Further criticism has been levelled at lenders following the publication of recent Moneyfacts research which revealed that lenders’ margins on mortgage products have hit an all-time high, owing to the widening difference between the cost of swap rates and the average fixed rates paid by borrowers.
Yet, the CML has hit back at the figures being interpreted as a sign of lender profiteering, saying that to judge lenders’ profitability by only looking at the difference between swap rates and fixed rates ignores a far more complicated picture.
Given the complexities of pricing and how much the market has changed of late, can either view be taken as an absolute?
Moneyfacts found that the average swap rate on two-year fixed rate money was 1.26%, while the average two-year fixed rate mortgage was 4.55%, resulting in a lender margin of 3.29%. By comparison, two years ago the margin on a two-year fixed deal was 1.28%.
It also found that the margin on an average five-year fixed rate product was 3.35% and 3.57% on a three-year fix.
However, in its News and Views newsletter, the CML said the trend in fixed rate pricing has been downwards for the last two years, with the average new fixed rate currently at 4.45% compared to 5.68% in December 2008 and 4.88% in December 2009.
Swap rates have also fallen over the same period and at a faster rate than fixed deals.
In addition, the CML noted that pricing is affected by current regulations which ensure that risk attracts greater premiums than in the past, while financial institutions are now required to hold more capital and liquidity.
The CML said that the dramatic changes in the funding environment since the credit crunch means there is no single convenient measure of lenders’ funding costs: “Spreads on wholesale or retail funds, or against swap rates, are pieces of a complex jigsaw, but it is now highly misleading to use them as a proxy for lenders’ costs. It is similarly misleading to suggest that widening spreads characterise lenders’ desire to increase profitability.”
Darren Cook, spokesman for Moneyfacts.co.uk, said it acknowledged the variables at play in pricing and the higher risks now involved, and added: “Lenders will only make a profit if none of the probabilities they have factored in happen in the next five years.”
Tony Ward, chief executive of Home Funding, pointed out that the difference between swap and fixed rates does not amount to a profit margin – it is a gross margin, from which other costs, such as operational costs, have to be taken into consideration and this varies from lender to lender.
As such, Jonathan Cornell, communications director of First Action Finance, said we cannot know how large lenders’ margins are or if any are profiteering given that the strong correlation that used to exist between swap and fixed rates has weakened as the money markets have become dysfunctional.
Cornell said: “Most lenders were able to fund mortgages by borrowing with three-month Libor, but now the FSA doesn’t want short-term funding. As the money market heals, the correlation between swaps and fixed rates will likely return to a degree proportionally – if one goes up a lot then so will the other.”
Given the limits on lenders’ funding in the face of huge demand for mortgages, Cornell added that margins are being used to control and maintain business at levels lenders have funding for.
Certainly, this prudent approach to lending has permeated the mortgage industry following its bumper decade.
Ward highlights that this is in stark contrast to the industry of old: “Lenders were losing money hand over fist before the credit crunch. Many products from all types of lenders had zero or negative spreads built in and the game was to make a profit on fees. Spreads are now being built in to have a profit and moderate the level of business coming through the door.
“Margins are wider, but they were absurd and unsustainable before, even outside of the credit crunch.”
Ward continued: “People have to readjust their expectations; a 2% margin is not unreasonable. Lenders are in the business to make profits, because no business would survive otherwise. I think that had been lost sight of by the industry.”
Indeed, the industry has to acknowledge that the days of failing to price for risk are over. What remains is to find the right product for the client at a price they can afford in a market that will take time to recover.
However, as Ward warns, the lack of competition in the lender market increases the risk of profiteering occurring and greater choice has to be introduced. Lenders must be accountable to their customers and treat them fairly, but pricing will always be a sensitive and complicated issue; second-guessing lenders is a fool’s game.
