Interest Only Mortgages

• Published analysis shows that fewer than 1 million interest-only mortgages originated pre-2008. A detailed survey shows that 50% of these mortgage holders will face some degree of shortfall in repayment, and many are overly optimistic about their ability to make the final repayment.

Green Mortgages

• UK climate change committee predicts that £250 billion will be required to equip houses to fully decarbonise by 2050, noting that many houses can improve their EPC ratings for less than £1,000.

Finance Bill

• Securitisation is an important instrument in financing mortgages. HM Treasury will establish a framework for regulation.  - A draft was published on 10 July 2023 (period for comments has now closed). PRA and FCA published guidance on 7 August 2023.
• Consultation revealed that the proposed framework does broadly achieve intended outcomes and will be retained, with amendments to make the bill more practical and suitable to the UK market as well as to remove any barriers to issuance.
• Changes include: clarifying due diligence requirements and the information investors should have access to when investing in a securitisation; and amendment and clarification on risk retention requirement to facilitate non-performing asset securitisation.
• The consultation period is due to close on 30 October 2023. The new rules will be published either by the end of Q1 or Q2 2024. Second consultation period will then commence which will focus on reporting regime as well as ESG reporting.

The UK Mortgage Market Outlook Amid Low Housing Supply, Declining Values in Commercial Real Estate, High Inflation and Political and Legislative Developments

• Pressure on interest rates likely to continue in the short to medium term but the UK market is likely at, or close to, peak interest rates (5.25 – 5.75%).
• The buy-to-let market is down 40-45% compared to last year. Rates for 2022 were 2.9% on a 5 year fixed term rate – currently rates are in the vicinity of 6-7% for various products.
• The current unemployment rate, at 4%, is not high enough to affect the market. Rating agencies observed if this would start to affect the market significantly if around 6-7%.
• A significant unwinding of investor positions in commercial real estate.
• Decline in house prices - 5.3% decline compared with last year, with another 1.2% projected drop before the end of 2023. Part of this decline is attributed to changing buyers’ expectations. The panel predicted that property prices would likely flatline and then grow modestly from mid 2024 onwards.

Elections, Inflation, and the 2024 UK General Election: Heading toward a Labour Government?

• Labour projected to win the next general election. Keir Starmer requires 2.5 point lead to secure victory in 2024. His popularity is currently at +15%.
• Rishi Sunak’s popularity reached its height during the Covid pandemic however this has dropped significantly since then. Narrative in Downing Street is that he can turn this around, however, his ratings are the lowest they have been since coming into office.

Navigating Choppy Waters: What’s on the Horizon for Specialist Mortgage Lenders in this Challenging Market?

• Mortgage lending in the UK is still robust with delinquency rates of retained mortgages still very low.
• The market is being propped up in part due to the delayed passthrough of interest rates to consumers.

The Macro-Economic Picture and its Impact on the Housing Finance Market

• Rating Agencies projected an overall 10% decline in house prices but noted that most of this has already played out in the market. They expect house prices to stabilise in 2024.
• Policy rates have further to rise in the UK: two more rate rises likely later this year
• The UK is lagging behind other advanced economies: delayed cuts in rates will prolong affordability challenges
• Housing market and finance show some limited signs of distress: this may build over time, but mortgage lending can still be profitable.

Re-Imagining the World’s Cities: The Potential for Commercial to Residential Conversion as a Means of Improving Housing Supply

• Despite high volumes of vacant space (both retail and office), vacancy rates are at roughly 10%, which suggests the picture may not be as bad as often suggested More than a third of the UK’s unoccupied offices are in London, however US cities are more problematic with vacancies in New York at 22% and San Francisco at 30%.
• Polarisation of both retail and office stock in terms of location and quality – Canary Wharf currently has office vacancies of 18%, the increase of which was triggered by post-covid home working which is likely to continue.
• The ability of developers to convert commercial real estate to private residential dwellings is much harder in practice due to the challenge of finding a building that meets the parameters required for conversion. Also the number of conversions is not likely to make a dent in solving the UK’s housing supply issues.
• From a lender’s perspective, it is advantageous to find commercial buildings that comply with the Permitted Development Regime as this can expedite planning permission. Most of these opportunities are in outer London boroughs (zones 4-5) as compared with central London. Costs associated with a conversion in central London would mean that any houses available for rent would be at market rents  or otherwise lenders would need to sacrifice on margins.
• Obstacles and challenges to conversion fell into three broad categories (1) policy/regulatory/planning (2) physical/structural and (3) financial.

