The recent 10-year anniversary of the financial crisis has caused much soul-searching over what lessons have been learned. Banks’ progress has, of course, been a major focus of attention in a variety of areas, but one area that has not received much scrutiny is that of residential mortgage lending.
How cautious are banks being about risk and how shock-proof is the market? An analysis of Bank of England data suggests that risk may be rising as high loan-to-value ratios make a comeback.
The evidence for this is that in the first quarter of this year, 4.5 per cent of residential mortgages were written at 90 per cent loan-to-value (LTV) or more. That is a substantial increase compared to the same time a year earlier when 3.4 per cent of mortgages were written at that level. Roll back to the end of 2009, during the height of the recession, and the figure was just 1.5 per cent.
That may not sound like a high proportion, but it represents hundreds of millions of pounds advanced in riskier lending. Mortgages advanced at 90 per cent-plus LTV were worth £2.73bn in the first quarter of 2017, compared to £2.18bn last year and just £623m in the fourth quarter of 2009.
Does this signal the start of a return to pre-credit crunch levels of risk-taking? We are still nowhere near those levels yet – at the pre-crunch peak in the second quarter of 2007, more than 16 per cent of mortgages were written at 90 per cent or above.
However, the fact remains that an upward trend is emerging. With house price inflation now showing signs of cooling after a long period of sustained growth, this is a cause for some concern as a market correction could put homeowners at risk of owing more than their house is worth.
Why is this trend happening?
High-risk mortgage lending of this type fell dramatically during the credit crunch as banks scrambled to shore up their balance sheets. A decade on, balance sheets look more robust and attitudes to risk might be starting to relax. Lending at 90 per cent LTV or higher allows banks to grow their loan books relatively quickly – a boon at a time when banks are continuing to keep a tight lid on other forms of lending, such as to small businesses.
Key points
- High loan-to-value ratios are making a comeback.
- Lending to property developers is suffering.
- Keeping a firm handle on LTVs is vital to control risk.
The government-backed help-to-buy scheme, which enables buyers to purchase homes with just a 5 per cent deposit, has likely played a part in changing attitudes too. And the search is on for higher yields, making charging steeper interest rates for higher LTV products an attractive prospect. This begs the question of whether the return justifies the risk.
It is certainly a high-stakes strategy – for banks and for the market as a whole. Extending loan-to-value ratios could store up trouble for the future, pushing up house prices as buyers are able to “afford” to offer more to secure the home of their dreams. This creates an upward spiral, as buyers have to stretch themselves further to buy in popular areas.
Nowhere is this more evident than in London, where buyers borrowed another £17bn in new mortgages last year. Those purchasing in the capital’s SW and SE postcodes alone were collectively lent some £8bn – more than the whole of Wales put together and almost as much as all the buyers in Scotland. In spite of Brexit, house prices in these sought-after locations have climbed sharply, as lenders continue to see the London market as a safe bet.
Property developers suffering
As banks continue to pile into the owner-occupier market, the downside is that lending to property developers is suffering, along with other small and medium-sized enterprises. The past couple of years have seen bank lending to property developers halve, as lenders continue to focus on de-risking their balance sheets.
Loans for developments that banks see as more speculative – for example, those that are not fully pre-sold or let – has become far harder to secure because banks are expected by regulators to hold more capital in reserve in case of default. That is well and good, but unless this issue is addressed, developers will struggle to deliver projects at the rate needed to meet housebuilding targets and solve the housing shortage. As demand continues to outstrip supply, prices are likely to be pushed further and further to the limits of affordability.
The problem is most acute in cheaper areas of London as developers focus their activities on the wealthiest neighbourhoods. According to recent research conducted by Lendy, the most expensive boroughs such as Kensington and Chelsea, Wandsworth and Hammersmith and Fulham top the table for most new residential developments per capita. At the other end of the scale, boroughs such as Barking and Dagenham were at the bottom of the table. That means that key public services workers might be missing out on new homes, exacerbating the housing crisis in the capital.
Keeping a firm handle on LTVs is vital to control risk, which is why, in my view, lending ceilings should be far lower. If that is true for residential owner-occupiers, it is even more pertinent to property investors. Investing by making loans secured against property, rather than using an equity-only strategy, can play an important part in mitigating the concentration risk faced by a lot of property investors. For some, 70 per cent LTV is their maximum, but they are keeping the average lower at just 60 per cent LTV. This provides lenders with a layer of protection against fluctuations in the market and helps investors to spread risk.
It seems that banks are moving up the risk curve once again, but as they do so, it is vital that high loan-to-value mortgages remain rare exceptions rather than becoming commonly available.
Approving a 90 per cent-plus LTV mortgage might be justifiable on a case-by case-basis, but if the practice becomes widespread again, the potential impact on market risk could be significant.
Learning the lessons of the past means looking at the bigger picture and continuously re-assessing where risk really lies. In the mortgage market, sensible LTVs are a lynchpin for stability and security. Banks that might be starting to drift back towards more risk taking in the mortgage market ignore that at their peril.
Liam Brooke is co-founder of P2P secured lending platform Lendy
