Details of "Funding for Lending" scheme confirm positive expectations
Posted on 13 July 2012 by
With today’s announcement from The Bank of England giving further details of the Funding for Lending scheme, which was originally outlined by The Governor and The Chancellor at The Mansion House on 14 June, it is now possible to evaluate the scheme more comprehensively.
The lessons of the failure of the previous scheme, Project Merlin, to boost lending last year in line with expectations, have been learnt and this new scheme has been much more sensibly crafted and as such I think it offers a very genuine prospect of increased funding for both the mortgage and SME markets. Although the mechanics of the scheme are slightly complicated the effect is that the rate lenders will pay to borrow is Bank Rate (give or take) + 0.25%, guaranteed for 4 years from the date of drawdown, which can be any time over the 18 month period from 1 August.
Each tranche of funding is for 4 years and so I would not be surprised to see more lenders start offering 4 year fixed rate mortgages. However, I expect most lenders will draw down whatever funds they choose to use under this scheme over the course of the next 18 months so rather than straight away and therefore they could still finance 5 year fixed rate mortgages with funding from this scheme.
There will some interesting calculations for lenders to do, looking at both their average and marginal cost of funding. The marginal cost of borrowing using this scheme will be about 0.75% p.a. for as long as Bank Rate stays at 0.5%. The fact that this scheme will last for up to 5½ years, i.e. 4 years from the latest drawdown date of 31/1/14, suggests that The Bank (and by implication also The Government as the scheme has been launched with The Chancellor’s approval) expects the banking system to remain under pressure for most, if not all, of that period, with the implication that Bank Rate is likely to stay at 0.5% for most of this period.
It appears from the published details that all banks and building societies will have access to the scheme, even small societies. This is obviously important to avoid these smaller lenders being put at a competitive disadvantage. Clearly banks and building societies have to look at both marginal costs and average costs but where I think this scheme has been cleverly crafted is that the more lenders increase lending to the target groups (or the less they reduce it) the lower will be their average cost of funding because a higher proportion of their overall funding will be at this very cheap rate.
Swap rates closed at a new all time low yesterday – 0.90% for 2 years and 1.12% for 5 years. This also helps reduce the cost of fixed rate mortgages because as lenders’ funding using the Funding for Lending scheme will be linked to Bank Rate they are still likely to use the swaps market to hedge their risk when offering fixed rate mortgages. 3 month Libor is also continuing to fall and is now 0.84%, 15 basis points cheaper than when the outline of this scheme was announced on 14 June.
As a result, although I would be very surprised to see any other lender drop its 5 year fixed rate as low as the 2.99% (60% max LTV) HSBC has announced today, I think the recent trend of fixed rates getting cheaper has further to go. This scheme should also at least stabilise variable rates and will probably result in some lenders following Clydesdale’s cut today in some of its offset rates by making small cuts in their discount or tracker rates.
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