In last month’s commercial column I wrote about the useful lessons that the commercial lending sector can learn from the more established intermediary residential mortgage sector. I also promised to look at the other side of the coin his month – in other words, some wise practices in commercial mortgage lending that the residential sector might consider emulating for its own benefit. While the commercial sector has grown at an amazing rate over the past few years, the market is still very much in its infancy. But there are undeniably lessons that the wider residential mortgage market should conside, perhaps increasingly so in today’s climate of uncertainty.
The first of these concerns pricing for risk, with the pricing of residential mortgage products currently being maintained at the lowest viable level. This argument was planned before the recent events in the wholesale finance market, but has been vindicated even more by the recent spate of rate rises by many residential lenders. The market has become dominated by an unrelenting quest for volume, which has driven down margin and driven up the risk being taken. Ironically I suspect we can all anticipate an over-reaction the other way in the coming months, and this will prove an interesting time for all those active in the market.
Commercial mortgage lending is perceived as higher risk. Businesses do fail and the commercial property market is historically more volatile than its residential counterpart. This has led, in the past, to potentially higher losses for lenders. This risk is reflected in the pricing of commercial mortgages, and criteria that is less aggressive. Businesses have recognised the cost of capital, and they operate within these boundaries. What is more important for many in this market is certainty of cash flow. As a result, mortgages without payment variations, and those which are fixed, provide the basis for sound budgeting and financial
A move away from short-term discounts
This leads me on to my next point. The residential mortgage market could benefit from a move away from short-term discounts. At what point did the residential market change into competing on deep discount fixed rates only? I was discussing this with a significant lender only the other day – who confirmed that they did not complete one single variable tracker product in July.
As the quest for net lending continues to drive the lending community, discount or teaser rates have become staple diet. In reality the reversionary rate is never actually achieved as the payment shock prompts the client to remortgage – adding to the cycle of churning that dominates the industry. This is a problem recognised by the government, with first the Miles Report recommending ways to encourage long-term fixed rates, and now a new Treasury initiative to boost 25-year fixed rates. In commercial mortgages discounts are, thankfully, rare, although this is the result of being a less competitive lending market than design. You could certainly argue how it can be in the client’s interest if they are forced into a cycle of continuous refinancing or if the client cannot afford the standard rate in the first place. There are significant lessons to be learnt here, and the combined rise in residential remortgages acts as a timely reminder of this scenario.
High quality distribution
Finally, regarding distribution, the vast majority of commercial mortgage lenders rely on high quality sales personnel and underwriters to support the intermediary. This support can include joint marketing activities, seminars and sales calls to potential introducers. Underwriting teams provide detailed explanations on how to structure a deal or definite reasons why it will not work. Technology is crucial to the mortgage industry, but it must be complemented by professional people who can add value to the intermediary. It is more frequent than not to hear an intermediary pass comment that their business development manager wastes their time or that they cannot speak to an appropriate decision maker.
Looking at the overall picture, many residential mortgage lenders need to look at the risk reward balance, the structure of their products and the role high quality people play alongside strong technology. We are already starting to see a major re-pricing movement as a consequence of the turmoil surrounding the US non-conforming market. Lenders are responding to the increasing difficulties within the capital markets and perhaps it will provide the catalyst needed to re-think strategy. Within the UK market, it is impossible to stand still, and those that do rest on their laurels will be left playing catch up. By the same token, it is possible to teach an old dog new tricks.