Alan Cleary – Managing Director – Blames the ratings agencies
Building societies have been under the spotlight in recent weeks after Moody’s downgraded nine, some to just one notch above junk status. But why?
This was a massive overreaction from Moody’s because they screwed up their ratings on the way up. The mutual sector isn’t worthless and Moody’s has misfired again. For societies who want to prove their worth, there’s only one way to go. Do it yourself. The ratings agency methods are opaque and there has been an industry backlash against the house price deflation expectations used by Moody’s. Adrian Coles of the BSA believes they’re heavily overdoing their house price fall predictions. Instead of relying on the agencies to qualify credit risk, mutuals should think about assessing their own mortgage books. Understanding your risk is a step closer to managing it – and that puts you a step closer to proving your stability. Knowing your borrowers and their financial stability in today’s economic environment means you know yourself. vAnd that’s gold at the moment.
It’s coming round to that time of year – the papers are full of tentative tales of green shoots emerging. Spring is in the air and talk of hope is battling the poor economic data released day in day out for valuable column inches. Rightmove said last week that the number of house hunters in April this year was up on the same month in 2008, signalling a turn in the state of the market. Estate agents have also noted a rise in the number of residential property transactions in March, qualifying this claim with the added assertion that the flurry of activity has been fuelled by a rise in the number of cash buyers.
I don’t want to burst their bubble, but the plain state of the matter is that we aren’t through this recession yet. The nub of the problem is the continuing lack of credit in the market. It may be true that consumers are getting feisty at the thought of picking up property cheaply – at least in comparison to the prices people were having to pay two years ago. But rising buyer interest isn’t going to translate into rising transactions. The estate agents have put their finger on the money – it’s cash buyers (and only cash buyers) who have the power to purchase property. Everyone else is scuppered.
First time buyers can’t get finance without a perfect credit score and a very decent deposit. Without movement at the bottom of the ladder, no-one else can move up it. This is made worse by the fact house prices are falling fast – Halifax has recorded a 22.5% drop since their August 2007 peak. There are a lot of homeowners out there who’ve dropped into negative equity during that time – even if they can afford their mortgage payments every month, they’re paralysed by their lack of equity.
Mortgage finance is still unbelievably tight and with gross lending this year on track to hit around £150bn, it doesn’t look as though the banks are planning on offering much more for the next nine months. The simple truth is that house prices are going to stay on a downward spiral until the mortgage markets free up – a flurry of activity from cash buyers is just hiding what’s inevitable.
The point of this preamble is to set up a realistic view of the market we’re in, and what that means for building societies. The move by Moody’s to downgrade nine societies so dramatically takes into account the dire prospects for house prices in the UK, predicting the peak to trough fall at around 40%. Some in the industry felt this forecast was unmerited and overly gloomy, but I have to admit I think, given all the evidence, it’s not unrealistic. I don’t agree with Moody’s decision to mass downgrade though – far from it.
Their ratings methodology is opaque, and it doesn’t look at mortgage assets individually, assessing each loan’s current credit risk. The ratings agencies make high level value judgements based on asset classes and previous performance. But take buy to let for instance – the range of borrower in this asset class is enormous. One may own one BTL property and be in negative equity on it, another may have only 40% gearing on ten.
There’s no way of being sure that credit risk assessment is 100% accurate for a specific book of assets without looking at the underlying loans in isolation. The other shortcoming is that data gathered on a mortgage at the point of origination is almost certainly irrelevant in terms of assessing credit risk in today’s economy. Levels of secure debt will have changed, as might payment history and property values.
The future of the UK’s mortgage market is going to depend on the ability of building societies to pick up some of the slack from the larger retail banks, which are now interested only in prime customers and, the gaping hole where the specialist lenders used to be. Mutuals have the right kind of model for today’s lending environment – high retail deposits allowing them to loan cash back out to their members. But before building societies can get into a position where this is possible, a spring clean is in order.
There are two sides to this: one, mutuals need to work out what’s on their balance sheets; two, they need to make it work harder for them. Cash is king in this type of economy.
Servicing your mortgage back book efficiently, getting the most out of it in terms of cash flow, and ensuring you’re treating customers fairly all without a completely transparent understanding of what your borrowers’ credit risk looks like is akin to driving a car through a thunderstorm with no windscreen wipers. Dangerous. It makes no sense to feel your way blindly, writing off bad losses after they hit when a simple risk assessment could show you where the black spots are and how to avoid them.
Exact is so committed to the benefits of this that we’re offering to run our AQA service at cost on building societies’ mortgage books. Moody’s are giving mutuals a window of opportunity to prove their ratings wrong – take it.
The added advantage of running a detailed assessment of your mortgage book with Exact is that we can stream loans by risk. Spring cleaning is about more than just remembering what you’ve got hidden at the back of every cupboard – it’s about throwing out the rubbish you didn’t even know you had. It’s not quite that straightforward with mortgages – there are borrowers involved and the first priority is to treat customers fairly. But that doesn’t preclude tidying up a mortgage book.
Exact’s Mortgage Asset Reduction Strategies (MARS) identifies the cash sum individuals require to enable them to remortgage with another lender. By awarding high risk borrowers a way out, you treat them fairly (they’re being given a cash lump sum on a plate) and encourage them off your book at the same time. Although lenders take a loss, the loss mitigated by adopting this strategy is much higher. In a down market where house prices are falling, unemployment is rising, arrears are exploding and possessions are inevitable, any cost which protects a lender from the risk of collapse is a cost worth covering.
The media might be right to some extent, the green shoots are there.They don’t denote rising house prices or burgeoning transactions, but there is hope for lenders who roll their sleeves up and give their housekeeping some serious attention. The dust is beginning to settle, which makes perfect timing for a good spring clean.