The Changing Buy-to-Let Landscape Amid EPC Deadlines, Small Operator Departures and Funding Challenges

• 15-20% of landlords have been passing on increases in interest rates to their tenants for new lettings, resulting in a 7.5% increase in the rental market this year.
• Pre-financial crisis BTLs are generally floating rate mortgages – in practical terms the average monthly payment has gone up from £208 to £620.
• Investors are anxious not to see an increase in arrears and have noted downgrades on some junior notes [in securitisation transactions?]. If house prices continue to decrease, the BTL sector will struggle. An uptick in BTL arrears is expected.
• While Mortgage Charter rules do not apply to BTL, the FCA expects lenders to proactively help landlords.
• Product transfers will likely become more common in the future.
• Government intervention will be required to hit the target of ensuring all rental properties achieve an EPC rating of at least C by 2028. This date will likely be extended by the government if drastic measures are not introduced soon.

Amping Up Affordaibility: Products for First Time and Later in Life Homebuyers

• Specialist lenders on this panel offer LTV products at up to 95% .
• Lenders noted that negative equity presents a perceived risk which does not apply for long term fixed interest mortgages. Also, some lenders do offer 100% LTV mortgages but they can be difficult to find.
• Not much interest in long term fixed interest rate products by consumers given that they are likely at the high point of the interest rate cycle.
• Late in life lending reached £6.4 billion in 2022 and this is projected to increase by  advancing interest only products and removing the upper age limits for certain products.
• Specialist lenders lamented that the market is set up to favour big lenders and that the barriers to entry as a result is stifling innovation in this space for other non-conventional bespoke products that could be offered to consumers.

Greening the Mortgage Market: Whole will Finance the Energy Transition and How?

• The current EPC certification system is not fit for purpose as the grading is based on the cost to fuel a property instead of providing a measure of that property’s carbon emissions.
• The EIR (Environment Impact Rating) Certificate by contrast, provides a measure of a property’s impact on the environment in terms of carbon dioxide emissions and therefore a detailed Home Energy Survey should be required to determine what is required to upgrade a home to make it energy efficient in addition to the EPC certificate.
• In terms of reporting obligations for securitisations, investors must ask for information that is traceable in order to avoid allegations of greenwashing.
• The government could incentivise landlords to increase their property’s ratings from D and E to C and above, whether it be through the form of capital relief to lenders.

Key Regulatory and Legislative Developments on the Horizon Affecting the Mortgage Market and its Lenders

• Recent overhaul of the ‘Treating Customers Fairly’ regime by the FCA to introduce the Consumer Duty and Mortgage Charter

Consumer Duty

• Outcomes based approach, using broad principles to extrapolate backwards to determine if a consumer has suffered harm.
• Gives rise to a couple of issues for Forward Flow transactions
  • it catches originators of mortgages plus any 3rd party who has a material influence on the outcomes ie potentially a forward Flow financier as well as the originator of the mortgages could be subject to the Consumer Duty principles.
  • How do originators protect against future liability where they have lost control as a result of legal title holder perfection or termination of servicing arrangements.

Mortgage Charter

• Changes to MCOB to permit lenders to voluntarily sign up to Mortgage Charter
• Mortgage Charter applies only to residential mortgages ie not buy to let
• Broadly analogous to COVID forbearance measures. Equally prescriptive but more wide ranging including no repossession in the first year, ability to lock in a product switch 6 months in advance, extended term, and switch to interest only
• Is the Mortgage Charter truly voluntary? 90% of the mortgage market lenders have signed up to the Mortgage Charter
• What will be its impact on financiers who have purchased closed books (ie an unregulated business) if they are required to offer product switches, etc.
• New regime applies to closed books from July 2024

Basel 3.1

• UK consultation has closed but final position is not yet known
• Expected to have a significant impact on mortgage lending, especially in respect of capital requirements
• Move from using current valuations to original valuations for purposes of calculating capital requirements which means certain products (eg. lifetime mortgages) will become more expensive from 2025, providing opportunities for non-banks to increase their market share of these products as well as increased likelihood of portfolio sales and securitisations by banks to free up capital

London Bridge, Indeed! The Future of Bridge Financing and Development Loans in the UK

