This is perhaps the most uncertain and unpredictable time since the Second World War. The scale of the impact of Covid-19 on global economies, financial markets and, as a result, housing markets is beyond the scope of anything the world’s population has experienced in living memory. Stock markets have lurched lower worldwide. Even bond markets (traditionally a safe harbour in times of crisis) are coming under increasing pressure, not least because of the huge surge in Government and State borrowing to fund massive economic stimulus packages that make the quantitative easing measures of the 2008 Global Financial Crisis look tame.
Turmoil in the financial markets is to be expected given that the world has, in effect, put the global economy on hold. On our own streets in the United Kingdom the majority of high street shops and offices are closed, demand in service industries has plummeted and the general sense of uncertainty weighs heavy on consumer confidence, curbing what little spending might otherwise have taken place with the country’s pollution on lockdown. The housing market, like the rest of the economy, is also on hold, with the Government telling people that new viewings on properties should not take place, and that all measures should be taken to delay the completion of house purchases until the current lockdown measures are lifted.
In the context of this backdrop one would expect mortgage lenders to take a more cautious approach to new loans. However, the reactional change to underwriting policies amongst major lenders in the UK goes beyond cautious. Nationwide, the country’s biggest lender, has capped their Loan to Value (LTV) ratio at 75%, whereas Halifax, Barclays and a number of other major lenders have capped their LTV ratios at 60%! To put this in context, borrowing at up to 90% LTV was available through major high street lenders throughout the Global Financial Crisis! So, what’s the different this time?
Well, there are a variety of factors. The banks say they are struggling with staffing, which I suppose is to be expected given that call centres and offices the world over are shutting. In the context of needing to limit work volumes, and thus the volume of new business, it’s probably natural for lenders to want to concentrate their efforts on higher quality (lower risk) loans, particularly where both the future of the housing market and the security of borrower’s jobs is uncertain. Additionally the banks will have some very real concerns about liquidity in the housing market, making traditional valuations, which rely on comparing the property being valued to similar properties that have sold in the past, less reliable (not to mention the difficulties of actually getting a surveyor out to value a property in the current climate). Aside from the practical considerations, there is also the question of what the bank does with the mortgage after it is granted. Many loans are not actually held on the bank’s balance sheet throughout the mortgage term, but are packaged with other loans and sold to investors in a process called securitisation. To understand the current reluctance of mortgage lenders to write all but the most secure loans one must consider the situation that the securitised mortgage debt market now finds itself in.
Many readers will recall that poorly graded (sub-prime) mortgage-backed securities were the catalyst for the 2008 Global Financial Crisis. Since that time, mortgage securities have been treated with greater caution by investors and the secondary mortgage market has not, in recent years, been entirely self-sustaining. The Bank of England has, in effect, become and alternative source of cash for mortgages by way of schemes such as Funding for Lending, which provided funds for mortgage lending throughout the financial crisis, and more recently the Term Funding Scheme which, until 2018, provided banks with cheap cash for lending following turmoil in the securitised debt markets after the Brexit vote. Indeed, to fill the securitisation void left by the Covid-19 outbreak a new Term Funding Scheme was announced in March 2020, offering four-year funding of at least 10% of lenders’ stock of real economy lending at interest rates set to be close to the base rate of 0.1%. But will this be enough?
Lenders will be considering the likely outlook for the secondary mortgage market on expiry of the four-year Term Funding Scheme. The message that current underwriting policies are sending is it looks bleak, and I think they are probably right. Mortgage-backed securities (with the exception of the low grade sub-prime stock that kick-started the 2008 meltdown) are boring, low risk, long term, low yield investments. As such they are in direct competition for attention in the market with Government bonds. With Government and State borrowing set to stay at all-time highs over the next few years there is going to be a flood of bond issuances, upsetting the supply and demand dynamic in a market where mortgage-backed debt securitisation was already failing to sustain mortgage lending.
So, what does this mean for the housing market? It seems likely that, in order make securities containing higher LTV mortgages attractive to investors, lenders will have no option but to raise interest rates, making borrowing more expensive for home buyers. As a result, when the housing market eventually re-opens, in addition to contending with the potential impact of job losses and a likely recession, the market may also have to cope with a serious curtailment in the borrowing power of would-be purchasers. A reactive adjustment in house prices seems inevitable – the only question is the extent of the impact and the degree of that adjustment.