To understand the implications of the current economic climate with regards to lending and conveyancing it is important to look at how we got to be in the state that we are in and where we are heading in the future. The article focuses on the residential property market and on problems and prospects for solicitors and licensed conveyancers.
Where are we now?
It has never been more difficult to make sense of housing-related statistics. House sales grew rapidly in the second half of 2009 (but not evenly over the UK: England almost got back to 2008 levels, Wales fell by 12% and Scotland fell by an alarming 33% from 2008 levels, which were themselves already low). Even in the more cheerful regions, many residential conveyancers now inhabit a business environment where volumes of transactions are not reaching the levels needed for profitable operation.
Because most house-buyers need to borrow, it is useful to use mortgage approvals as a measure of activity. The picture here is not encouraging either: the little table below (taken from Bank of England figures for the entire UK) compares levels for “net” approvals for house purchase: it excludes remortgages and cases where the application was cancelled. The figures are for approvals only: there is no easy way of finding out how many applications were rejected by the lenders. The pattern varies considerably across different regions of the UK.
Mortgage approvals for November each year
2010: 43,500 (projected, and possibly high)
The economist’s view: where are we, and how did we get here?
A web of factors combined around the end of 2007 to create what some commentators have called a “perfect economic storm”. Like any other storm, this one caused damage and left behind wreckage. We can look at “damage” and “wreckage” in turn, because each has a different effect on current conditions. The main point of reference, as mentioned above, will be the supply of mortgage funds, and how this affects prospects for residential conveyancers.
What caused the storm, and is the worst past?
The simple explanation, at least for mortgage lending, is this: as economies continued to grow and wages rose and unemployment remained low, consumers wanted to spend more than they could sensibly expect to repay in the short to medium term. Lenders were quick to oblige with easy access to funds. Regulators allowed lending practices to become lax. To sustain growth (of lending and hence profits), lenders had to break out of the traditional deposit-related funding model and began to borrow funds for re-lending from global capital markets. The accumulated lending was parcelled up by lenders, sold on within the banking system and used to fuel more and riskier lending, again without attracting attention from regulators. This funding approach became normal practice. Mortgage debt (books of loans) was moved off lenders’ balance sheets through securitisation. Bonds were sliced and diced and recombined into even more complex financial instruments (such as collateralised debt obligations) which earned investment bankers huge bonuses, and these instruments spread throughout the global financial system. It became almost impossible to assess the quality of the assets supporting these instruments (think of asking your supermarket for a quality assessment of the eggs in the particular sponge-cake you want to buy). When major weaknesses began to show up in parts of the mortgage market (as when sub-prime borrowers in the USA started defaulting on loans secured on property which turned out to be hopelessly over-valued), the infection spread very rapidly and the lenders’ funding carousel stopped turning. Suddenly (and remember how quickly Northern Rock, once a shining example of creative funding, failed), lenders had huge books of questionable loans which no-one wanted to buy. To make it worse, depositors started wanting their money back. The rest you know.
Repairing the damage
Storm damage is usually cleared up fairly quickly. In terms of lenders, “damage” has meant lower profits or even losses. But UK lenders have been quick to repair their profit and loss accounts, and many are reporting record gains. Two of the things lenders have done to get back into the black have a direct effect on the accessibility (rather than just availability) of mortgage funds (and, of course, “accessibility” takes in affordability to borrowers).
Lenders have pushed lending margins as high as they can for new borrowers. Low interest rates may mean that existing holders of variable-rate loans have it as “good”, as Lord Young suggests (at least for the time being) but new borrowers (and those moving off fixed-rate deals) are not so fortunate. Secondly, lenders have boosted their own income by introducing or jacking up fees for new and repositioning borrowers.
These are real cost barriers. Added to equally real employment worries and low rates of wage increase, they are helping to keep many potential buyers out of the market. Mortgage approvals have recovered somewhat since the depths of 2008, but over the UK as a whole they are still only around one third of 2006 levels.
Another way for lenders to help mend the P&L damage is by reducing their own transactional costs. For conveyancers, the most obvious effect is likely to be shrinking lender panels. Lenders claim that it is more economical to deal with a smaller number of conveyancers who handle larger volumes, so smaller firms are already being excluded by some lenders.
Clearing the wreckage
Ignoring the cost barriers, the main problem for UK house-buyers certainly appears to be a general lack of funds available from UK lenders (although there is also a serious lack of new-build properties, partly because builders also find financing hard to get). This affects availability of funds (rather than accessibility) and is partly a sign of the wreckage left by our “perfect financial storm”.
There are two separate heaps of financial wreckage on our financial shores which will have to be cleared before UK residential lending markets will return to their former volumes, even if the UK economy returns to real and consistent growth (which in turn involves the housing market).
