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“Cyclical vs Digital”

Challenges and opportunities for UK mortgage providers

The key chart

Trends in YoY growth rates in UK mortgages, consumer credit and corporate credit (Source: BoE; CMMP)

The key message

The relative stability in UK mortgage demand has been a consistent theme in the “message from the UK money sector” over the past five years. During the COVID-19 pandemic, this stability was the only bright spot in an otherwise gloomy UK retail finance market:

  • Monthly net borrowing hit £11.8b in March 2021, the strongest net borrowing since records began in 1993, driven by the expected ending of temporary stamp duty tax relief
  • Looking forward, approvals are below their November 2020 peak but remain relatively strong
  • Margin pressures are easing as the effective rate on new mortgages continues to rise, but remain a challenge for mortgage providers.

Against this cyclical backdrop, digital transformation remains the primary challenge and opportunity for the sector as providers seek to meet their customers’ needs more effectively while delivering operational efficiencies.

Experience across Europe shows how digitalisation can deliver tangible benefits including reduced costs, automated scoring/applications, enhanced market segmentation, and improved treasury and liquidity management.

Challenges and opportunities

The relative stability in UK mortgage demand has been a consistent theme in the “message from the UK money sector”. Over the past five years, the annual (nominal) growth in mortgages has averaged 3.3%. The lowest rate of growth (2.7%) was recorded in August 2020 and October 2020 and the maximum rate of growth (3.8%) in March 2021. The relative stability in mortgage demand contrasts sharply with the more volatile corporate (NFC) and consumer credit demand, especially during the COVID-19 pandemic (see key chart above).

Twenty-year trends in UK mortgage demand (Source: BoE; CMMP)

That said, current mortgage demand remains subdued in relation to historic trends. For reference, the average nominal and real rates of growth in the five years between March 2003 and March 2008 were 12.2% and 10.1% respectively, compared with 3.3% and 1.5% averages in the past five years (see chart above).

Monthly flows (£bn) in UK lending to individuals since January 2020 (Source: BoE; CMMP)

During the COVID-19 pandemic, this stability was the only bright spot in an otherwise gloomy UK retail finance market. The chart above illustrates monthly mortgage flows in blue, other consumer credit in maroon and credit cards in green. The weakest net borrowing occurred at the height of the pandemic in April 2020, but mortgage borrowing remained positive. In contrast, UK households have been repaying consumer credit in each of the past seven months.

The latest data for March 2021, for example, shows lending to individuals totalling £11.3bn. This includes £11.8bn mortgage borrowing and net repayments of both credit cards and other consumer credit of £-0.4bn and £-0.2bn respectively.

A new high in monthly net borrowing of £11.8bn (Source: BoE; CMMP)

Monthly net borrowing hit £11.8b in March 2021, the strongest net borrowing since records began in 1993. Net borrowing had averaged £6bn over the previous six months, with a gradually rising trend. The large jump in March reflects expectations that temporary stamp duty tax relief would be ended in March. This has now been extended to the end of June 2021. The previous peak in monthly net borrowing (£10.4bn) occurred in October 2006.

Trends in approvals for house purchase (Source: BoE; CMMP)

Approvals are below their November 2020 peak but remain relatively strong. The number of approvals for house purchases has fallen from 103,100 in November last year to 82,700 in March 2021. The latest approvals are 45% and 32% above the 56,945 and 62,663 approvals in March 2020 and March 2019 respectively.

Effective rates on new mortages and on the outstanding stock (Source: BoE; CMMP)

Margin pressures are easing as the effective rate on new mortgages continues to rise, but remain a challenge for mortgage providers. The effective rate of interest paid on the outstanding stock of mortgages has been stable during 1Q21 but at a new low of 2.08bp, down 4bp YTD. The effective rate on new mortgages has risen to 1.95% from the series low of 1.72% in August 2020. So while margin pressures remain, the spread between the effective rates has narrowed to 13bp.

What now for UK mortgage providers?

Against this cyclical backdrop, digital transformation remains the primary challenge for the sector as providers seek to meet their customers’ needs more effectively while delivering operational efficiencies.

