On the face of it, the market appears highly competitive: we’re seeing intense price competition, new lenders coming to market and increasing numbers of products available. The FCA itself in its Mortgage Market Study interim report, concluded that, on the whole, the market is working well. But is it really?
Break the surface and things don’t seem so rosy. There are over 140 active lenders in the market today but the top six account for around 73% of total residential lending in the UK. That leaves 136-plus active lenders chasing a 27% share.
Those lenders can’t possibly compete with the top six, with their massive funding advantage and dominant position in the market. And to compete among themselves, they need to carve themselves a niche, to differentiate themselves somehow from all the other lenders fishing in the same small pool of customers left behind by the top six.
The science of specialist lending
How do they successfully do that? Once upon a time they would have developed increasingly risky lending products and practices, joining in the race to the bottom. But that’s not an option today.
The Mortgage Market Review (MMR) restricts just how far lenders can move up the risk curve. The Prudential Regulation Authority (PRA) has also moved in on buy to let. There are new boundaries in place: that small pool of credit-worthy customers left behind by the big banks isn’t going to get any bigger.
These lenders need to price for the risk they are taking and need those margins to survive. But they also need to be able to compete on price, or at least be in the same ball park.
So they inevitably react to the aggressive pricing we are seeing at the super-prime end of the market. Margins are squeezed. And wholesale-funded lenders need to price to offset funding costs.
Higher funding costs in the wholesale markets is putting pressure on already thin profit margins. With consumer confidence falling, rumours of a recession and house prices under pressure, it’s a brave originator who will looking to acquire mortgages other than low LTV prime.
Lenders under pressure
We’re starting to see the impact of all of this with firms halting lending and even exiting the market. Something has to give.
So is competition working in the interests of all customers? The market is severely lacking in competition in the areas that need it most.
The top six cream off the prime customers while those customers who are not perfect prime, who have complex incomes, who are newly self-employed, who are nearing the end of their working careers or are retired, are suffering from severely restricted access. They rely on those smaller lenders currently being squeezed.
The FCA has already been pushed by the Competition and Markets Authority (CMA) to consider the detrimental effect of the loyalty penalty on customers who do not remortgage off lenders’ standard variable rates (SVRs) as part of its work following Citizens Advice’s super complaint last year.
There’s been a lot of focus on this – and a great response from the industry.
But competition is failing far more widely than just this. The loyalty penalty is not the problem; it is a symptom of competitive failure in the mortgage market more generally.
The FCA must not ignore the much more fundamental issues in today’s market when it publishes its Mortgage Market Study final report later this year.
Lynda Blackwell is a consultant at Thistle Dhu Consulting, specialising in financial services regulation. She was formerly mortgage policy manager at the Financial Conduct Authority, and primary author of the Mortgage Market Review.