must, of course, accept its share of responsibility for what has gone wrong. Some lenders have priced products in ways that have encouraged consumer churn, or enhanced their commission for particular types of products, relaxed credit standards in products, for example, without income verification, or not priced properly for risk. With mortgage funds now scarce, however, this laxity is not likely to return in the foreseeable future.

Risky products?

Does this mean that we need to ban “toxic” products or even to put limits on loan-to-value ratios or loan-to-income multiples? We are asking members for their views, and will feed them into the debate. And the Turner review has said it will look at the evidence and experience in the UK and internationally.

We know that some countries already have loan-to-value limits. Some also have enhanced government-backed insurance. “We also know that the UK has developed better, more focused mortgage products to meet consumers’ needs at different times in their lives than in any other country in the world.”

So there has to be a balance between reducing risk and volatility, and reducing the availability of products that have benefited customers. These include higher loan-to-value loans that have allowed people to become home-owners, flexible mortgages which help financial planning, offset products that encourage both saving and borrowing together, equity release that helps people enhance their income in old age, products that comply with Islamic principles and so on.

There are ways of offsetting risk other than simply by banning products. Compulsory mortgage payment protection insurance, for example, might be preferable to simply stopping customers from taking out mortgages. Feedback from lenders has already highlighted the need for the FSA to look more closely at prudential risk and higher capital requirements for more risky business models. We believe that a product ban is too blunt an instrument and would not achieve its objective.

Reassuringly, the FSA accepts that the emphasis must be on getting it right, and not rushing to implement knee-jerk reaction in the way we warned against in our speech.

In his own address to the conference, Lord Turner made it clear that he had not made up his mind about banning products and made “no apology for that lack of certainty.”

He continued: “What I have tried to do today is to indicate that the issue is a complex one, which requires careful consideration and further empirical analysis, running up to the FSA September discussion paper, and indeed subsequently, in a wide-ranging debate.

“We do not need to rush to decision. We do not face today, nor are we likely to face any time soon, the danger of irrationally exuberant behaviour by either borrowers or lenders. We have time to get it right. And getting it right is very important, given the huge importance of the mortgage and housing markets to individual households, to banks, building societies and other credit intermediaries, and to the macro economy.”

The scope of regulation

We have consulted on whether lenders believe that regulatory scope should be widened. We first suggested that the FSA should regulate secured second charge lending in 1999. If that were to happen, however, it would be important for the FSA to manage any additional responsibilities without taking its eye off the ball of delivering the enhanced supervision we all want to see in place first.

Regulating buy-to-let lending is more problematic. There is support in principle for it among lenders, but should it be regulated by mortgage or investment conduct of business rules? And clearly an amateur landlord has a different regulatory need than a professional, perhaps running a sizeable business. A blanket approach would therefore be inappropriate.

Conclusion

So, what lessons can we learn from the past?

“First, the FSA spent too much time on the minutiae of consumer protection issues, and the treating customers fairly agenda, and insufficient time and rigour on prudential issues and systemic banking risks.” Regulatory activity therefore needs to be re-balanced. Recent feedback, however, suggests that FSA staff in their various silos are still pursuing too many small issues, rather than focusing on the “big ticket” risks.

Second, better supervision needs to be embedded within the FSA. Until that happens, there are risks in extending the FSA’s scope. But a view is emerging from the industry is that there may be a case for widening the regulator’s role to protect consumers taking out secured and buy-to-let loans.

Third, in a market influenced substantially by intermediaries, a culture of compliance must be enshrined in small firms to ensure that a better outcome is routinely delivered for customers in future. Otherwise, the structure of the intermediary sector will need to change.

Finally, there is a case to be explored for banning particular types of high-risk products. Our initial perception, however, is that risk can be addressed in more appropriate and better targeted ways.

Chief executives from the new agencies set up to deliver and regulate affordable housing told delegates at the CML’s first conference on the funding of the sector earlier this month that their continuing action to invest was essential to ‘kick start’ the housing market.

The chief executive of the Homes & Communities Agency (HCA), Sir Bob Kerslake, welcomed recent signs of a slowdown in the rate of decline of the housing market but urged delegates, including policy-makers as well as representatives of lenders, housing associations and developers, to face the reality that the full effect of the wider economic downturn was still to come. 

Addressing the conference, he said that market conditions would be crucial in using his budget of £17.3 billion, for the period 2008-11, to lever in private investment. The key priority for his teams in the year ahead was to respond to the market downturn. New teams had been set up within the HCA to focus on its recently launched kickstart housing delivery programme and new funding models.

Lenders and social housing

Lenders’ behaviour was highlighted as the biggest single factor in delivering the HCA’s goals on housing and regeneration. It was also clear that from the perspective of the Tenants Services Authority (TSA), the agency set up to regulate housing associations, working closely with lenders had helped the sector avoid the business failures seen in other parts of the economy. 

