With competition among lenders reaching unprecedented levels, and profit margins being slashed to the point at which many lenders seem forced to have loss leading products in order to maintain a competitive edge, it is inevitable they will look for cheaper, more efficient ways to offer loans.
However, even with securitisation, wholesale funding and generous funding lines from multinational parent companies, lenders are being forced to innovate even further in order to compete in the present market.
With this in mind, the UK market has been witness to the introduction and development of ‘correspondent’ and ‘through’ lending in recent years, allowing lenders to acquire business at a fraction of the cost involved if they themselves had originated the business.
Back to basics
Correspondent lending is where a lender uses a third party such as a packager or large intermediary to market and sell its mortgage products. In return the third party has more autonomy over the deal and can call itself a mortgage lender. The third party, or correspondent lender, takes on all the work surrounding origination, administration and completion. But the lender supplies final underwriting and many correspondent lenders have an underwriter from the lender partner working with them ‘in-house’ to help speed up the process. And, upon completion the lender then buys the loan from the third party.
Correspondent lending began in the US in the 1980s, and now the majority of loans in the US are carried out along these lines. Figures from the Mortgage Bankers Association of America show that this sector was responsible for more than US$180bn in 1999, which was almost 75% of all advances in the US.
However, it was not until the last few years that the concept was brought over to the UK. The first lender to bring over the concept was US-based lender, Moneystore, whose UK outlet is now known as Platform Home Loans.
Of the lenders active in the market at the moment, they are mostly sub- prime, non-conforming lenders. New players include Preferred Mortgages, which only started its correspondent programme at the start of the year and now has around six correspondent lenders. Other big players are GMAC-RFC, Mortgages plc, Platform Home Loans, and Southern Pacific Mortgage Limited (SPML).
Nevertheless, as with many innovations from overseas, it has not been possible to transplant the idea directly into the UK market.
John Webster, managing director of Preferred Mortgages, says: ‘Ours is based on the US model, although it is not 100% genuine correspondent lending. We think we are unique as we can give our correspondent lender limited powers to change the package within certain parameters. However, we offer a fixed product rang, and the correspondent cannot change the terms of this.’
Essentially brokers and packagers are attracted to correspondent lending because it offers them the potential to develop their business by generating increased levels of business and controlling the process from inception to completion. While brokers and packagers do not have the same financial backing as a lender, some possess the ability and skill to process the mortgage up to completion.
Julian Wells, marketing manager at Mortgages plc, says: ‘The big issue for brokers and packagers is control. They want to be in as much control of the application process as possible. They want to be seen as the lender ‘ in control of everything.’
Keith Dearling, managing director of packager and correspondent lender, Advance Home Loans, agrees: ‘The three main advantages are that it gives the correspondent more control. They are quality driven and it can be frustrating to have to wait for the lender. It gives them more income, both to pay brokers and to reinvest in the business, and it allows them to build a brand.
‘For our brokers it rounds off the service. It gives them a more complete product range from one ‘lender.’ We have a better product range, collectively, than some individual lenders.’
Wells says: ‘It allows the correspondent to become more of an entity, more of a brand, and therefore receive more recognition. A lot of correspondent lenders have now developed their own marketing tools and are becoming bigger businesses because of it.’
For borrowers it means they should be getting a faster, more efficient service, while still getting the right product. Some funding lenders even allow the correspondent to tailor the package right down to the individual, although this again is not suitable for small brokers’ as they need to offer a broadly consistent package back to the funding lender. Correspondent lending is only really suitable for larger packagers and brokers, or those that deliver a high turnover of business.
Webster notes: ‘This is not the sort of thing that small brokers can do. They need to be able to manipulate the funds to match our requirements, as they are managing a pool of money.
‘Our model requires a high volume of business and commitment. We say to the correspondent lender that there is a pool of money available and they must use it within our parameters. So if we say they have to do 75% loan to value deals they can do an 80% loan to value deal, but it must be balanced by one at 70% loan to value, so to do this they must have plenty of volume.’
The benefit for a lender is that it can focus more of its energies into servicing and securing further funding, whether this be through warehouse funding or securitisation.
