Posted on 21 June 2012 by
The policy actions announced by The Chancellor and The Governor of the Bank of England at The Lord Mayor’s Banquet at The Mansion House last Thursday evening were, in part, designed to deal with any market turbulence following the Greek election. Although in the event the need for such action has been deferred, the fact that The Bank and The Chancellor have gone public with some additional weapons to deal with an escalation of the Euro banking crisis, whenever it occurs, had an immediate positive impact on the market.
Not only that but other proposals announced at The Mansion House have significant potential to be a “game changer” for the UK mortgage market, regardless of what happens to the euro in the short term.
So what did Mervyn King, Governor of The Bank of England, say to bring about these positive impacts, no doubt following pressure our banks? Two things in particular:
· The Bank of England will provide funding to banks at below market rates for “several years”, probably three, on condition they lend on to the consumer and SME (smaller and medium sized enterprises) sectors, also at lower rates, “during the present period of heightened uncertainty.” Details of this scheme are still to be finalised but funding under its terms is expected to be available within “a few weeks.” Although the amount of this funding appears to be somewhat flexible, comments from the Treasury suggest that the target amount is £80bn.
· The Bank guarantees to make available “unlimited” amounts of liquidity if necessary, against suitable security, “given the prospect of turbulence ahead.” This should give the banks extra flexibility in the operation of their Treasury function and help profitability by allowing some liquid assets to be employed a little more productively.
In addition, Mervyn King said that “In current exceptional conditions, where central banks stand ready to provide extraordinary amounts of liquidity, against a wide range of collateral, the need for banks to hold large liquid asset buffers is much diminished, and I hope regulators around the world will take note.” It seems unlikely he would have said this without prior discussion with other central bankers and so this suggests that the progressive requirements for banks to hold increasing amounts of regulatory capital to support lending will be scaled back next year, not from where we are now, but from planned increases already in the pipeline.
This should help to mitigate the reduction in lending specifically resulting from increased regulatory capital requirements. Despite details of these schemes still needing to be finalised there was a very strong, positive reaction in both the swap rate and Libor markets, particularly on Friday in the immediate aftermath of the speeches.
This funding appears to have some similarities to previous initiatives from the Bank early in the credit crunch - the Special Liquidity Scheme and Credit Guarantee Scheme. It seems highly unlikely that all the target £80bn of new medium term funding will find its way into new lending and as far as mortgages are concerned lenders will be very aware that the average life of a mortgage, which at around 4 years in 2007 would have fitted quite well to this funding, is now much longer, particularly for certain types of mortgage which are difficult or impossible to refinance under current criteria - such as interest only, self cert and sub prime.
Some funds will probably need to be used to refinance maturing RMBS and other wholesale funding which the market no longer has the capacity to refinance at reasonable rates. However, despite suggestions from some commentators that the banks don’t want to increase lending, as residential mortgage lending is generally the least risky type of bank lending it would be surprising if some of this extra funding is not allocated to the residential mortgage market.
Gross mortgage lending last year was £141bn and the general expectation was that, despite a £3bn year on year increase in the first quarter of this year, the second quarter would be lower year on year and we were heading for a reduction to around £130bn this year. As a result of The Governor’s announcement volumes in the second half of this year should hold up to leave both gross and net lending broadly unchanged on the year.
Furthermore, the additional funding available to the market, coupled with the sharp reduction in swap rates, is likely to result over the next few weeks in a reversal of the increase in new business rates this year, which has averaged about 0.5%, at least on fixed rates. Banks are less dependent on swap rates than they used to be, because they rely more on retail deposits, but nevertheless swap rate reductions on this scale to new all time lows will have an impact on pricing.
As mentioned above not all of the new cheap medium term funding from the Bank is likely to be available for new lending but if only £10bn finds its way to the mortgage market that will be enough to make a difference in the current constrained funding environment. To put this in context net lending has been under £10bn in each of the last two years. Hence why Thursday evening’s speeches are so important for the mortgage market.
One lender, Nottingham Building Society, has this week announced a new market leading 5 year fixed rate to 75% LTV at 3.69%, and Leeds B S has reduced its 2 and 10 year fixed rates. These cuts are likely to set the trend for other lenders over the next few weeks.
One other interesting point from Mervyn King’s speech was a not very subtle criticism of the FSA. He said “We intend to change both the culture and style of prudential supervision, and to base it on three key principles.” The third principle is particularly relevant in the context of the mortgage market and the micro management planned by the Mortgage Market Review, which itself has been heavily influenced by the forthcoming EU Mortgage Directive.
Mr King said “The spirit of our approach is simple: less focus on unnecessary details and more on the big risks. If banks have adequate capital and low leverage, and are resolvable, we won’t need to focus on the details of their day-to-day business. So alongside the much greater engagement on the big risks, we are committed to a root and branch review of all reporting requirements."
Unfortunately, with the EU planning to interfere with UK domestic mortgage regulation from about 2015, on the ridiculous premise of harmonising something which in practice, because of other constraints, will continue to operate within national boundaries, Mr King’s ability to focus less “on unnecessary details” will be severely limited.”
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