Cablegate: Uk Mortgage Lenders Ok for Now; Housing Prices Falling

DE RUEHLO #1285/01 1281635
R 071635Z MAY 08




E.O. 12958: N/A


1. (SBU) Recent announcements of lenders withdrawing mortgage
products from the market incorrectly suggest that UK mortgage
lenders are in crisis. As a group, mortgage lenders are solvent
with significant equity cushions in their mortgage portfolios and
default rates remain low. Building societies are flush with cash as
savers transfer out of equities to deposits. The industry is under
stress, however. The liquidity shortage in the general banking
sector also affects mortgage lenders that are finding it difficult
to meet the demand for new mortgages. Wholesale interbank markets
remain essentially closed limiting the funds available for new
mortgages. The buy-to-let market for mortgages is effectively shut
down. The securitization market remains closed further limiting
other lenders' ability to write new mortgages. For more than six
months, industry representatives have argued for Bank of England
(BOE)intervention to increase liquidity in the mortgage industry in
order to meet mortgage demand and slow the rising cost of mortgages.
On April 21, the BOE unveiled a GBP 50 billion special liquidity
plan that will permit lenders to swap illiquid assets for easily
tradable assets. Industry reaction to the plan was positive but
cautious, and an industry spokesman said he regrets the lack of
greater transatlantic cooperation. It is too soon to assess the new
plan's overall impact.

2. (SBU) Similar to the U.S., UK real estate values have been rising
steadily for over a decade. Amid the global financial crisis and
declining economic growth forecasts, UK housing prices have begun to
decline. In April, house prices suffered their first yearly decline
since 1996, and some are forecasting house price declines of up to
30% over the next few years. The solvency of mortgage lenders as a
group is not in jeopardy since mortgage debt currently totals only
40 percent of real estate value due to the long period of escalating
prices. Notwithstanding, many argue that continuing declines in
house values would adversely affect consumer spending and drag down
overall UK economic growth and adversely affect the mortgage
industry. End Summary

3. (U) In recent weeks, numerous press articles have painted a
picture of a deteriorating UK mortgage industry. HSBC projected the
number of mortgage transactions in the UK would drop by 30 percent
in 2008. The Financial Times reported that the last of 20 banks
offering 100 percent loan to value (LTV) mortgages at the beginning
of March had withdrawn from the market. On April 9, Halifax
reported that UK home values had declined 2.5 percent in February,
and the BOE reported April 29 that approvals for new mortgages fell
by 11 percent to 64,000 in March.

UK Mortgage Industry Not In Crisis, YET

4. (U) Lower growth forecasts and recent property value declines
make the outlook for the UK mortgage industry more challenging.
However, the industry is not in crisis, Adrian Coles,
Director-General of the UK Building Societies Association (BSA) told
Econoffs. He said that the withdrawal of 100 percent LTV loan
offerings had little impact since such loans are a very small
portion of mortgage lending. Among Building Societies, loans
greater than 95 percent LTV have never represented more than 2
percent of lending. Building societies currently are flush with
cash as risk-averse customers switch from stocks to savings
deposits. Coles said HSBC bank was moving to gain market share in
the industry by matching existing terms on mortgage rollovers,
albeit only for selected buyers and for a limited time. Michael
Coogan, Director General of the CML confirmed the views of Cole.
CML members account for 98 percent of all UK mortgage lending, of
which BSA members account for about 20 percent. However, Coogan
also said that demand for mortgage funds continues to exceed supply,
and government intervention was needed to add liquidity to the
market. (NOTE: the BOE intervened April 21 with a special liquidity
plan - see below).

5. (U) Because building societies are flush with cash from new
deposits, they are still making mortgages. However, Coles said they
traditionally source 25 percent of their funding in the wholesales
markets (i.e., interbank market or securitized borrowing), and these
sources are effectively closed. Accordingly, while mortgages are
available, lenders are being very selective. Coogan added that even
BSA members with large deposit inflows were being cautious about
increasing lending in the current market where liquidity concerns
are paramount.

6. (U) Although the overall industry is healthy, there are
exceptions. Buy-to-let mortgages,(that is, mortgages to buy
properties to lease them out), have largely been discontinued.
Coles said Paragon, the second largest UK buy-to-let lender, told
him it could no longer raise any money in the wholesale markets and

LONDON 00001285 002 OF 003

was effectively out of business for the moment as it offers
buy-to-let mortgages exclusively. Also, those that relied on
securitization as their principal source of funds, such as GMAC,
Lehman Brothers, and Morgan Stanley, have been hit by the shut down
of the securitization market.

