Money, unfortunately, does not grow on trees and for mortgage providers the search continues for access to sufficient, sustainable and cheap funds to support seemingly ever-increasing mortgage business across the UK.
The UK mortgage market has grown out of the mutual fund model, and is still controlled by some of its legal requirements. It still relies on many of its processes.
Building societies still have to fund at least 50% of their lending through retail deposits, and it remains the funding backbone of the UK mortgage market. However, retail deposits do have their drawbacks, and are closely linked with the need to balance the rates paid to savers with those taken from borrowers.
In a low-interest rate environment, it is difficult for the building society lenders to find this balance and keep their mortgage products competitive, while also maintaining attractive returns for savers.
Although in the main, savers tend to be loyal, they offer no long-term guarantee. As such there is always the underlying mismatch between long-term lending in the shape of mortgages, being funded by short-term retail deposits. Although loyalty and saver apathy help to make it unlikely retail funding will dry up, it is nonetheless a threat that building societies are heavily exposed to.
Jennifer Holloway, head of corporate communications at Skipton Building Society, says: ‘As a building society, under law Skipton has to maintain at least 50% of its funding through retail share accounts. This acts as a form of restriction as it is easier to tap into the wholesale markets for large amounts of money. These big ticket deposits contrast to the average retail balance of approximately £6,000.’
Wholesale funding sees the lender turn to the money markets to borrow what it then lends out through mortgages. This has the benefit of being a fast route to large sums of money, and provides greater security than retail funding due to the fixed term of the loan. Retail and wholesale funding have been the mainstay of the UK mortgage market, but things have been changing in recent years.
One form of raising funding that has become increasingly popular in the UK since the late 1980s is securitisation, which sees books of mortgage business being sold off. This has multiple benefits, taking the business ‘off balance sheet’ for the lender, and freeing it from the risks and capital constraints involved.
Graham Leftwich, senior public relations manager at Britannia Building Society, explains: ‘Often mainstream lenders will securitise their riskier and higher margin books. By doing this they are seen in all areas of the market without taking all the risks on board.’
Although Britannia does not securitise any of its Britannia branded products, Leftwich says securitisation is used to help fund its Verso and Platform subsidiaries, which deal through the intermediary market and tend to offer riskier products.
Tony Armstrong, director of communications for Northern Rock, adds: ‘If the business is on the balance sheet then you have to have capital beside it.’
Not only does the lender free up some of the capital held in reserve against the book of business, but it also enables itself through the sale of the business to use the capital generated for additional lending.
Gina Collman, head of corporate communications at GMAC-RFC, says retail funding is a costly way for the lender to raise funding, compared to securitisation.
‘With preservation of capital in mind for further acquisitions, many UK institutions are now considering the securitisation market to fund their mortgage loans as this is an efficient use of capital. For the sub-prime lender the main driver is a better use of limited capital. For the prime lenders the motivation is mainly to release capital and a cheaper source of funding. For those acquiring the securities, a profitable market linked variable rate of return can be enjoyed,’ says Collman.
In a report for the Council of Mortgage Lenders (CML) earlier this year, Simon Walker, partner at KPMG, also extolled the virtues of the securitisation option.
He says: ‘Securitisation is increasingly regarded as a useful balance sheet management tool. By moving assets off the balance sheet, institutions can increase the volume of lending and the range of their offering, for example, including non-standard lending, without impacting on their overall risk profile, and without significant levels of capital. Alternatively, existing assets can be maintained using a lower capital base. Lenders can therefore use the tool to increase their return on equity or offer more competitive products.’
However, there are constraints to securitisation, and it is not the method of choice for all. Jeremy Wood, divisional director of the treasury operation for Nationwide, says the building society does not use securitisation at the moment, but can see its attractions as a capital management tool. Nonetheless if relying on it as a means of funding. He says: ‘There would always be the fear that investors would not take up the issues as they fell due.’
The set-up costs are also expensive, with legal, accounting and rating agency fees to pay. Size is also a factor, with commentators suggesting an issuance should be upwards of the £250m mark to be economically viable.
There are also worries for building societies that the transfer of business to a securitisation vehicle will deprive borr-owers of their membership status, and so any benefits to be derived through such moves as a company flotation. However, as the securitisation market matures, these logistical concerns are being addressed, and set-up costs are falling.
The UK is leading the European securitisation market, and it looks set to grow. Not only are lenders beginning to see it as a viable option, as it becomes a more mainstream form of funding, but it is continuing to evolve and offer different options. This evolution has led to the introduction of new types of securitisation such as ‘synthetic securitisation.’ In effect, the process affords the same benefits as a normal securitisation issuance.
However, the loan itself is not actually sold on and is retained on the lenders books. Although the deal generates similar cash flow results to a normal securitisation, the disposal of the loan is economic and not actual. Time will tell how quickly lenders grasp the concept and if they take to it as a viable option.
For some, there is no need to turn to the various financial markets for funding, with large balance books in the form of parent companies sitting behind them.
Brian Pitt, sales and marketing director for Future Mortgages, says: ‘The sole provider of capital is our parent Citigroup. The main benefit for our business has been to reduce the cost of our borrowing to below the rate that we previously paid through warehouse funding. There are no constraints and no other options are needed when we have access to one of the biggest balance sheets in the world.’
Such a financing structure affords many benefits and Pitt continues: ‘It can have a tremendous effect on profitability and therefore as a consequence provide the ability to support the product range if necessary with substantial capital. For example, if any lending market degenerated into a price war, obviously those with the biggest balance sheets would win out if they chose to join in. However, a more likely benefit would be the use of capital backing to support an entry into a new market or to buy market share.’
Adrian Murnaghan, head of mortgages at HSBC, agrees: ‘We have a strong capital position which alleviates the need to get capital elsewhere. By funding internally, it enables us to have funds which are cheaper than through securitisation or any other method as nobody else has to make a margin.’
As the mortgage market has developed, new lenders and influences have brought with them other alternatives such as through and correspondent lending (see feature on page 22). As long as this continues, only the consumer can benefit as providers find new ways of funding their business, and improving their flexibility in the market.
Edward Murray is news editor
Building societies are restricted by the need to fund 50% if they are lending through retail deposits.
The UK is leading the European securitisation market, and it looks set to grow.
In a price war, those lenders with the largest balance sheets would win as their access to funds would cost least.