This gives lenders just under three months to make a decision on which changeover rate to commit to on two-year loans for new mortgage customers.
Speaking to Mortgage Solutions, Beaumont, deputy CEO at TML, warned there may be lenders who have not woken up to the ‘scale of the problem’ suggesting this is potentially a dangerous place to be.
“The message is really clear. The Financial Conduct Authority (FCA) says stop issuing Libor contracts as soon as you can, get on to alternatives, minimise the size of the problem and make sure you’ve got a cohesive executive-led transition plan for your existing borrowers,” he said.
The FCA confirmed it had already engaged directly with the six smaller mortgage lenders issuing Libor mortgages back in 2018, adding: “We strongly encourage mortgage lenders, intermediaries and mortgage borrowers to avoid new mortgage contracts that rely on Libor continuing beyond end-2021.”
Beaumont said in TML’s discussions with the FCA it explained how central mortgage brokers will be to the changeover.
“We’re issuing contracts but they’re recommending the advice to the customer. So, they’re the ones that need to follow the reasons for doing this.
“We want to be able to start educating the advice community on this change. Brokers are going to be issuing or recommending contracts to customers, whatever that may be. There’s a huge education piece here,” he added.
Specialist mortgage lender TML said its transition plans were well advanced and underway for both new and existing customers.
Alternative risk free rates being considered by the industry include Bank Base Rate, Standard Variable Rate and Sterling Overnight Index Average (Sonia), currently the working group’s preferred rate.
The Sonia benchmark is based on actual transactions and reflects the average of the interest rates that banks pay to borrow sterling overnight from other financial institutions.
Mortgage industry impact
FCA figures suggest there are an estimated 200,000 or £30bn of Libor-linked mortgages outstanding in the UK, with four lenders – Foundation Home loans, Pepper Money, Kensington and The Mortgage Lender still offering new customers Libor-linked mortgages, according to a Moneyfacts listing.
Precise Mortgages stopped offering Libor-linked mortgages to new customers in July, swapping to Bank Base Rate (BBR)-linked home loans and is continuing to work toward a benchmark for existing customers.
Alan Cleary, managing director at Precise Mortgages said: “When it becomes clear what index the industry is to settle on we will make our decision. The terms and conditions in our mortgage contracts allow us to use a suitable alternative index in the event of the withdrawal of Libor.”
Precise ran a 12-month project before making its decision and the move to BBR. It considered direct alternatives to Libor, including Sonia, but said despite assessing Standard Variable Rate, BBR ‘fitted its proposition better.’
Cleary said as the changeover only involved new customers, its customer communication strategy has so far involved a change to the European Standardised Information Sheet (ESIS) document and general mortgage conditions.
“We didn’t do any specific communication on this change, it simply wasn’t necessary given how well known this index is. When we move our back book to a replacement rate for Libor, we will communicate the details to our customers directly,” said Cleary.
Brokers already understand BBR and SVRs, he added, so the lender is not planning any further targeted education at this point.
No confirmation yet
The other lenders, Foundation Home Loans, Kensington Mortgages, Pepper Money UK and TML have not confirmed a decision and continue to consult on next steps for new and existing customers.
However, all recent and new securitisations have been linked to the Sonia daily rate.
Jeff Knight, marketing director at Foundation Home Loans said Sonia has replaced the three-month Libor and its funding documentation has always incorporated Libor replacement language as has its mortgage documentation since 1998.
Knight explained: “As yet there has been no guidance from the FCA around replacement measures for mortgages and it is complicated by Sonia being a daily measure, whereas most mortgages are monthly.
“There needs to be transparency around how the rate is set and the current methodology which is an interpolated retrospective rate, so too complex for consumer use. Consequently, we are waiting for the FCA to advise on what needs to be a market-wide move away from Libor.”
Alex Maddox, capital markets director, Kensington Mortgages, said it has been working ‘hard’ on its preparations but that he expects the securitisation markets to be Sonia-linked as standard from now on.
The lender’s latest July-launched Finsbury Square 2019-2 residential mortgage backed securitisation was its first securitisation linked to Sonia.
He said: “The deal saw very strong demand with a number of investors saying they are reticent to buy deals linked to Libor.”
Maddox added that Kensington is due to make a decision imminently on its benchmark rate for its mortgages and will be in touch with brokers as soon after the decision as it can.
“We have undertaken an extensive review of the terms and conditions of the almost £6bn of loans that we have to existing customers and will communicate to those customers about what changes will need to be made to their loans and when that will take place. Our key focus is to make sure that the rate change is fair for customers and clearly communicated.”
Pepper Money UK said it has already set up its own working group to closely follow industry developments and written to customers to explain that alternatives to Libor are being explored.
Paul Adams sales director for Pepper Money UK, said: “We are currently exploring the different options available to us, for example our recent securitisation; Polaris 2019-1 was structured using Sonia in preparation for the end of Libor-based transactions.”
Edwin Schooling Latter, the FCA’s director of markets and wholesale policy, said: “The key to this is that the end of Libor should not result in mortgage customers being transferred to other reference rates that are expected to be less favourable to the customer than Libor would have been.”
Latter suggested mortgage prisoners are unlikely to suffer detriment from the changeover because Sonia may offer less volatility in the medium to-longer term because it does not reflect the lenders’ costs of unsecured borrowing in wholesale markets, unlike Libor.
However, he added: “Some mortgage lenders may prefer to reference the Bank Base Rate directly rather than Sonia because it is well understood by consumers, and already used in some floating rate mortgages.”
UK Finance director of mortgages Jackie Bennett said the key consideration for firms is acting in their customers’ best interests and ensuring that any changes made are fair to customers.
Bennett added: “In the UK, coordination of the process is being led by the Bank of England’s working group on sterling risk-free reference rates. The working group is reporting good early progress in derivatives market adoption of Sonia as a replacement for Libor and is looking to promote similar progress with respect to other product types.
She added the mortgage lender trade body is working closely with members to understand any communication challenges they face: “We will continue to monitor messages from the regulators and developments in adoption of Sonia across other market users.”
One of the challenges for the industry is that closed book lenders which often sit in an unregulated space outside of FCA supervision, and so outside of working group efforts, may not be as supported as other mortgage lenders.
But the immediate mortgage market-related focus is on the small to medium enterprise and retail space driven by trade bodies and the regulator.
The Bank of England (BoE) through its steering group, Dear CEO work, publication of best practices, speeches and industry outreach continues to encourage consultation, debate and offer the industry support as a priority for Q4 and into 2020.
Commentators suggest the BoE is working with trade bodies to get mortgage lenders to move in a ‘peleton’ formation given the benefits of agreement and is encouraging all lenders to be involved in the UK industry group consultations. However, lenders will be left to make their own decisions with regulators loath to stray into anti-competitive waters.
And time is ticking down.