The first heap, still largely untouched since 2007, is the amount of “old” debt which lenders still have on their balance sheets. In previous years, as I have already mentioned, this would already have been recycled through securitisation and other exciting mechanisms, and would have been replaced by new tranches of debt created from equally exciting mortgage products. The recycling routes all but closed as the crisis unfolded, and there are only tentative signs of residential mortgage-based activity re-emerging in the capital markets. Access to capital markets is important. Lenders had moved away from old-fashioned ideas such as tying lending to deposits, and in any case it is difficult to see how that approach could ever sustain the level of activity which the UK property market now needs if all participants are to be fed. Lenders face real dilemmas: how do they create space in their balance sheets by replacing loan books where asset values (house prices) books underpinning those are falling? Should they leave the loans in place (and ignore questions about revaluation), or attempt to sell them on and recognise the loss in their accounts? Neither is particularly palatable but rules on capital adequacy and risk pricing (such as Basel II) will make decisions hard to avoid.
The wreckage does not only hamper UK activity. The global financial system remains strewn with storm debris, and this shows up in general uncertainty and lack of confidence, in both institutions and their products (and, increasingly, in countries’ ability to sell or service their “sovereign” debt). Previously efficient capital markets are hesitant and (belatedly) cautious about the quality of assets underpinning debt. Within the UK, economic policy will struggle between restoring activity (for example, through quantitative easing, which really means purchasing debt from the lenders) and controlling inflation (e.g. by curtailing government spending and wage rises). Some attention is being given to preventing the recurrence of property-based “bubbles”, fuelled by easy access to lending. It may be a cynical view, but tightening of lending criteria generally seems more likely to be a response to the belated attention of regulators, or a way for lenders to ration funds, than an outbreak of self-discipline among the lenders themselves.
Until the fundamental “wreckage” problem starts to be cleared, it remains difficult to see how lenders can begin to restore the levels of financing (to builders as well as to prospective house-buyers) which would be needed to bring real activity and confidence back to the housing markets.
The real world view: what can we do to change things?
Economists are useful for explaining where we are and how we got there. However they are, individually and collectively, next to useless at giving practical advice on what to do about it. That needs a completely different, more practical, approach. The situation, as reviewed above, is not cheerful, but is there anything conveyancers can do to improve it?
As well as meeting clients’ expectations on service, conveyancers have to balance the practice requirements imposed by law, by their professional bodies and by lenders (and the CML) with running a business and (one hopes) making a profit. They have to do this at a time when professional indemnity insurance is becoming harder to find and more costly.
If it is accepted that the supply of residential mortgage loans is a fundamental factor here, then it seems to me that there are equally fundamental questions around it for conveyancers. Ignoring them, I believe, is not an option to be considered.
There are no simple answers, but the following are a few initial conclusions and suggestions.
1. Be realistic
Conveyancers, acting alone or collectively, cannot expect to cure the economic problems which lie behind the problems in their own industry (such as by increasing the volume of housing transactions or the supply of money). Nor is it likely that conveyancing fees will rise significantly. Conveyancers’ prosperity will depend more than ever on managing the business component in a way which allows them to deliver client satisfaction and meet practice requirements in a profitable way. For some, survival as conveyancers will depend on finding ways of retaining the authority to handle mortgage funds. Where this is a risk management question, insurance can provide new ways of approaching the problem.
2. Talk to each other
Lenders changed the way residential remortgaging worked because they knew what they wanted, they worked together (through the CML) to achieve it and they were able to articulate their views. Conveyancers need to find more effective ways of presenting their common aims and fighting common battles (such as lenders’ pruning of conveyancer panels). They need, also, to make sure that service providers (including insurers) understand what has to be provided to ensure profitable business operation.
3. Embrace change
The Law Society’s view is that “The history of residential conveyancing is gradual evolution punctuated by periods of rapid change.” Which phase are we in or entering now?
It will be interesting to see whether the Law Society’s consultation on “Improving Residential Conveyancing” will follow through on any of the more radical suggestions in the launch document (from which the quotation above is taken), and how individual conveyancing firms will be able to respond. The Law Society appeared ready to promote or consider a number of changes, including a “quality guarantee” scheme (now in place), an electronic conveyancing portal, adoption of a solicitor/estate agent model (which has operated in Scotland for many years) or even acceptance of a more notarial function within a commoditised process. The responses to the Law Society’s on-line survey suggest that most respondents would aim to preserve what they see as the traditional role, with some acceptance of improved working methods.
4. Use all the tools
There will always be a place (and clients prepared to pay for) a “traditional” approach to conveyancing, but many consumers are used to dealing with even major transactions on-line. Conveyancers already have quick access to searching and insurance services on-line. These provide an efficient business footing to handle client and practice demands. Even within the traditional conveyancing firm, efficient access to information allows work to be done within tight fee constraints. Title indemnity insurance is an effective and cost-efficient way of dealing with a wide variety of problems which otherwise eat into slender margins. Insurance gives clear transfer of risk: it protects both the client and the conveyancer against known and unknown risks.
So in the drive to retain market position, battle with professional indemnity insurance and meet an ever demanding client base, conveyancers may have to roll with the financial punches for some time to come. That said, using tools such as title insurance to smooth the process and at the same time give comfort to the lenders that their interest is being ring-fenced may help push through more transactions and build confidence on the road to recovery.
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