Mortgage Lenders Are Solvent-But Need Funding

7. (SBU) Currently, UK mortgage lenders and building societies in
particular are financially sound. Coles and Coogan both said the
average mortgage is only 40 percent of value. Even after forecast
declines in real estate values, there will be ample equity to
collateralize their mortgage books. According to recent statistics
from the Financial Services Authority, mortgage arrears also remain
low. Repossessions are running below the current CML forecast rate
of 0.38 percent (45,000 repossessions). Notwithstanding, the CML
has argued for BOE intervention to increase liquidity for mortgage
lenders. Without it, the industry argued it could not meet mortgage
demand and mortgage costs would spiral upward to ration the
available supply.

Government Action

8. (SBU) On April 9, Chancellor Darling announced the creation of a
Mortgage Finance Working Group (MFWG). 008.
Coles and Coogan both said the MFWG was a positive development.
Coles added, however, that it was not clear what the UK government
could do on its own to improve the mortgage-backed securities market
as a stable source of mortgage finance over the medium and longer
term. Further, Coles said, the UK practice of including significant
prepayment penalties on 25-30 year fixed-rate mortgages (often 3 - 5
percent) makes it hard to see what the MFWG could do to further its
objective of enhancing the supply and demand for them.

9. (U) On April 15, PM Brown met with leading UK bankers and heard
their concern over the lack of liquidity in the mortgage market.
Then, on April 21 the BOE announced details of a special liquidity
plan designed to increase liquidity by allowing banks to finance
part of the overhang of currently illiquid assets on their balance
sheets. Banks will be able to exchange illiquid assets for up to
three years for more easily tradable assets. For details, see the
latest BOE Financial Stability Report:

Reaction To The BOE Special Liquidity Plan

10. (SBU) Privately, Coogan told Econoff that the CML had cautioned
for the past six months that if additional liquidity were not made
available, lenders would be forced to ration mortgage lending by
tightening lending criteria, increasing price, or withdrawing
selected mortgage products altogether. This could exacerbate the
decline in property values which would adversely impact economic
growth. He also said he believes illiquidity in the mortgage market
is an international issue that requires coordinated action by
central bankers, including the U.S. Federal Reserve, and there is no
indication in the current BOE plan of transatlantic coordination.
Publicly, the CML quickly issued a statement welcoming the facility
that is expected initially to total GBP 50 billion while reiterating
the following cautions. First, the plan will benefit only issuers
of mortgage backed securities (MBS). Only five building societies
have issued MBS so smaller building societies and specialist lenders
will not benefit directly. Second, the plan will increase
liquidity, but it is not clear that there is any means of ensuring
that lenders will recycle the funds into mortgage products or
reduced pricing. The muted industry response reflects uncertainty
that it will significantly increase liquidity available specifically
to mortgage lenders.

11. (SBU) Speaking April 30 at a Debt and Personal Finance All
Party Parliamentary Group meeting, Coogan's comments regarding the
benefits of the new liquidity plan were less positive than in the
initial CML response. He echoed BOE Governor Mervyn King's April 29
comments to the Treasury Select Committee and emphasized that the
special liquidity plan is designed to improve liquidity in the
banking system, not to support the housing market. Coogan said also
that he expects some of the added liquidity will be recycled into
the mortgage market, albeit with uncertain timing and scope.

12. (U) Regarding the special liquidity plan not being directly
available to smaller building societies who do not issue MBS, Sir
Callum McCarthy, Chairman of the Financial Services Authority (FSA)
testified May 6 to the Treasury Select Committee and said that the
FSA had been extensively consulted in developing the current

LONDON 00001285 003 OF 003

liquidity plan and he was confident there will be a transmission
mechanism to provide small building societies access to the plan.
The BOE has not yet reported on usage of the new facility.

Downturn In The UK Housing Market Is Worsening
--------------------------------------------- -

13. (SBU) Although the UK mortgage market is healthier than many
commentators suggest, Coles cautioned that the 2.5 percent decline
in property values in February was troubling. The downward trend
continued in March, and in April house prices fell below their value
a year earlier for the first time since 1996(1 percent below a year
earlier according to an April 30 report by the Nationwide Building
Society). Coles said that the BSA officially still projects
property values will decline by only 3-5 percent in 2008, but he
privately told Econoff that he believes values will decline further.
Coles said he expects property values will then stabilize but not
increase in real terms (net of inflation) for several years
thereafter. Like Coles, Coogan said he expects property values will
decline farther than most have forecast officially. He said that a
10 percent decline this year was likely. Current funding is the key
issue for both Coles and Coogan since with aggregate mortgage debt
currently totaling only 40 percent of real estate value, there's
plenty of equity cushion to protect lenders.

14. (U) Speaking on his own behalf to the Royal Society in Edinburgh
on April 29, BOE Monetary Policy Committee member David Blanchflower
said that house prices may drop by a third over the next three
years. Separately, the BOE chief economist said he is sanguine
about the implications of any fall in house prices for consumer
spending, but Coles, Coogan, and others argue that falling home
values over an extended period will hurt consumer spending, drag
down overall economic growth, and adversely affect the mortgage

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