Experience across Europe shows how digitilisation is already delivering tangible results across operations, sales and risk. Examples include: the automation of credit applications to deliver 70% FTE reductions; improved risk scoring for first time borrowers; micro-segmentation to support more targeted sales; and optimised treasury and liquidity management.

Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.

“No time to relax”

Increasing pressure on UK mortgage providers to digitalise

The key chart

Monthly flows (£bn) in UK lending to individuals throughout 2020 – mortgages have driven the recovery but this is still no time for providers to relax (Source: Bank of England, CMMP analysis)

The key message

The Bank of England’s latest Money and Credit release for October 2020 had three pieces of positive news for UK mortgage providers:

  1. Mortgage demand remains relatively robust
  2. Approvals for house purchases are at their highest levels since 2007
  3. The effective interest rate on new mortgages has risen from its August low

This is no time for providers to relax, however. Current mortgage demand remains very subdued in relation to past cycles (despite the low cost of borrowing) and the pressure on net interest margins and revenue generation continues.

The strategic requirement to accelerate digitalisation across operations, sales, and finance and risk is growing.

“Lenders and brokers that use technology to differentiate and improve the customer experience will be the ones that ultimately come out ahead”

BSA, December 2020

Six charts that matter

Outstanding mortgages, YoY growth and monthly flows (£bn) throughout 2020 (Source: Bank of England; CMMP analysis)

In its October 2020, “Money and Credit” release, the Bank of England highlighted relatively robust UK mortgage demand. On a net basis, households borrowed £4.3bn in October, the third highest monthly borrowing total this year (see graph above). Outstanding mortgage balances grew 2.7% YoY in sharp contrast to the new record YoY decline in consumer credit (-5.6%YoY). Overall lending to individuals grew 1.6% YoY. As can be seen from the key chart above, mortgages accounted for £4.3bn out of a total (net) monthly flow of lending to individuals of £3.7bn. A rare bright spot.

Mortgage approvals for house purchase hit the highest level since September 2007 (Source: Bank of England; CMMP analysis)

Looking forward, mortgage approvals increased from 92,100 in September to 97,500 in October (see graph above). This is the highest level of approvals recorded since September 2007 and represents a 10x increase since May 2020’s low (9,400). High approval rates indicate that demand for mortgage borrowing should remain positive in the coming quarters.

Effective interest rate on new mortgages (Source: Bank of England; CMMP analysis)

The effective interest rate on new mortgages, which had been falling steadily since the end of 2018, increased to 1.78% in October. This compares with the recent low of 1.72% in August 2020 (see graph above). The effective rate has fallen 18bp YoY, however, and remains a negative drain on the rate on outstanding mortgages which has fallen 27bp YoY to 2.12% in October 2020.

Real growth rates in UK mortgage lending since October 2000 (Source: Bank of England; CMMP analysis)

Nonetheless, current mortgage demand remains relatively subdued in relation to past cycles despite the low cost of borrowing. In real terms, mortgage demand is growing at only 2.3% YoY, much slower than the double digit real growth rates seen before the GFC (see chart above). As described in previous posts, a key factor here is that, despite the deleveraging seen since 1Q10, the UK household debt to GDP ratio remains at 85%, the threshold level above which the BIS considers debt to be a drag on future growth (see chart below).

HH debt ratios remain elevated at the BIS threshold levels (Source: BIS; CMMP analysis)

Of on-going concern to mortgage providers, the effective rates on new and outstanding mortgages have fallen 10bp and 24bp YTD respectively. The gap between the rate in outstanding mortgages (which peaked at 55bp in February 2020) is still 34bp, indicating further downward pressure on net interest margins and revenue generation (see graph below).

The on-going challenge of delivering top-line growth (Source: Bank of England; CMMP analysis)

Conclusion

Despite the positive news noted above, this is not time for mortgage providers to relax. With subdued growth and further margin compression ahead, they need to embrace digitalisation to deliver effective market segmentation/client knowledge, alternative revenue sources, further efficiency gains and more effective liquidity and risk management.

As noted in a blog on the Building Societies’ Association website yesterday (2 December 2020), “Lenders and brokers that use technology to differentiate and improve the customer experience will be the ones that ultimately come out ahead.”

Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately