Firms welcome rule change for 'high net worth' borrowers
Published: 7 October 2014 | Author: Bernard Clarke
The market in mortgages for 'high net worth' individuals is small and highly specialised. Often, such borrowers have significant assets, as well as a high income, which makes assessing the risks associated with lending to such customers rather different from the mainstream market.
We therefore welcome the decision by the Prudential Regulation Authority (PRA) to ease the effect of new rules on high loan-to-income lending, which would have restricted, for no good reason, the ability of niche lenders to advance mortgages to high net worth borrowers.
In June, the PRA put forward proposals to impose limits on higher loan-to-income (LTI) lending as part of its broad remit to reinforce the soundness and safety of firms, and reduce exposure to potential economic shocks.
Now, in response to our comments in conjunction with the lenders specialising in lending to this group of consumers, the PRA has made a modest amendment to its earlier proposals.
The size of firms affected by the PRA’s change to its rules – and the number of loans they advance – are both small compared to the size of the overall mortgage market.
We agree with the PRA’s assessment that the modification of its original proposals will help maintain competition in the market – without undermining the safety and soundness of regulated firms or posing a threat to economic stability.
The proposed rule change
The PRA’s June consultation sought views on how it was proposing to implement the recommendations of the financial policy committee on LTI ratios in mortgage lending.
The key provision relating to the mortgage market for high net worth individuals was to ensure that, from the beginning of this month, firms had to limit lending at a ratio of 4.5 times income or above to no more than 15% of their new mortgages each quarter. In its proposals back in June, the PRA accepted that small firms – those advancing mortgages worth less than £100 million a year in total – should be exempt from this restriction.
In response to analysis from us and other organisations, the PRA has now added a new clause, which extends the exclusion from the 15% cap on lending at 4.5 times income to firms writing fewer than 300 mortgages a year. This means that as well as lending more than £100 million a year, a lender would also have to complete more than 300 mortgages a year before being bound by the new 15% limit.
Although there will be a small increase in the number of firms not now constrained by the LTI cap – because they operate below at least one of the thresholds – we agree with the PRA that this does not represent a threat to economic stability. The PRA says it will monitor the proportion of lending at high LTI ratios by these firms, even though it remains outside the scope of the modified rules.
How does the high net worth mortgage market work?
When deciding whether to advance a mortgage to a high net worth borrower, lenders will often assess affordability on assets, as well as income. It is not unusual for a borrower to take out a loan at a relatively high LTI ratio, even though there is no issue with affordability. The borrower’s assets may also provide security for the loan, and can be drawn upon if mortgage payments are not maintained – so the lender’s risks are well covered.
Private banking relationships tend to be built on a thorough understanding of individual personal financial circumstances and the needs of the client. If a customer takes out a mortgage, it may be a bespoke product, and for a much shorter term than is typical in the mainstream market – perhaps for only a few years. The decision to take out a mortgage may also be shaped by broader decisions about the financial management of assets in a complex and highly individual portfolio.
The result is that lenders in this sector may therefore often have a large proportion of customers with high loans relative to income (as opposed to assets). It is therefore not uncommon for them to wish to advance more than 15% of their mortgage book at a ratio higher than 4.5 times income. But such a business model – and indeed the business itself – remains entirely sustainable.
So, while the PRA continues to focus on a clear remit to guard against economic shocks, the rule change suggests that it too believes that proportionately larger volumes of higher LTI lending to high net worth customers by lenders who specialise in this market does not pose any risk to macro-economic stability.
First of all, the amount lent to these customers is small compared to the wider market – and so are many of the firms operating in this sector. Perhaps more significantly, however, lending in this sector is very stable. The PRA has identified over-indebtedness as a source of potential instability – but high net worth customers with a large mortgage relative to their income are highly unlikely to be ‘over-indebted’ in the normal sense of the word, when all their assets are taken into consideration.
Compared to the mainstream mortgage market, affordability for high net worth customers is also much less likely to be affected by changes in interest rates. They have investment and funding strategies that are fundamentally different to more mainstream borrowers, and their spending commitments and levels of debt are much less likely to be affected by interest rate movements.
High net worth customers also take out mortgages for reasons that are less likely to apply to mainstream customers. It is possible, for example, that they may take out a large mortgage to fund a business. Imposing unnecessary restrictions on lending in this sector could therefore have some implications for the funding of small- and medium-sized enterprises.
Reasons for the change
In explaining its modest relaxation of the rules on higher LTI lending, the PRA said its original intention had been to put in place “insurance against the risk that there could be greater momentum in the housing market than currently anticipated.” In other words, the PRA acknowledged that its rules were not intended “to be binding at this stage.”
The PRA accepts, however, that the LTI lending limit would have had an immediate and unintended impact on the business model of niche lenders.
The PRA is also proposing another modest adjustment to its original proposals, which allows firms to apply the 15% higher LTI limit at a group level. Initially, it had argued that the limit should apply separately to each regulated entity. It now accepts, however, that this could have a disproportionate effect on groups in which there is more than one regulated entity engaged in mortgage lending.
Lenders within a group will now therefore be free to allocate part or all of their high LTI allowance to other firms in the conglomerate. The PRA says its primary intention is to ensure “that the proportion of very high LTI lending does not become excessive in aggregate” and that its primary concern should therefore be “the aggregate number of mortgages extended by that group.”
If the PRA’s view is that relaxing the rule in this way presents no increased threat to financial stability, it does have the positive benefit of promoting competition in the market – and enhancing customer relations. Easing the rules means that firms operating as part of a larger group are now less likely to have to turn away customers with whom they have a long-standing relationship, just to stay within the limit for higher LTI lending.
We welcome the PRA’s decision to amend the rules. High net worth lending is very different to the mainstream mortgage market, and this makes a 15% limit on higher LTI lending inappropriate for small lenders operating in this specialist sector.
The revised rules are sensible and practical. By avoiding the unnecessary exclusion of firms from the market, they facilitate competition – and widen consumer choice in what remains a niche sector. And they do so without undermining the PRA’s key objective of addressing risks to financial stability.