Having just implemented the MCD, which we spent a year getting ready for, I was looking forward to a period of relative regulatory peace and quiet.
Wrong again! Along comes CP11/16, aka underwriting standards for buy-to-let mortgage contracts. This time, instead of coming from the FCA it comes from the Bank of England’s Prudential Regulation Authority.
Anyway, after reading the paper front to back several times over, I am experienced enough in such matters to allow a period of reflection in order to let the implications set in and to think rationally, not emotionally.
Human beings are not very good at change so CPs tend to create a lot of knee-jerk reactions and quite a lot of hot air. I will focus on the impacts of the CP that are most likely to affect mortgage intermediaries although I should make it clear that the CP is directed at lenders, not intermediaries.
The interest coverage ratio affordability test should give consideration to all costs associated with renting out the property that the landlord is responsible for and any tax liability associated with the property. Lenders can take account of the borrower’s personal income when assessing affordability – this is subject to the same regulations as Residential lending in terms of income validation, expenditure data and credit commitments. The PRA does not expect lenders to reduce the minimum ICR requirement below 125 per cent.
Interest Rate Stress Testing
Firms must incorporate a minimum of a 2 per cent stress on either the initial or the reversion rate, subject to a minimum rate of 5.5 per cent being used. Fixed rate products of 5 years or longer do not require a stress rate to be applied which is consistent with residential lending and MCoB.
A portfolio landlord is defined as a landlord with four or more mortgaged properties – a specialist documented underwriting process is required for lending to portfolio landlords.
Taking data from the slide deck attached to the CP, it is possible to summarise the PRA’s market view in the chart below.
Our view is more conservative than the PRA’s, in that we believe that buy-to-let gross advances in 2017 are likely to be flat with the potential to drop 10-20 per cent before recovering in 2018/19.
Unregulated firms and non-banks
One glaring omission as far as I am concerned is that the CP only covers PRA regulated firms. Theoretically, unregulated firms might see a market to address customers failing the new rules.
However, it is expected that bond investors (remember non-banks are funded via largely by capital markets) and rating agencies will penalise such an approach, which will clearly be non-compliant with PRA policy.
Given the current difficult environment for funding a non-bank, it is considered unlikely that many will take this risk and cost for a relatively small market opportunity.
Furthermore, the PRA has already made clear that it would seek to extend the rules to firms outside of its jurisdiction if it considered that there was a material impact on the overall buy-to-let market.
Further, the Bank has just published a proposal for new buy-to-let reporting (from Q2, 2017).
It is interesting to note that all firms originating £20m+ per annum are captured, even if they are unregulated.
While this introduces further discrepancies in the regulatory oversight, it will mean that unregulated firms will be subject to specific scrutiny if they are active in the market and their policies fall outside the requirements that materialise from CP11/16. But will this level the playing field eventually?
Market fundamentals remain unchanged and the continuing lack of supply of housing coupled with a growing population is likely to continue to fuel house price inflation, making home ownership less attainable for many.
The CP proposals in respect of affordability and stress testing are likely to lead to a more resilient and stable market less sensitive to interest rate rises. These are sensible regulatory precautions which we largely support and believe are likely to be adopted.
Many landlords with low LTV and/or higher yielding properties will be unaffected by the affordability and stress testing proposals.
Smaller or new entrant lenders may perceive a larger barrier to entry in the buy-to-let market and therefore less likely to enter the market, especially by offering looser underwriting standards and/or lower pricing than the incumbent lenders.
Increased complexity in the underwriting process for portfolio landlords is the biggest immediate impact of the proposals. This will significantly impact larger lenders which have less flexibility to adapt to fuller underwriting procedures.
We expect to see some lenders withdraw or retreat from what is becoming an increasingly specialist market.