From 1st July the Council of Mortgage Lenders is integrated into a new trade association, UK Finance. For the time being, all UKF mortgage information will continue to be published on this website, and UKF member-only mortgage information will only be available here.

UK Finance represents around 300 firms in the UK providing credit, banking, markets and payment-related services. The new organisation takes on most of the activities previously carried out by the Asset Based Finance Association, the British Bankers’ Association, the Council of Mortgage Lenders, Financial Fraud Action UK, Payments UK and the UK Cards Association. Please go to www.ukfinance.org.uk for wider content and updates from UK Finance.

Analysis

Published: 19 July 2012 | Author: Bob Pannell

  • Residential mortgage lending has been drifting lower over recent months on the back of softer housing transactions, once we adjust for the distorting effects of seasonal factors and the now earlier stamp duty concession for first-time buyers. 
  • The UK authorities have unveiled a potent set of measures over the past few weeks, aimed at safeguarding our economy from ongoing Eurozone uncertainties.
  • The recent launch of the funding for lending scheme (FLS) comes at a time when credibility in further quantitative easing had started to wane. FLS will help guard against a contraction in lending over the next 18 months and, if the external environment is sufficiently supportive, should underpin the housing market and the government’s wider growth agenda.

Housing and mortgage markets

Broadly speaking, the housing market continues to echo the subdued tone of the wider economy.

Mortgage lending has experienced something of a see-saw pattern over recent months, largely reflecting the short-term spike and subsequent trough in house purchase activity associated with the ending of the stamp duty concession for first-time buyers in late March.  

Chart 1: Gross mortgage lending, not seasonally adjusted, £ million

Gross lending

According to the Bank of England, seasonally adjusted gross lending was £12.2 billion in May. This was a little below the six-month average, and is consistent with a gentle downwards drift since the turn of the year.

Our forward estimate is for unadjusted gross lending of £11.9 billion in June. Although this would place Q2 lending at £34.2 billion, a little higher than Q1 and the year earlier, it would also mark the weakest June outturn for a decade.

The latest market report from LSL Property Services highlights a near record low for housing transactions in June, but attributes this to adverse weather and the Queen’s Jubilee, rather than to any sudden deterioration.

Seasonally adjusted approvals for house purchase edged just 1% lower in May – to stand a little above 51,000 – which also suggests a less than dramatic picture. The recently announced funding for lending scheme (FLS) should help to stabilise market conditions through the second half.

Economy

The UK economy has been lacklustre and directionless for well over a year.

A GDP decline of 0.3% in the first quarter, after a revised drop of 0.4% in the fourth quarter, means that the UK is already back in recession. Distortions associated with the extra bank holiday for the Diamond Jubilee make it likely that the contractionary story will continue, when the initial estimate of Q2 GDP is published on 25 July.

The recent downturn has been very mild compared with the collapse in activity in the immediate wake of the credit crunch. With inflationary pressures easing – annual CPI fell back to 2.4% in June - there are grounds for expecting the second half to be a little better.

Nevertheless, it has provided a salutary lesson that the rebalancing of our economy has the potential to be a drawn out and haphazard affair, and that meanwhile the UK economy remains vulnerable to financial market turmoil.

Speaking at the Treasury Select Committee in late June, Mervyn King, Governor of the Bank of England, gave a particularly gloomy assessment of our economic prospects, warning that Britain may not yet be halfway through the crisis.

Mervyn King has on several occasions reflected the deep concern of the UK authorities about Eurozone developments, and the consequences for UK short-term growth. Both the debilitating effect that the Eurozone is already having on global investment and other spending decisions, as well as the devastating ramifications that would be associated with its break-up.

Since last month’s Mansion House speeches, the UK authorities have unveiled a potent array of measures, designed to show that they are not powerless to act in the face of continuing Eurozone uncertainties.

The recent activation of its Extended Collateral Term Repo (ECTR) facility is designed to reassure financial markets that the Bank of England will provide UK banks with whatever liquidity they need, should the eurozone be at risk of collapsing.

In June’s Financial Stability Report, the interim Financial Policy Committee suggested that the FSA might soften its microprudential liquidity guidance in the light of this additional ECTR liquidity insurance being made available by the Bank, and signal clearly that banks are free to use their regulatory liquid asset buffers in the event of liquidity stress.  For its part, the FSA has moved quickly to respond positively on both issues.

At its meeting in early July, the Monetary Policy Committee left bank rate unchanged at ½%. Although MPC members have considered the merits of a reduction, recent testimony at the Treasury Select Committee suggests that they are unsure whether such action would lead to improved cost or availability of credit for households because of the implied squeeze on the net interest margin for some lenders.

But, as widely expected, the MPC did announce a third wave of quantitative easing (QE3). The aim is to inject another £50 billion of funds into the economy over a four month period.

There has been a greater degree of scepticism amongst market commentators as to the ongoing effectiveness of quantitative easing, but this latest wave is to run alongside the new funding for lending scheme.

Funding for lending scheme (FLS)

On 13 July, HM Treasury and the Bank of England announced details of the funding for lending scheme (FLS), that was trailed in the Mansion House speeches just a few weeks earlier.

The context for FLS is important when looking to frame what success may look like.

The initiative takes place against a backdrop in which lending to the real economy has been broadly flat for over three years (growth in residential mortgage lending has in fact been positive, but averaged less than 1% per annum), loan pricing had recently got worse as banks passed on higher funding costs (mortgage rates had gone up by 0.5% since late 2011) and expectations were of worse to come.

Chart 2: Annual growth in residential mortgage balances and average rate for new mortgage business

Recent growth

FLS aims to counter these trends, by providing cheaper funding than might otherwise be available to banks and building societies.

The innovative element of FLS is that the funding costs for a participating firm are tied to the growth in its lending through to end of 2013. If lenders maintain or increase their lending, funding under the scheme is cheaper than if they reduce their lending.

The Bank mentions a figure of £80 billion but has not set any upper limit on the size of bank borrowing under FLS. June’s Financial Stability Report indicated that at the end of the first quarter banks had already pre-positioned collateral which, after applying haircuts, would support around £160 billion of Bank lending through its Discount Window Facility or ECTR Facility (or the new FLS).

Most organisations have welcomed the FLS in general terms, although it is unclear at this early stage what impact the FLS will have, both in aggregate and for the mortgage market specifically.

While the scheme provides a monetary incentive for lenders to increase their lending, or in some cases for firms to shrink their balance sheets by less than otherwise, firms will need to gauge how it influences their overall lending appetite and pricing strategy. The scheme will also help to test the extent of borrower demand, at a time of continuing pressure on household finances and wider economic uncertainty.

If the external environment is sufficiently supportive, then the FLS clearly has the potential to stimulate credit flows through the UK economy, lift the housing market and underpin the government’s wider growth agenda. But, perhaps even more importantly, it represents a helpful precautionary measure that can help guard against a contraction in lending over the next 18 months.