Buy-to-let: when should regulators intervene?
Published: 21 March 2016 | Author: Bernard Clarke
In our response to the Treasury’s consultation on buy-to-let powers of direction for the Financial Policy Committee (FPC), we set out our support for the rationale behind the new powers being proposed.
Lenders accept that there must be robust macro-prudential regulation of the mortgage market, including the buy-to-let sector. But on their behalf we urge caution over the cumulative effects of intervention in the market, given that landlords have yet to absorb the effects of a series of tax changes that are likely to have significant implications for the private rented sector.
Our response argues that, while buy-to-let is a significant and growing part of the mortgage market, it accounts for a small proportion (18%) of total lending. And we believe that the introduction of new taxes – which have yet to come into effect – will slow growth of the sector.
BTL is not the same as PRS
Buy-to-let does make a significant contribution to the private rented sector, which has grown strongly over the last couple of decades. Despite this, however, only around one-third of privately rented properties are currently financed by a buy-to-let loan. The rest are owned outright, or are funded by a commercial mortgage, a business loan or through institutional investment.
Buy-to-let borrowers are also a diverse group. Around three-quarter of them have a single property but, at the other end of the spectrum, a small proportion (2%) own 10 or more dwellings. Lenders reflect this diversity in the risk management strategies they apply to the sector. So, caution is needed about a ‘one size fits all’ regulatory approach, which could affect some parts of the market more than others.
If the proposed powers are granted, as we expect them to be, they would enable the FPC to impose limits on buy-to-let loan-to-value (LTV) ratios, and the interest cover ratio (rental income relative to the cost of the mortgage).
In recognising the over-riding need for the FPC to have at its disposal all necessary macro-prudential tools, our submission argues that any decision to apply them is a much bigger step. We believe that they should only ever be used with great sensitivity, and preferably only after consultation and the publication of analysis and assessment of the likely effects.
We will continue to work with the Bank of England to build a better understanding of buy-to-let business models, and of the behaviour of lenders and landlords. We would also like to see the development of more robust buy-to-let data, and are continuing to work with the Bank to help achieve this. In our view, this is essential before any macro-prudential intervention is implemented.
As part of the process of building this better understanding, we would like to see the Department for Communities and Local Government update its Private Landlords Survey, which was last published in 2010. Since then, the private rented sector has grown by a fifth, so there have been significant changes to the market.
Understanding the sector
Our response raises concerns about the risk and loss metrics used in the consultation because they include other types of lending, not just buy-to-let.
In some parts, the Treasury’s paper relies on information on non-regulated mortgages drawn from the Bank of England’s mortgage lenders and administrators’ return. As well as buy-to-let, this captures second charge loans and first-charge mortgages advanced before statutory regulation was introduced in 2004.
We are also concerned about the potential misinterpretation of buy-to-let data, for example, the higher rate of possession in the sector compared to owner-occupiers. It should not be forgotten that, while lenders extend forbearance when dealing with owner-occupiers in arrears, such an approach is inappropriate for landlords. So, buy-to-let borrowers are more likely than owner-occupiers to be faced with possession if they fall behind with their mortgage payments.
The property market
Part of the case for extending regulatory powers is based on the argument that buy-to-let reinforces the cyclical nature of the housing market, and therefore increases volatility. But is that really so? On one hand, borrowers do draw on growing income and housing equity to fund further borrowing, usually on an interest-only basis. But on the other, they tend to be long-term property investors. And there are other forces on the market which are counter-cyclical, with demand from tenants increasing when the housing market turns down.
Unfortunately, data on buy-to-let mortgages advanced before the financial crisis is patchy, so evidence on the extent to which the market is counter-cyclical is not clear.
What we do know, however, is that the sharp contraction in buy-to-let activity as a result of the financial crisis was primarily driven by the collapse of the global securitisation markets upon which many buy-to-let lenders then relied. This pattern is unlikely to be repeated now that lenders have more varied, stable and reliable funding options.
