THE UK MORTGAGE MARKET - August 2008

There has been so much going on in the mortgage market in recent weeks, and so much press and media coverage that we felt that our clients may find it useful to have a document to help them understand and "take stock" of the current situation. We will issue further updates to this as market conditions require.

What is going on?

The UK Mortgage Market is currently operating in a way in which it has not done within the last 30 years - and certainly in a very different way from recent years.

From a position of oversupply this time last year - with intense competition amongst lenders - both new and traditional - on criteria and on price, we've moved to a state of under supply, tightening criteria and widening lender margins and hence higher price to the consumer.

Many lenders have left the market - some large, some small. Others have withdrawn new lending and are "sitting on their hands". Even those with strong balance sheets funded by deposits are restraining their new lending so as not to damage their operations or overrun their funding budgets.

The most obvious consequences of this position are a shortage of exclusive products, products being withdrawn at very short notice, products being re¬-priced upwards and criteria such as loan to value or rental coverage on buy-to-let being adjusted.

All this makes for a very difficult operating environment for mortgages, and frustration for  customers, both existing and new.

Why is this happening?

There are three key reasons why this is happening.

Firstly, a lack of liquidity in the money markets - that is the money that would previously have been available for banks to lend to each other. In the past (the far past!) banks would have used their deposits - money in savings accounts - to fund mortgage and other lending. More recently however, mortgage lending has increasingly been funded by the money markets - borrowing from other banks -or from the sale of packages of mortgages (Mortgage Backed Securities or "MBS").

But because of very poor arrears experience of the mortgage loans within these MBS which had been used to fund the American sub-prime mortgage market, banks have had to write off huge losses - often billions of dollars or Euros for each firm. Note : the problems have been with the US sub-prime market -where over 20% of lending has been sub-prime for many years - not the UK sub-prime market which is much better controlled and has only been at around 7% to 8% of total lending in recent years.

So - major banks are now in a scramble to adjust their balance sheets - to have less of them funded by money markets and more funded by deposits - getting back to the old days. The technical term for this, which you might see in the papers, is "de-leveraging". And if a bank has any cash - like from a redeeming mortgage - it is not going to lend it out to another bank that may have problems. They worry that they may not get it back. So this is why you see that LIBOR -the rate at which banks are prepared to lend to each other - at a level way above the Bank of England base rate (3 month LIBOR currently around 6.7%, BBR 5.00%). Over the last few years, 3 month LIBOR has normally run at about 0.15% to 0.25% above BBR - so you can see that here too, things are far from normal.

In short - there is not much cash around to fund new mortgage lending.

The second key problem is simple confidence. Lenders fear that as a result of all the other problems in the market that house prices will fall and that mortgage loan performance - arrears - will worsen considerably. The consequence of this is the tightening up of criteria we've seen - first 125% lending goes, then 100% and who knows where it will end. No lender wants to be the last one in the market with wide open criteria.

The third issue is processing capacity. As we all know from experience -lenders administration can run into serious problems if too much volume is taken on too quickly. So lenders faced with warning signs like high telephone traffic or DIP (Decision in Principle) levels have been taking the decision to "cool it" either by adjusting criteria or price, or in some extreme cases, telling the market they are not open for new business.

You may feel that this could all become a self-fulfilling prophecy - that house prices will fall because buyers can't get mortgages to buy properties. This certainly is a concern.

When will things "return to normal"?

The short answer is, nobody knows.  Indeed, it is quite possible that we won't see any return to the sort of market we have had in 2006 and 2007, for many years. Arguably, that market wasn't normal either - there were lots of aggressive new lenders with big aspirations who made the market compete on risky terms at little or no margin. With their departure, the remaining strong lenders are rebuilding a more appropriate approach to risk - taking criteria back to where they were several years ago.

The hope in the market is that perhaps a year or so after the "credit crunch" started, when all the banks have gone through a whole reporting cycle, all the bad news will be out in the market, and the write downs and losses will be history - albeit recent history.

If the confidence issue can be handled until that point, we may see lenders becoming more competitive again - with a return to larger lending appetites and willingness to grow.

At the end of 2007 many were predicting that 2008 would be a year of two halves - difficult in the first six months but improving in the second six. But as time has gone on, this looks less certain, and it may be that 2009 will be the time that the market returns to stronger activity levels. At present, the current state of the market looks certain to continue for the remainder of 2008, and possibly into 2009.

Are there anv reasons to be cheerful?

There are some positives in the current situation - fundamentally the fact that the UK is not the US!

In the UK, employment is still close to record high levels (unlike the early 1990's) providing a high demand for housing. At the same time, we are, as a country, not building enough new homes. Supply and demand economics will mean that the housing market is strongly underpinned and is unlikely to suffer a crash.

In addition, interest rates may be on their way down - with some possibility of further cuts this year and the possibility of BBR getting as low as 4.25% by the middle of next year, with further cuts later in the year, according to some economists.

Whether falls in Bank of England Base Rate are followed by falls in mortgage rates is far from certain - but with sufficient cuts, the cost of borrowing should get cheaper - perhaps encouraging more people back into the mortgage and housing market.

Independent Intermediaries remain the most favoured route for consumers to obtain mortgages from lenders - this proportion having been growing for several years as "shopping around" becomes more common. Customers need advice more than ever, and we have the key role to play in this.

What can the industry do to make things better?

There are a number of things going on which may make things better.
At a macro level, the Bank of England is providing more liquidity support into the market. In addition, certain industry bodies are trying to encourage new sources of funding into the market - in particular by showing them that UK mortgage debt is not poor quality, and that there are good margins to be made.

At the level between lenders and brokers there are also things that should be done. We need to work out ways of better balancing supply and demand in the market. If we are set for a period of under supply, we need better ways of managing processes to avoid the current chase for deals between lenders. We and the various Mortgage Clubs we use, are working with lenders to see if we can develop solutions for this medium term problem.

What are we saying to our Clients?

All the information above is intended to help you better understand what is going on and how things may develop over coming months.

There are mortgage lenders who want to lend this year, and we will be doing our best to make sure you are able to access mortgage funds throughout this difficult time.

However - some "expectation management" will be needed. Mortgage rates may not fall as fast as Bank Base Rate, and loans will not be as available on such open criteria as in the past. Larger deposits will be needed. Poorer credit risks - people who have missed payments or have CCJs etc will find it difficult if not impossible to get a new mortgage. Keeping a clean credit history has never been more important.

Never has it been more important to check product availability with lenders throughout the process. Often products are withdrawn without warning, leaving us no time to react. We ask that our Clients understand that prompt decisions are called for in these really difficult times in the market.

It is possible we may return to the days of lenders being able to confirm that a mortgage will be available, but not when. Some waiting may be required. So, the other feature of the market that may develop is some form of supply and demand management - queuing or rationing - perhaps by quotas.

We are intending to issue updates on the market like this one from time to time over the remainder of the year. In the meantime, our team of Advisers is available to talk through the current market conditions whenever you want.