With the dust beginning to settle after implementation of the European Mortgage Credit Directive, it’s a good time to review of developments in the second charge market.
The MCD represented a huge regulatory change in the second charge arena, comparable in scale to 2014’s Mortgage Market Review impact. MCD implementation demanded a full switch-over of regulatory regime from the Consumer Credit Act and Office of Fair Trading, to the FCA’s Mortgage and Home Finance Conduct of Business rules. No transition period, no phase-in, no grey areas. On 21st March all second charge mortgages had to be MCOB Regulated Mortgage Contracts, and if incomplete on a CCA basis, the sales process had to be re-started as a regulated mortgage contract.
Unsurprisingly we saw major short-term disruptions, as the market tried to complete as many CCA deals as possible before 21st March, while simultaneously preparing new systems and processes for MCOB regulation. In effect, business pipelines had to restart in April. However, as we observed in our new-look Second Charge Report, business volumes look like they recovered through May and June. Despite the added uncertainty of Brexit since June, July also suggests the short-term impact of MCD has passed: new processes are bedding in and the market is adjusting to the new regime. Total lending looks similar to pre-MCD levels, though at lower transaction volumes.
So what of the longer-term effects of MCD? Beforehand, market commentators were predicting anything from a 30% drop to a doubling in size of the market, showing just how significant MCD was expected to be. These wild forecasts ignore the fact that the fundamentals haven’t changed. The underlying drivers of the second charge market – particularly debt consolidation and home improvements – still exist and are likely to show resilience even with post-Brexit market volatility. That suggests a positive outlook for growth. We are also seeing rises in sizes of second charge mortgages, as the sector grows in respectability and becomes a recognised mainstream alternative to first charge options for releasing home equity.
A second longer-term effect may be in the fees charged to customers on loan completion. The best customer outcome is getting the best available product for their needs, at a fair cost. With as revolutionary a change to market operation and structure as MCD, we are maintaining a watching brief on what the ‘new normal’ operating model ultimately will look like. This means making sure the right level and quality of advisory service is provided, to get that product selection done well. It also means understanding the right level of fees to charge that gives the customer a fair deal, while covering costs and allowing brokers to operate a sustainable business. Pre-MCD, we anticipated that it would take around 6 months for a clear, more settled view of this new world to emerge. That’s still our expectation and we are monitoring three factors closely to understand it.
First is the service level to advise the customer well, and its associated cost. Clearly, with both a different advisory regime and changes in responsibility for delivering advice to customers, the cost of preparing an advised mortgage application under MCD would always be different from the previous CCA experience. Equally, where a brokerage chooses just to package deals, processing will be dramatically lower than for firms advising, and we are already seeing some master brokers offering significantly lower fees on a packaging-only basis. Understanding how much time is needed to work through an application, as well as to have sufficiently-comprehensive Compliance oversight, clearly impacts costs that fees need to cover. However, with new processes that needed to be learned and embedded, costs observed in the first weeks and months post-implementation were unrepresentative. Further, like others, we’ve invested significantly in online portal technology to make the customer and broker experiences, simpler and more efficient. At present, advised processing costs look higher, but time is needed to get a stable view of the end game.
Second is the conversion rate from application to completion. We are seeing significant uplifts in completions rates post-MCD. This is because brokers have better understanding of second charges as well as the advice process helping customers understand their options more clearly too, leading to better quality applications and customers more ready to sign once an offer is made. Improvements in conversion increases overall cost-efficiency. Should these improvements prove to be sustained, fees would reflect those efficiency gains.
Third are market volumes themselves. To plan any business and be sure that fixed costs – including those for technology and compliance investments – are fully covered, market predictability is critical. Over a six month period, even with Brexit effects taken into account, we expect to have a far better view of MCD on total market growth as well as the make-up of that growth – volumes of second charges or their size. Master Brokers like us will then have a better view of the right size of their total cost base as well as the fees needed to maintain a sustainable bottom line.
The post-MCD world is still evolving every day and we are keeping a close eye on these key factors. Clearly, second charge fees are a hot topic at the moment. A couple of Master Brokers have made the commendable move to cut fees now. For us, where second charges are a large part of our business, we are taking a more cautious approach. In a period where uncertainty has been compounded by Brexit, we need to be comfortable that our business will remain robust and sustainable – just as we did through the 2008 recession. This appears to be the view that most of our competitors are taking as well. That should ensure that the industry can continue to operate within the required FCA standards of compliance diligence and advice quality, and deliver the best customer outcomes over the long term.
Harry Landy is sales director at Enterprise Finance