But perhaps Wells is optimistic when he says: ‘The key benefits mean there will be more lenders and therefore choice. Eventually we could be heading towards a state of ‘perfect competition’ where somewhere down the line everyone, lenders and borrowers, are getting the perfect deal.’
Despite this there are a number of issues that could affect the development of correspondent lending to the extent of the US model. At the moment, correspondent lending is still a niche area, and as Webster says: ‘It would be harder to grow this type of lending in the prime sector. With sub-prime there are more variables. Whereas with ‘vanilla’ mortgages there are not enough different characteristics between the type of applicants to make it worthwhile.’
There have also been concerns that correspondent lending could suffer at the hands of regulation. At the moment the non-statutory regulator, the Mortgage Code Compliance Board (MCCB) is currently in ongoing discussions on the subject and is due to publish its own rules on correspondent lending in the Autumn. At the moment it is thought that it will accept correspondent lenders as they are but will insist that correspondent lenders disclose that the loan is to be sold on to another on completion, at the offer stage.
Following on from this, the publication of CP146 has shown the Financial Services Authority (FSA) is to regulate correspondent lending when it becomes the statutory regulator for mortgages in 2004. It is thought that while there will have to be some changes, most lenders will be able to carry on in this area, as long as they are transparent about how the deal works, and stick to best practice operating procedures.
An FSA spokesman says: ‘It will be regulated, but who will be regulated depends on what activities they are carrying out. If they are deemed regulated activities then they will obviously need to be regulated.’
Webster says: ‘It is no surprise that the FSA has proposed that correspondent lenders are to be regulated. And, at the moment, the MCCB appears satisfied with it as long as we disclose who the funding lender is at the offer stage.’
However, there is a potentially larger problem looming around the corner in that there could be problems over capital adequacy requirements.
The Basle Capital Accord will be implemented in 2006. It proposes that capital requirements for lenders will be based on specific credit risks, rather than existing asset class groupings, and they will need to make further capital requirements based on operational risk. This will affect capital adequacy calculations and monitoring, as well as accounting principles. It could mean many brokers and packagers are prohibited from entering the market as they do not have the cash reserves required to be a lender. Others may have to drop out of the market for the same reason. Wells says: ‘Because correspondent lending means the loan is on the books of the correspondent, albeit briefly, there is a potentially large impact from Basle 2, it could even wipe out this type of lending.’
However, correspondent lending is not the only other recent development in funding and with and out of correspondent lending has come ‘through’ lending. Through lending allows existing lenders to acquire books of new loans at a more cost-effective price than buying existing loans straight from another lender, and allows them to dip into niche areas they may not have been operating in before.
The lender, typically a building society, agrees terms with the specialist lender to develop and market a range of mortgage products, and when the number of loans reaches an agreed size the specialist lender sells the loans on, and the registered titles to the property are transferred to the original lender.
This is a new area for lenders, especially building societies, and means that even small lenders can still compete in the marketplace. Paul Tilley, head of lending at Market Harborough Building Society, says: ‘We are a small lender with nine branches and our mortgage turnover is £60m a year. We deal mostly in the local market and through local brokers, although online applications account for 20% of our new business.
‘However, from time to time the channels become stagnant and we need to acquire business quickly. We have purchased blocks of loans from other lenders, but this is expensive. We entered into through lending in 2001 and it is generally cheaper to acquire in bulk this way as we do not have the resources to increase the level of business like this ourselves. It is cheaper than buying a book, and we have effectively agreed certain safeguards that tie in with our lending criteria. It has worked extremely well so far.’
Other lenders, such as Derbyshire Building Society, have used through lending as an opportunity to dip their toe into other markets, such as sub-prime. By agreeing the lending criteria with the marketing lender they are getting a safer deal than they may have done if they had tried to originate this number of deals alone.
Both these changes are hugely significant for the mortgage market in the UK and represent new opportunities for lenders and intermediaries alike as they represent a further possible move towards more all encompassing lenders. If their development is not hindered by Europe and home-grown regulation then they could impact significantly on the landscape of the market.
Ben Marquand is deputy editor
Correspondent lending allows brokers and packagers to control the whole process as if they are the lender.
Correspondent lending will increase the number of products, making it likely the right product will be available.
Through lending could help prime lenders to become all status lenders, thereby increasing the number of one-stop shops.