Net mortgage lending dropped from £1.05 billion in April to £563 million in May, the lowest since last September. Gross lending reached £12.2bn in May, up from £11.6bn in April, but repayments rose to £11.7bn from £11.4bn, bringing the rise in total lending to just £0.6bn. Last month, the number of home loans granted fell from 51,627 in May to 51,098 in June, and the average LTV crept back above 40% for the first time on nine months.
The blame has been placed on increased funding costs. Several interplaying factors contribute to the cost of funding a mortgage: the price of funding from wholesale money markets, the cost of getting funds from savers and the amount of capital regulators require lenders hold against their loans.
While draconian capital requirements demanded by regulators have played their part, it’s the increasing costs of borrowing funds via the wholesale money markets that is chiefly responsible for tightening credit conditions. Much of the blame lies with the political inertia in Europe. Germany is reluctant to bear the brunt of pan-European debt mutualisation, which has left the leaders of embattled Mediterranean countries scratching around for the scraps from the ECB’s table.
While the eurozone looks so combustible, investors have no choice but to regard lenders as a riskier option. The crisis has also spooked lenders. With some exceptions, they are reluctant to expand their loan books while the future of the eurozone is so uncertain. Their balance sheets were able to cope with last autumn’s spike in LIBOR, but we’ve reached a watershed point where they can’t afford to absorb any extra costs without passing them onto consumers. As a result rates have gone up. The Co-op (hot on the heels of Halifax) has hiked its SVR up from 4.24% to 4.74. RBS has followed suit, and it will be interesting to see whether Nationwide, Santander and C&G are able to honour their commitment to not to follow the rate-rising crowd. In addition high LTV lending has fallen steadily. Since February, our Mortgage Monitor has reported a steadily fall in house purchase loans to borrowers with deposits of under 15%.
In the Bank of England’s most recent credit conditions survey, lenders have reported a reduction in available mortgage credit, which they’ve admitted will push down the number of new loans they’re able to grant. They’ve warned lending levels may drop even further in Q3.
Unless George Osborne somehow manages to find the blue touch paper to ignite the economy, the best hope for reducing funding costs lies with an upturn in the fortunes of the eurozone. Direct recapitalisation of Spanish and Italian banks will offer lenders some short respite from the turbulence of the wholesale money markets – but it isn’t a long-term fix. As things stand, the only way to solve the eurozone crisis and calm the markets is a more federalised system of Eurobonds and fiscal integration. Until this happens, lenders will be at mercy of the volatile money markets across the channel.
Stringent capital requirements only add the problem of increased funding costs. As a defence against a repeat of the 2008 banking crisis, banking regulators are requiring lenders to hold large amounts of capital in reserve. Even though the Basel III requirements don’t come into effect until 2019, regulators are pushing lenders to build towards a buffer ratio of around 17% well ahead of the deadline. The more capital lenders are required to store away for a rainy day, the less funds available to would-be homeowners. Lord Myners was critical of stress-testing and capital requirements in a speech to the Lords last autumn. He argued building large capital buffers would do little to prevent a second financial crisis, and will only inhibit economic growth by restricting the amount banks are willing to lend. In a paper last summer, the OECD estimated Basel III will reduce GDP by up to 0.15% over ten years.
As the costs of funding mortgages rise and lenders pass the burden of these expenses onto borrowers, commentators have argued lenders are protecting healthy profit margins, rather than making a determined effort to sustain high LTV lending. Four out of the last five months have been marked by a decline in high LTV lending as lenders shift their focus to buy-to-let borrowers and wealthy buyers with low LTVs, according to our Mortgage Monitor. Amid the chaotic eurozone crisis, however, lenders are in reality up against a wall.
The severity of lenders’ funding problems for lenders has prompted the government to pump more money into the economy. On 14th June, in his Mansion House speech, George Osborne announced a £100bn ‘Funding for Lending’ programme, designed to cut bank funding costs in exchange for more extensive lending commitments. The Treasury claims this scheme could support an estimated £80bn in new loans. The hope is that as lenders become more active, competition within the market will naturally drive rates down. Osborne’s programme also includes a package that offers six-month liquidity to banks in tranches of at least £5bn a month.
By combining tight fiscal policy with active monetary policy, the government hopes to drag the mortgage market up off its knees and back onto its feet. In such an unpredictable economic climate, however, there is no sure-fire solution. Funding For Lending is a welcome step, but in all likelihood won’t be on a big enough scale to ease the logjam in the market.
