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Bland Unsight

The Spread Between 75% Ltv And 95% Ltv

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I was looking to get a feel for something else entirely (how the march of swap rates upwards and the end of Funding for Lending was feeding through into fixed rates) when I noticed the massive difference and thought to compare it to pre-crisis 'normal'. 95% LTV is back, but it ain't what it was...

I thought it was very striking. Lots of things going on here I'm sure, not least of which will be the sector trying to figure out where to go with regulatory change, but regardless of whether the impetus comes from regulators or from prudence on the part of the banks, it still looks that if you want a high-LTV loan, you'll have to pay through the nose to reflect the implicit credit risk, and IMO that means that somewhere out there people that matter are still trying to position bank balance sheets to survive a house price crash.

Edited by bland unsight

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The higher the LTV the higher the risk to the bank. You would expect a price difference.

The fact from the graph you are only seeing that now speaks volumes about how risk was assessed previously!

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The higher the LTV the higher the risk to the bank. You would expect a price difference.

The fact from the graph you are only seeing that now speaks volumes about how risk was assessed previously!

2Y fixed 75% LTV going up a bit at end of chart as well - does that mean banks now consider even those with larger deposits a risky proposition as well? ...AKA an indication they expect prices to fall?

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2Y fixed 75% LTV going up a bit at end of chart as well - does that mean banks now consider even those with larger deposits a risky proposition as well? ...AKA an indication they expect prices to fall?

May just be that they're pricing in the expected uptick in the base rate at the end of this year or the start of 2015.

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May just be that they're pricing in the expected uptick in the base rate at the end of this year or the start of 2015.

True, true....still prefer my line of thinking tho! :D

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May just be that they're pricing in the expected uptick in the base rate at the end of this year or the start of 2015.

Conventional wisdom is that the fixed rates track the relevant swap rate

Trends+in+Lending+April+2014+swap+rate+f

Swap rates looked to have turned a corner around January 2013, whereas the fixed rates only turned a corner in January 2014. It makes sense for there to be some lag between the swap rate moving and a BoE average for the rates on mortgages of the same fixed term available to Joe Public moving in response.

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Conventional wisdom is that the fixed rates track the relevant swap rate

Trends+in+Lending+April+2014+swap+rate+f

Swap rates looked to have turned a corner around January 2013, whereas the fixed rates only turned a corner in January 2014. It makes sense for there to be some lag between the swap rate moving and a BoE average for the rates on mortgages of the same fixed term available to Joe Public moving in response.

Looks like HtB2 has been playing a part too. The 75% LTV rate is what borrowers can get with mortgage insurance, the 95% LTV rate is what they get without.

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It's interesting that the gap between base rates and mortgage rates was so narrow before 2008.

So in theory interest rates could rise by 2 or 3 % and the banks could just absorb it without affecting mortgage rates by returning to the previous narrower spread.

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So in theory interest rates could rise by 2 or 3 % and the banks could just absorb it without affecting mortgage rates by returning to the previous narrower spread.

In theory yes but can they actually afford to now FLS has come to an end ? you would have thought if there was ever a time they could have worked on a narrower spread it would have been when FLS was available

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nothing+is+fecked.png

I was looking to get a feel for something else entirely (how the march of swap rates upwards and the end of Funding for Lending was feeding through into fixed rates) when I noticed the massive difference and thought to compare it to pre-crisis 'normal'. 95% LTV is back, but it ain't what it was...

I thought it was very striking. Lots of things going on here I'm sure, not least of which will be the sector trying to figure out where to go with regulatory change, but regardless of whether the impetus comes from regulators or from prudence on the part of the banks, it still looks that if you want a high-LTV loan, you'll have to pay through the nose to reflect the implicit credit risk, and IMO that means that somewhere out there people that matter are still trying to position bank balance sheets to survive a house price crash.