TSA chief executive Peter Marsh described how 93% of the borrowing needed in the next 12 months was already in place. Meanwhile, the recent threat caused by margin calls on swaps in the short term had been mitigated by many of these being incorporated into loan agreements that can be repaid over a longer period of time. 

This spirit of close working was the theme of the keynote address by Iain Wright, Parliamentary under-secretary of state at the Department for Communities and Local Government. The junior minister for housing congratulated lenders for their commitment to the affordable housing sector. 

Responding to a question on the need for stronger government leadership on future housing market and tenure policy, the minister referred to previous work jointly undertaken with the CML at the onset of the credit crunch. He asked to meet representatives of the CML and individual lenders in the next few weeks, and we are now trying to finalise a date for the meeting with the minister.

Investment opportunities

Many speakers referred to the opportunities for investment offered by the affordable housing sector. Peter Marsh described strong, consistent returns that were attractive to a range of funders, including covered bond houses, pension funds, lenders, including banks and building societies – some now returning to the sector – and insurance firms. 

Limited use of the capital markets by housing associations was seen as a lost opportunity, both for the sector and for investors. One delegate suggested, for example, that capital markets provided only 8.5% of total private finance for housing associations, compared to 84% for utility companies. 

A session on capital markets funding given by the managing director of global infrastructure at RBC Capital Markets London, Henrietta Podd, concluded that the affordable housing sector would increasingly need to look to the bond markets for funding. Its ability to access the markets would have the effect of encouraging bank lending in the longer term.

Regulation reduces risk

The TSA has increased its focus on the regulation of financial viability and governance of housing associations in recent months and, through quick and targeted action, has supported the sector and helped it to meet the challenges brought about by the recession. Housing associations have suffered from falling receipts from sales through shared-ownership schemes, as well as new funding becoming scarcer and more expensive. 

Under the strong regulation of the TSA, the sector has re-aligned its development programme, re-balanced tenures and continued to build even when private developers have pulled back. Stewart Baseley, executive chairman of the Home Builders Federation (HBF), highlighted a difficult picture for his members, with a dramatic reduction in funding continuing to decimate the ability to invest in land and in the workforce needed to deliver the new housing of the future.

Experts from both the housing and finance sectors agreed with academics that the key concern was not the viability of affordable housing providers but a loss of confidence in the sector and a slowdown in activity. This would slow both the rate of housing market recovery generally and efforts to get developments going again by bringing forward public investment.

First-time buyers

As the housing sector and policymakers search for a new model to provide affordable access to home-ownership, particularly when there is a revival of interest from first-time buyers, the conference confirmed that current housing and economic conditions continue to dampen the supply of lending to this group of mortgage customers. 

Providing an insight from a lender perspective, Phil Jenks, the former chief operating officer of mortgage business at Halifax and now an independent consultant, stressed that falling house prices continue to underpin lenders’ concerns for supporting low-cost initiatives requiring higher loan-to-value lending.

Bringing back lender support would, in his opinion, need an overall plan and vision which fits the market context, as well as a small number of schemes, based around shared equity, to deliver greater simplicity and lower risk. A recent issue of this newsletter set out our lobbying of government on reform of low-cost home-ownership products.

The debate for the conference’s final panel session saw Professor Christine Whitehead, of the London School of Economics, Piers Williamson, the chief executive of The Housing Finance Corporation, independent housing consultant Rachel Terry and Phil Jenks give their views on the role of affordable housing and intermediate tenure in the future. They agreed that a national approach was needed with much better availability and exchange of data before any assumption of widespread lender support.

Insurers have called for a long-term commitment to maintaining and improving flood defences so that cover remains widely available to the owners of two million homes and businesses known to be at risk of flooding.

Lenders support improved flood defences because being able to get insurance against flooding is normally crucial in obtaining a mortgage.

The Association of British Insurers (ABI) described the recent Flood and Water Management Bill as a “vital first step” towards implementing the recommendations of the Pitt Review to make properties in England and Wales safer from flooding. It said it wanted a political consensus to deliver reform, and urged all parties to work together. The ABI also called for a long-term strategy to:

• create strong national leadership on flood management, with targets and a statutory duty for the Environment Agency to reduce risk;
• establish new powers and responsibilities to tackle surface flooding, with a bigger role for local authorities, which would be required to produce water management plans;
• promote community action to reduce flood risk, with the Environment Agency and local authorities working on flood resistant and resilient measures to help property owners where it is not practical to defend from flooding; and
• modernising the approach to managing flood risk, for example by developing a more risk-based approach to regulating reservoirs.

The ABI also said it wants to see publication of a long-term funding strategy for flood management.