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Finding funding: where are we now?


Published: 1 February 2011 | Author: Bernard Clarke

For more than 40 months now, UK mortgage and housing markets have been suffering the fallout of the credit crunch, leaving lenders and borrowers to cope with a prolonged shortage of funding for home loans. Triggered by the collapse of wholesale markets, the crunch meant the abrupt closure of the market for UK residential mortgage-backed securities (RMBS) and covered bonds, a funding source that generated a net £78 billion in 2006, enough to finance more than 70% of net lending in that year.

Since August 2007, wholesale funding markets have functioned spasmodically. Until recently, only the largest banks and building societies had managed to complete securitisation deals. But since last autumn, there has been a noticeable pick-up in securitisation activity. Unfortunately, however, this has not had such a significant impact on mortgage availability. 

This is partly because commitments to re-pay support extended by the authorities during the financial crisis are now bearing down heavily on firms’ ability to expand lending activity. Another factor is the large volume of existing bonds coming up for redemption, which requires lenders to issue new ones just to maintain current levels of wholesale funding.

The impact on first-time buyers

The biggest impact of the continuing shortage of funding is on higher-risk borrowers, including first-time buyers. They are likely to continue to find it more difficult and expensive to get mortgages while current conditions persist. Some of these difficulties were highlighted in a BBC File on Four programme last week focusing on mortgage and housing markets, to which we contributed.

Some countries are taking a different approach to the UK, where the authorities are now beginning to wind down official support schemes. In Australia, by contrast, the government is this year planning to complete another tranche of investment in RMBS, with the aim of promoting a more competitive mortgage market and cheaper borrowing for consumers. In a recent paper, the Australian Treasury department concluded:

“The government’s support for the RMBS market has been absolutely vital in keeping some smaller lenders afloat, and allowing many smaller lenders to continue lending at cheaper rates to put more competitive pressure on the big banks.”

The collapse of wholesale funding markets – and the official response

From 2000 until the onset of the credit crunch, the value of outstanding UK RMBS and covered bonds rose from £13 billion to £257 billion. This helped fund a diverse and highly competitive domestic mortgage market, with a range of different types of lending organisation offering a wide choice of products for consumers.

The sudden collapse of the market in RMBS and covered bonds left a big hole in the funding of home loans. The authorities responded to the crisis by injecting funding into the system, chiefly through the special liquidity scheme (SLS) and the credit guarantee scheme (CGS). Over the next four years, however, firms will have to re-pay their commitments under these schemes as the Bank of England and the Treasury move to close them down. The clock is ticking and, by January next year, £110 billion is scheduled to be repaid under the SLS, with a further £120 billion advanced through the CGS due by 2014 at the latest.

Different types of lender were affected differently by the funding crisis, and not all have had the same access to official support schemes. The SLS, for example, was not open to non-deposit takers or smaller building societies. Funding problems have been particularly acute for smaller lenders in the UK, as well as those without access to retail deposits, and this has helped bring about a further concentration of lending activity in the hands of a small number of large banks and building societies. Unlike the government in Australia, the UK government has not sought to promote diversity or competition.

Growers, repayers and shrinkers

The impact on different types of lender of the ways in which official support measures were implemented was highlighted in a report published last month by UBS. Aptly titled UK Mortgages – Running Hard to Stand Still, the report concluded that UK lenders could essentially by grouped in three different categories:

  • Growers, comprising a handful of large lenders estimated by UBS to have advanced a similar amount of gross lending in the 18 months up to June 2010 as they did in the immediate 18-month, pre-crisis period up to June 2007.
  • SLS repayers, comprising those firms that have prioritised the need to repay commitments under the SLS and other schemes, so that they no longer have to rely on government-supported funding sources.
  • Shrinkers, including those firms that no longer have a strategic interest in the UK mortgage industry and are slowly divesting themselves of a legacy of existing loans on their books.

New activity generated by growers is being largely offset by the activities of shrinkers, the report said, with SLS repayers having a broadly neutral effect, leaving net lending almost flat – as we saw in 2010 and are now forecasting will continue in 2011. 

The UBS report concluded: “If the headwind to mortgage lending from SLS repayment or the run-off in legacy books becomes a structural impediment to a normalised level of credit creation in the UK, then we would foresee a need for government intervention to slow down the pace of contraction in the run-off books it controls or to provide a permanent successor to the SLS.”

We had already come to a similar conclusion in our own report The outlook for mortgage funding markets in the UK in 2010-2015, published a year ago. Our report questioned whether firms would be able to meet the proposed deadlines for repaying their commitments, and suggested that an extension may be required.

Market share, and consumer choice

The financial crisis, the official support measures introduced by the authorities in response to it and the impact on individual lenders have brought about some profound changes to the UK mortgage market. 

Gross lending fell sharply between 2007 and 2009, but the largest decline in volume from pre-credit crunch levels has been experienced by specialist or non deposit-taking lenders (92%), followed by building societies (64%) and banks (52%). Bank of England data shows that banks have increased their share of total lending from 68% to 83%, building societies have, in effect, been treading water (with a 13% share of lending in 2009, compared with 14% two years earlier), while the share of specialist lenders has shrunk from 17% to 4%.

Events since 2007 have also led to some significant changes in the range of products available to consumers. Chart One shows, for example, that the number of mortgages advanced with a loan-to-value (LTV) ratio of over 90% fell from over 310,000 in 2007 to 47,000 in 2009, a decline of 85%. And lending criteria for first-time buyers have tightened significantly, with the average LTV for this group declining from 90% in 2007 to just over 75% for much of last year (although it increased again to 80% in October and November 2010 – the last two months for which data is available.)

Chart One: The number of mortgages granted over 90% LTV


Source: CML

A dysfunctional market

The problems encountered by different groups of consumers – including first-time buyers unable to raise a large enough deposit, and existing home-owners who do not have enough equity in their existing property to move – were highlighted in last week’s File on Four programme. Questioned for the programme about the plight of first-time buyers, CML director general Michael Coogan replied:

“It is an irony that the people who are least able to afford it are exactly the people who are having to pay more. But that’s also a consequence of regulatory changes across the world, which mean you have to have more capital to protect yourself with high-risk customers.

“We are all frustrated by the fact that this creates a dysfunctional market, where first-time buyers who want to enter the market are being prevented.”

The Australian model – an alternative approach to the funding crisis

A recent report by the Australian Treasury department highlighted the “profound dislocation” of global capital markets, including the market for RMBS. The ability of smaller lenders in Australia to issue RMBS was identified as one of the biggest drivers of competition in the domestic market, allowing its regional banks, wholesale lenders and mutual credit unions and building societies to advance mortgages to customers.

The value of RMBS issued in Australia declined sharply from $68.4 billion in 2006 to $14.2 billion in 2009, with a partial recovery to $15.6 billion in the first eight months of 2010. Between November 2008 and early December 2010, however, $26.2 billion of the £34.3 billion RMBS that were issued – 76% of the total – were sponsored by the Australian Office of Financial Management (AOFM).  And $12 billion (35%) was actually purchased by the AOFM.

Now, the Australian government is planning to invest a further $4 billion in high-quality AAA-rated RMBS. The AOMB and the Treasury believe that direct investment is a better way of supporting the market than introducing a government guarantee of RMBS because, it argues, investors already understand that Australian mortgage-backed securities are of high credit quality. The Reserve Bank of Australia also agrees that direct investment is more appropriate than a government guarantee.

The Treasury report argued that government investment in RMBS “continues to put downward pressure on borrowing costs for households and small businesses…investment is helping the RMBS market again become a cheaper, more competitive source of funding for smaller lenders.

“It is giving private investors the confidence to invest increasing amounts of their own money in this important market, and helping smaller lenders to continue lending at competitive interest rates and keep more market share than would otherwise be possible.”

The report concluded that the subdued RMBS market had been a key factor in preventing smaller banks and non-bank lenders from competing against larger banks by offering cheaper home loans. “The Treasury and the AOFM advise that, with additional support, the RMBS market would be expected to improve further from current levels and become an even more competitive funding source for smaller lenders,” it said.


More than 40 months after the credit crunch, lenders and borrowers are still dealing with the consequences of an acute shortage of funding. Lenders have been affected in different ways, partly depending on their access to alternative sources of funding, and to measures introduced by the Bank and the Treasury in response to the crisis. Not all lenders have been able to draw on the official support – and those that have are now required to re-pay their commitments as the schemes are wound down.

The shortage of mortgage funding has left the UK with a dysfunctional market, with restricted choice and competition, particularly for higher-risk customers. Other countries, meanwhile, are pursuing different approaches to the crisis. Industry experts around the world will watch with interest to see how successful the Australian authorities are in promoting mortgage market competition and choice by investing directly in RMBS.