• Falling house prices in the past 12 months has mostly led to a tightening in LTV risk profiles from 70-75% to 80-85% although the reduction in deals means that some lenders have maintained 70-75% LTVs to win market share
• Generally the bridge loan market is not a rate sensitive environment as borrowers are primarily focused on flexibility and creativity.
• Bridge loans are counter-cyclical so good opportunities in the current environment to fill gaps when high street lenders pull mortgage products or tighten their mortgage requirements
• We are coming out of a 15 year cycle whereby anyone who lent against property could make money. Specialist lending will become more specialised as people for the first time in 15 years experience stress in the property market
• Specialist lenders initially funded by senior debt lines. As they reach a certain size and maturity other funding options, such as Forward Flow, are available.
• Securitisation, especially public securitisations, are not a practicable source of funding for specialist lenders because (1) the short term of most bridge loans doesn’t really align with the relatively lengthy time it takes to put a securitization in place; and (2) there are issues with rating bridging loans with bullet repayments. How can you rate loans if you don’t know how they will perform?
• Expectation is that the UK is nearing the end of interest rate volatility so the property market should perform well over the next 18-24 months, especially given the chronic undersupply of housing.
• New legislation in respect of EPC requirements for rental properties provides opportunities for specialist lenders to provide bridging loans for efficiency improvements with a view to refinancing when the necessary efficiency improvement works have been completed.

Investing Abroad: Comparing the Relative Value of the EU’s largest Mortgage Markets

• Dutch prime residential mortgage market is attractive as an asset class due to:
  • Length of mortgage term – good for insurers and pension fund investors
  • Good quality of returns on assets
  • Good mortgage market infrastructure, especially the deep broker structure
• Dutch Buy to Let is relatively new as a distinct asset class but its successful track record of performance is closer to the Dutch prime market than the UK Buy to Let market.
• Germany has the largest residential mortgage market in the EU with current overall inventory on its lender books at approximately € 1600 billion.
• German residential mortgages are a low risk product with losses of ca. 0.04%-0.07%, giving it a risk rating equal to AA/ A.
• German residential mortgages have fixed terms from 10 to 30 years and there are no interest only products  so income streams and repayments are predictable.
• There are 2 main equity release products in Germany including a relatively new product for which there is strong demand. This product provides an upfront payment equal to 50% of the equity in the property to the pensioner homeowner but enables the pensioner to stay in his/ her home for 10 years in return for payment of a fixed usage fee. The pensioner can ‘buy back’ his/her share at current market value at any time during the 10 year usage period.
• Later life lending in the Netherlands is not yet a developed product due to the good pension provision accumulated by older generations. However, it is anticipated that in the next decade or so there will be more demand for later life lending because younger generations have not accumulated adequate pension provision.
• Recent legislation in Germany to replace heating systems with carbon neutral alternatives will cost home owners and landlords significant amounts of money so there will be increased opportunities for lending. The typical ticket size is expected to be in the region of €50,000 – significantly larger than a typical consumer loan -  and likely will be unsecured. It is anticipated that the growth in consumer lending to re-fit housing stock to comply with energy efficiency legislation will attract institutional and international investors.

RMBS as a Funding Tool for Banks and Non-Banks

• the last 12 months has seen a return of the largest investors and prime issuers to the RMBS markets, including (amongst others) issuance by Lloyds Banking Group, Santander, Coventry Building Society, and Virgin Money
• Performance data for last 20 years indicates that current performance of residential mortgages is as good as ever. Despite an uptick in arrears the past few months, in general lenders are starting from a strong position to deal with any headwinds in the coming 12 to 18 months. This will support RMBS as an integral component of banks and non-banks suite of funding.
• Pricing between RMBS and covered bonds is converging so there is an element of Banks and Non-Banks weighing up the pros and cons of the two funding tools.
• For some bank and non-bank issuers, certainty of execution is more important than pricing and they will be looking primarily to pre-place tranches of RMBS.
• Forward Flows, rather than RMBS, may be used for strategic purposes as well as a funding tool especially for products that do not align with a lender’s brand or the lender needs a platform for loans that are bigger than the ones it can originate in the normal course of its business. Forward flow also is useful from a regulatory perspective to a lender because it demonstrates to the PRA that someone is willing to purchase that lender’s loans on an ongoing basis.
• The disadvantage of Forward Flows is that there is a risk of a lender losing control over the loans if the Legal Title Holder is perfected and the original servicing arrangements are terminated
• The decline in house prices has  led to residential loan portfolios with higher LTVs. It is anticipated that banks will seek to mitigate the increased risk and regulatory capital costs associated with higher LTVs through SRTs so more activity is expected in the coming 12 to 18 months in this market
• The Mortgage Charter has resulted in hedging challenges for signatories due to the difficulties in hedging for a product 6 months out when borrowers have the option to cancel and borrow elsewhere. The difficulties are compounded by a lack of historical data to assist lenders with determining how much of their pipeline they should be hedging.