Funding
This remains the biggest issue we are all facing. We have now had more than three years of liquidity squeezes within the banking and finance industry and it looks like this is going to remain the case for some time to come.
Since the credit crunch, it has become clear that the funding crisis and its effects are not short lived, having lost the leveraged investors from the market.
These were banks, hedge funds and structured investment vehicles which borrowed multiples of their own capital and funding to invest in assets, particularly mortgage backed securities, covered bonds and other structured paper.
This type of investor will probably not return for a long while to come, so radically reducing global investor appetite for mortgage backed securities and other crucial debt instruments, which had become significant drivers in global liquidity.
Other forms of funding, of course, include retail deposits. However, these are not sufficient to meet all funding requirements of the banking and finance markets and are not particularly well matched to funding mortgages, which are after all long-term assets.
What else do banks have to deal with from a funding perspective? Quite a lot, actually.
According to the Bank of England, the amount of funding required in 2011 is higher than in 2010, with close to half of the 2010 to 2012 refinancing needs due this year.
This coincides with the end of the public support schemes from the Bank of England and the Treasury.
In total, banks need to raise between £400bn and £500bn of wholesale debt by the end of 2012.
This includes £110bn of repayments under the Special Liquidity Scheme, due for final repayment by January 2012, and the Credit Guarantee Scheme, although a proportion of that can be rolled over until 2014 providing the scheme has been reduced to £83.5bn or below.
There will be no replacement scheme; banks are going to be on their own in the funding world from now on.
On top of this, banks have to cope with a fragile economy.
We are not powering out of recession and it should be no surprise. We have too many factors being assimilated at once, including lack of funding, spending cuts and unemployment staying stubbornly high and rising.
Furthermore, CPI is currently running at 4% against a target of 2% and there is clearly a divergence of opinion between MPC members on what should happen to interest rates, Economists just can’t agree what should happen next.
Ultimately, we must assume that Mervyn King is trying to balance all arguments and judge when he can safely put up rates without stopping the economy dead.
If it were down to me, I wouldn’t touch rates until early next year. My best guess though is that the pressure to put up rates will be too much and we should be prepared for them to rise by a quarter per cent by around the halfway point of the year.
GDP has slowed down, falling by 0.6% in the fourth quarter of 2010. Although recent manufacturing figures look more encouraging the services sector is still struggling and the Office for Budget Responsibility forecast of 1.8% for 2011 looks optimistic.
With a struggling economy, it is not surprising that house prices remain subdued and will likely remain so for some time.
Regulation and the rest
I can’t write an article about 2011 without looking at regulation and the international scene.
We already know from FSA chief executive Hector Sants that the regulator will publish its proposed framework for the Mortgage Market Review (MMR) in Autumn 2011, with no rule changes due before 2012.
However, continuing uncertainty isn’t good for the market and so the sooner the new rules are made clear, the better.
My suspicion is that the more risk-averse approach of lenders in recent times has less to do with potential regulation changes and more to do with liquidity shortages.
Perhaps a bigger threat is the European Mortgage Directive, which is bearing down on us from Brussels. It is one to watch.
Capital and liquidity levels will be rising under a package of reforms agreed by international policy makers. This will not be such an issue in 2011, because it will be introduced over an extended transition period so as to avoid sudden additional shocks to banks and building societies. Nevertheless, banks will now have to think about these new rules and how they intend to meet them.
This year has plenty of challenges for us. It’s good that funding has eased a little and that things seem to be resuming a more normal path in some respects, but sadly I think this year will prove to be another very challenging one for most lenders.
Tony Ward is chief executive of Home Funding
