When I first started in the mortgage industry, in 1982, the only funding for mortgage lending was the retail deposits provided by members of building societies. We had quotas or limits on how much we could lend strictly geared towards the inflow of saver’s money. People used to walk into my office on their knees begging for a mortgage.
How times have changed.
There is no shortage of money available to the UK mortgage market which has created hundreds of mainstream and specialised lenders. They fund their mortgages via:
Retail Funding
Much the way of the building society in 1982 and this model hasn’t changed a bit. Lenders need a banking license to collect deposits and use interest rates and product features to lure in savings. You will recall the phrase “lending long”, and this model allows for short term deposits to be used to fund long term mortgages. Margins are maintained to provide the profit. Paying interest at 1% and earning rates of 3% offers a 2% profit. This is eaten into with costs of marketing and such, but it is a robust model.
Securitisation
Famed for causing the financial crash in 2008, mortgage-backed securities (MBS) allow lenders to move tranches of loans to other institutions without selling them off ultimately. The loans are still owned by the lender, and they receive repayments and deal with arrears and other matters. A small proportion of the monthly mortgage payments are paid to the holders of the MBS who provide a lump sum up front in return. Their lump sum is gradually repaid by the mortgage payments over a 20 to 25 year period. The lender is now armed with a large lump sum again which they can then re-lend.
Wholesale Market
This is where lenders who don’t have the retail deposits available, secure their funding for the short term before they embark on securitisation. It’s a wide and varied marketplace, virtually a forum for institutions (banks, governments, corporates and the like) who have surplus cash, to lend it to those who need it to fund their mortgage operations.
The standard approach is to seek warehouse lines of credit. These are repaid within two to three years — enough time to get lending and securitising to repay the loan. Often in the sum of £300 to £500 million and the providers will want some say in how the money is lent, this will impact on criteria.
Peer to Peer lender, Lendinvest, has reported having received a £200 million line from HSBC, which it will use to finance its bridging loan activities. Interestingly it will use its Peer to Peer platform to attract investors to ultimately repay HSBC rather than securitise the whole lot in two or so years.
Forward Flow Agreements, popular in the States, are methods of raising finance differently. One institution lends a large tranche of money to another. They lend this money on mortgage using the original lender’s appetite to risk. Ultimately the loans are then transferred back to the original institution to sit on their balance sheet, and the whole process continues.
With the world awash with cash seeking higher interest rate returns, with a minimum of risk, the supply of funding for the mortgage market seems endless. All it takes, though, is for confidence in the wholesale market to run out and funds will dry up overnight causing a systemic crash. That’s what happened in 2007 when Northern Rock Bank ran out of money and went to the wholesale market. There was no one at home that day; they’d all been frightened away. The rest is history.