The most obvious and striking lesson from this graph is that BoE base rate is FOLLOWING industry, Market rates move and then the BoE moves in the same direction months later. Only post-2008 did the complete disconnect happen. BoE base rate is at an all time low and it has been OK since 'real' rates have been falling - because of the wall of money effect from QE. Notice that in the last couple of months real rates have pipped up again. If this continues as the solid trend, then BoE base rate will HAVE TO rise.

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So the gap between base rate and both LTVs since 2008 has been VAST. i wonder how much recapitalisation has taken place over this period? Enough for a economy-restructuring crash?

There's a lot of profit in that space, and for 5 years...

What a privileged sector!

Edited by Reck B

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The most obvious and striking lesson from this graph is that BoE base rate is FOLLOWING industry, Market rates move and then the BoE moves in the same direction months later. Only post-2008 did the complete disconnect happen. BoE base rate is at an all time low and it has been OK since 'real' rates have been falling - because of the wall of money effect from QE. Notice that in the last couple of months real rates have pipped up again. If this continues as the solid trend, then BoE base rate will HAVE TO rise.

Or to put it another way the market anticipates BOE policy.

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What increase in rates?? Base rates wont go up it will destroy the mirage of the recovery.

It's not just about the Bank's policy rate. As the High Street banks are not borrowing from the Bank of England at policy rate, it is not policy rate that sets their cost of funding and therefore the rates they charge when they lend.

My take is that two significant things have changed, both concerning credit risk.

Firstly the High Street banks' creditors are presumably now giving due regard to the fact that should they lend to a bank that bank may fail and rather than getting their money back, they may get equity or nothing. Even if it is yet to be put to the test when you have Carney talking about how central bankers are seeking to end too big to fail and the attendant implicit subsidies then as night follows day that must be priced into the banks' cost of borrowing as they are potentially now a credit risk to their wholesale market creditors in a way that was not the case in the past.

Secondly, with house prices having reached the levels that they have reached and earnings under sustained attack from CPI the banks have to look their customers as a credit risk. In the past they could work on the principal that HPI would eliminate that credit risk - and indeed it did, which is why throughout the boom and the wave of HPI we had repossession rates that were huge compared to prevailing rates today, (this is one of the ironies of those who say that hpc'ers are scum because they see repossession as part of a functioning housing market - those same bulls had precious little to say about repossession when it was rampant...) Outside London HPI is all played out. Inside London, London appears to be essentially using its own Green Belt to garotte itself, and it appears that even that bizarre process has an end game and with asking prices stalling in July, it looks like we are there. Hence HPI cannot protect the banks from credit risk in a way that it was able to in the past.

The only way to deal with credit risk is to pass on the costs to your borrowers - and that is my guess as to why high-LTV rates are so high. There is certainly an argument to be had as to whether the second credit risk (banks' customers default on their mortgages) is being priced in because the banks see it or because Basel capital accords and other aspects of regulatory change are requiring them to act as if they see it - personally I assume the latter, (“It is difficult to get a man to understand something, when his salary depends on his not understanding it.”- Upton Sinclair).

Long and short of it, it is very possible that until incomes explode (don't hold your breath) or house prices crash (holding your breath has been problematic in the past) the 'customers default' credit risk is not going away. Personally I think that until we have a house price correction, this risk premium in the price of borrowing is baked in.

The 'banks default on their creditors' component is trickier, but I'm willing to go with the thesis that as the banks are so interconnected and as plenty of European banks have massive exposures to crummy Euro-area sovereigns, this component is not going away until the essentially insoluble Euro crisis is solved - so again it looks baked in for, what 5 years? 10 years? Maybe more?

It seems to me that even though the policy rate is on the floor, mortgage rates for new entrants are already almost back to the levels that they were at the height of the boom. However, some other things are different to the pre-2008 world. Firstly high-LTV interest only has gone and secondly if these credit risk premia are stable (whether for the reasons I give or for other reasons) then as we are now at the zero rate bound on the policy rate, these mortgage rates can only go up, and if these rates can only go up then the only pressure that mortgage rates can exert on house prices is to make them less affordable.

