Posts Tagged ‘Residential Mortgages’

Lehman Brothers

I‘m not going to write much about Lehman’s demise because there will be thousands of column inches out there (most ignoring the equally important news of the BoA purchase of Merrill Lynch and the problems at AIG). Lehman’s British companies have mostly been put into administration. All I want to note is that in a live interview with the Administrators (PwC) it was stated that some of the best assets left in the UK companies were real estate assets, held in special purpose companies and joint ventures. This shows that – despite the current hand wringing about property markets and reference to ‘toxic’ real estate involvements in the Media – owning real estate assets is safer than lending on them. This is a point I will return to in a future post.


Amongst the carnage on the Stock Exchanges around the world yesterday, HBOS shares took a huge battering again in the UK. Quite why still baffles me, although this article suggests that one reason is that the bank is ‘ so exposed to the mortgage market and falling house prices ‘.

In the current climate, the relevance of falling house prices in relation to HBOS is not that important – the ability of mortgagees to meet their payments is the critical issue. Over the life of a mortgage, a house value can fall below the amount of the mortgage (known as ‘negative equity’) and rise well above it. It has happened to me. This is not a cause for concern so long as the borrower can make payments. Therefore, interest rates and the job market should have a greater impact on HBOS’s position, rather than the state of the housing market. When panic spreads throught markets, logic and common sense seem to go out of the window.

The same applies to commercial property loans, but since they are for a much shorter period, the state of values and the market is relatively more important than for residential mortgages. Nevertheless, so long as a borrower can meet their income payments, only a foolish or desperate bank will force the sale of properties in a weakening market. It will only make things worse – for them and everyone else.


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The previous article points out that banks invariably cause themselves harm by restricting lending when markets need liquidity and – based on recent announcements and revelations in the UK – they appear to have found a new way of hurting their customers and thereby, themselves.

There are 3 main choices for banks when seeking to cut down on levels of new lending:-

  1. Stop lending and close down a particular lending unit (the favoured choice in a recession for commercial property lending units);
  2. Impose tougher conditions for loans, so that fewer borrowers qualify;
  3. Make the cost of lending markedly greater to deter potential borrowers, possibly making other sources of finance more attractive.

Interestingly, many have opted for a fourth choice: temporary suspension of lending, ostensibly to deal with an overwhelming load of applications. This both flatters the lending institution (‘We’re so popular”) and holds the promise of a forthcoming return to the market, hopefully avoiding a further collapse in confidence that could harm their existing loans.

Depressingly, a number have opted to make lending more expensive, either by raising interest rates or by increasing arrangement fees, sometimes both. This appears to be a such a lurch towards self-harm that it might justify psychiatrists being offered seats on bank’s Board of Directors. It automatically increases the likelihood of default for struggling existing borrowers and makes any Bank of England reduction of Base Rate somewhat pointless. What’s the point if the reductions don’t get passed on to the people they are trying to help ?

Is this greed or stupidity in action ? Possibly neither, yet perhaps inadvertantly both. The banks that have chosen to do this may have other things on their mind. It’s interesting to note that those who have ‘ temporarily closed ‘ residential mortgage lending are generally Building Societies whilst those who have tightened lending criteria and also raised interest rates are banks. Commentators have suggested that this may be because these banks are seeking to build up deposits and capital reserves. This could well be true and may even be essential in a few cases.

However, as anyone who has been involved in UK property lending knows, the ability to service the debt grows more important than the underlying asset value the longer the loan period. So, for commercial property lending, where loan periods are from 2 to 7 years, both are critical to the repayment risk. Yet, for residential mortgages, where loan periods are typically between 20 to 25 years, the ability to pay interest is far more important than comparatively short-term movements in the property’s value.

So the banks that have raised interest rates on residential mortgages may help themselves in the short-term, but run the risk of creating serious problems for themselves down the line. Bearing in mind the old adage that one bad loan can wipe out the profits of a hundred good ones, increasing the likelihood of defaults by raising interest rates may not please the more discerning of their shareholders.

Why do banks behave like this ? On Robert Peston’s excellent blog he talks of stable doors and horses bolting, which is partly true, but the fundamental issue is that banks never pay enough attention to the skills of lending to property markets – of which knowing how to behave at different phases of the market is one of the most important ones.

What is so baffling and infuriating is that they have had painful lessons in the past, yet still refuse to learn from them.

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