Buoyed by low interest rates, increasing customer demand for specialist lending and the dominance of the intermediated mortgage market, the specialists really had a year to remember.
There were new brands coming to market, like New Street Mortgages from Northview Group and Vida Homeloans (backed by Belmont Green), while a number of established players such as Kensington, Bluestone, Together and Masthaven all beefed up their specialist mortgage lending capabilities.
This growth is all the more impressive given some of the changes in the market, which might have been expected to depress the sector.
Buy-to-let (BTL) is an obvious one. With house price growth stagnant and uncertainty over Brexit, the buy-to-let market is not expected to reignite any time soon.
UK Finance downgraded its forecasts in June, predicting BTL loan values will fall 14% for the full year 2017, and a further 6% next year.
Despite buy to let’s relative decline, this hasn’t dampened the overall attractiveness of the sector, which shows that the specialists are gaining decent traction in residential and remortgage business.
As such, the specialist lending market overall continues to see good interest from investors and acquirers.
In terms of the listed space, 2017 saw private equity consortium Pollen Street Capital and BC Partners take challenger bank Shawbrook private at a 30% premium, citing the potential for Shawbrook to achieve its growth targets by adapting to the economic environment, away from the public eye.
We’ve also seen Aldermore’s board agree a takeover by South Africa’s FirstRand, again at a significant premium, to help accelerate the delivery of the company’s strategy and further enhance its growth profile.
Bullishness in the specialist lending sector is undimmed, investors clearly see a place for these assets going forward and continue to believe the market undervalues them.
There are good reasons for investor confidence in specialist lending. First, both the challenging economic environment and more stringent rules on underwriting seem to be benefiting specialist lenders relative to the mainstream banks.
Many already meet the requirements for in-depth underwriting envisaged by the PRA’s changes, for example.
This means they are well-placed to assess risks and continue to grow through the cycle, even in a more challenging economic environment.
The leading players in the sector remember the lessons of subprime and are avoiding excessive risk. Some of the specialists already do not lend at loan to values higher than 75% and enforce strict borrowing to income multiples.
A number of specialist lenders have been around for long enough to show that they can prosper through the cycle while maintaining underwriting standards. In any event, interest rates look set to remain low relative to historic levels, especially with Brexit on the horizon in the UK.
Benefits of regulation
Future regulatory changes may directly benefit the challenger banks.
We’re still waiting for clarity on exactly what the PRA will do to address the disparity between banks’ approaches to modelling credit risk capital requirements, with some able to use the internal ratings based (IRB) approach and others (mostly the challenger banks) using the standardised approach, possibly requiring different banks to hold different levels of capital for the same loan.
Any moves that level the playing field for capital adequacy will further benefit the sector.
Scope for growth
The most important reason for optimism, however, is the scope for growth.
Analysis from Barclays noted that the Big Four high street lenders still hold 57% of total mortgages outstanding and delivered 53% of total mortgage lending in 2016.
For the five leading specialist lenders, the equivalent figures are 1.7% and 2.6%, respectively. In the BTL market the specialists have less than 5% each.
There’s huge potential to take market share from the high street, especially via the intermediated mortgage market. New mortgage-focused fintech platforms like Habito and Trussle can play a part by disrupting the traditional mortgage application process, generating further opportunities for specialist challenger brands.
More and better
In a relatively flat housing market some might say the specialists had a great year, but there’s scope to do more and better in 2018.
Interest rates are still at historic lows and – given Brexit – likely to stay there for some years.
As specialists continue to shake off the legacy of their subprime forbears from a decade ago, now it’s time to see if they have the ambition and if their backers have deep enough pockets to move from specialist lending to begin to really chip away at the mainstream market.
Sometimes it takes a decade for disruption to really work through the system, that was certainly the case for the first wave of dot com businesses, for those with memories long enough to remember back that far.
The specialists took their knocks back in 2007/08 and they’ve come back stronger, fitter and with better propositions and better technology. There’s every reason to believe that the next decade could be a transformative time for the sector. The mainstream mortgage market is there to be disrupted, if the specialists can seize the opportunity.
Quayle Munro is an independent mergers and acquisitions advisory firm