Meanwhile, the growth of buy-to-let in recent years, which has coincided with a more general property market recovery, partly reflects a recovery from the huge contraction of buy-to-let lending during the financial crisis.
Population growth and economic recovery – as well as the restoration of funding options for lenders – have also contributed to the recent growth of buy-to-let. But the recently introduced taxation measures, which have yet to come into effect, are expected to slow down the acquisition plans of landlords and lead some to sell their properties.
Another trend had been the modest decline in the number of loans advanced at higher loan-to-value ratios over the past two years, despite the buoyancy of the buy-to-let market. The forthcoming tax changes could reinforce this trend.
In our market forecasts published at the turn of the year, we predicted that these tax changes would contribute to a slowdown in activity. The full effects will not be properly understood until some time after the measures have been introduced, but recent survey data shows that the tax proposals have knocked landlord confidence. A survey of landlords undertaken by BDRC Continental in January showed that:
- Landlord confidence had fallen since the Budget last year, and is now lower than at that the start of the financial crisis in 2007.
- The number of landlords intending to sell property exceeds those who are planning to buy. Some 43% do not intend to acquire any more buy-to-let properties or will reduce the size of their portfolio. And three-quarters of those intending to decrease their portfolio say the measures announced by the chancellor are driving their decision.
Interest cover and loan-to-value ratio
While the Treasury’s proposals would limit LTV and interest cover ratios, some lenders favour a more bespoke approach to assessing affordability, taking into account customer profile and mortgage product features. This might be a more reliable reflection of the personal and property income of borrowers, and their ability to increase rents. This kind of tailored approach to “underwriting the whole customer” might therefore better reflect the borrower’s circumstances, the affordability of the mortgage and market risk.
Our response also suggests that, in considering whether to set minimum interest cover, regulators should reflect on whether the ratio should take into account the impact of void periods, the cost of maintaining the property, and whether or not any limit should apply before or after tax.
When would intervention be necessary?
We believe that any power to intervene should only be applied where there is strong evidence that the buy-to-let sector poses a particular risk to macro-prudential stability. And lenders also want to be confident that intervention would address specific risks identified by the regulator.
While recognising that there is sometimes a need for regulators to act quickly, we believe that in other circumstances they should go through a process of consultation and carry out cost-benefit analysis and a regulatory impact assessment.
Even if the regulator sees a need to intervene quickly without going through these processes, we would like to see the authorities set out their reasons for intervention subsequently and for parliament to scrutinise those decisions.
Our response sets out a number of other issues that we believe should be clarified in considering the extension of powers of direction, including:
- Newly-built property. Is it the intention that regulatory intervention should capture property development loans? The Treasury’s paper does not distinguish between lending to individuals and small and medium-sized enterprises. We would also like clarity on whether lending on homes in multiple occupation would be captured by the proposals.
- High net worth borrowers. Is it intended that lending to high net worth individuals should be excluded from any proposed regulatory intervention, as it is in the owner-occupied market?
Lenders do not dispute the need for robust macro-prudential regulation of the buy-to-let sector, but it is crucial that regulators have the right powers – and that they use them in the right ways. The decision to grant power of direction to the FPC should be based on careful analysis of all the appropriate data and on a proper understanding of the real risks.
Should the regulator be granted powers of direction, as we expect, we would like to see the FPC consult and undertake cost-benefit analysis and a regulatory impact assessment before seeking to intervene. We accept that in some circumstances intervention may be necessary without going through these processes. But, if that happens, the regulator should set out its rationale for doing so subsequently, and come under the scrutiny of parliament.
Finally, regulation of the buy-to-let sector could also be affected by proposals from the Basel Committee on Banking Supervision to change the rules on holding capital against mortgage assets. While the Basel measures would only come into effect after plans to extend powers to the FPC, it is crucial for the authorities to understand the cumulative impact of intervention in the buy-to-let market.