At the moment, the writing is already on the wall. If the Bank of England raise the base rate by even 0.25% before the end of the year, people will look up and see it. It's not impossible that the London bubble will go before that point. I'm astonished that we've got this far, but I don't take that as compelling reason to believe that a continuation of the correction forestalled in 2009 can be postponed indefinitely. We cannot live with these house prices.

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Long and short of it, it is very possible that until incomes explode (don't hold your breath) or house prices crash (holding your breath has been problematic in the past) the 'customers default' credit risk is not going away. Personally I think that until we have a house price correction, this risk premium in the price of borrowing is baked in.

The 'banks default on their creditors' component is trickier, but I'm willing to go with the thesis that as the banks are so interconnected and as plenty of European banks have massive exposures to crummy Euro-area sovereigns, this component is not going away until the essentially insoluble Euro crisis is solved - so again it looks baked in for, what 5 years? 10 years? Maybe more?

It seems to me that even though the policy rate is on the floor, mortgage rates for new entrants are already almost back to the levels that they were at the height of the boom. However, some other things are different to the pre-2008 world. Firstly high-LTV interest only has gone and secondly if these credit risk premia are stable (whether for the reasons I give or for other reasons) then as we are now at the zero rate bound on the policy rate, these mortgage rates can only go up, and if these rates can only go up then the only pressure that mortgage rates can exert on house prices is to make them less affordable.

At the moment, the writing is already on the wall. If the Bank of England raise the base rate by even 0.25% before the end of the year, people will look up and see it. It's not impossible that the London bubble will go before that point. I'm astonished that we've got this far, but I don't take that as compelling reason to believe that a continuation of the correction forestalled in 2009 can be postponed indefinitely. We cannot live with these house prices.

Any update on this? Risk premium. I have been hoping it will manifests itself in tighter mortgage lending (MMR criteria becoming more stringent), and banks not being able to access liquidity as easily as they were allowed to in the past, via FLS/ BoE/ECB windows.

And futilely looking for signs of rates decoupling from Bank rate. A hint here and there of teaser rate borrowers of recent years, being bumped onto higher cost rates, or even SVRs.... even downvaluing house for mortgage purposes to ensure LTV is higher (or perhaps they read the market lower unlike the indicies) to the howls of some 'customers' who think the banks should be helping them as big mortgage borrowers.

This quote is not in full context, or perhaps I don't understand it.... higher borrowing costs (0.5% Bank rate?), but not necessarily lenders' rates?

Subdued inflation means the Bank of England won't be 'pushed into' raising interest rates sharply, according to rate-setter David Miles. ..The Bank said that higher borrowing costs now hinge largely on an improved outlook for pay, and that when rates do return to normal they will be far lower than in the past. ..Miles said Britons were probably getting pay settlements of around 2 per cent on average, and that he expected to wages to start outstripping the rate of inflation going into next year. He added that the 'spread' or gap between mortgage rates and the Bank's official interest rate would probably be higher than it was in the past - a legacy of the financial crisis. As a result, Bank rates will probably run at a 'new normal' in future that is lower than before the financial crisis, he suggested. Miles also noted that some of the forward-looking indicators of Britain's housing market were starting to cool.

(Yes Daily Mail, but they do pay for stories from other news agencies all over the place, to present as their own - which is one of the reasons I check it.)

Edit: (link) http://www.dailymail.co.uk/money/news/article-2724719/BoEs-David-Miles-says-subdued-inflation-means-no-sharp-rate-rise.html

Edited by Venger

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From Carney's opening remarks at the Press Conference for the August inflation report - he's trying to sell us the idea that these spreads are permanent, (emphasis added):

Uncertainty about the sensitivity of the economy to changes in Bank Rate is another reason why gradual increases may be appropriate. Small, slow increases in Bank Rate should help mitigate the risk that higher borrowing costs trigger a sharp slowdown in domestic demand.

Even if spare capacity were to be eliminated at a stroke overnight, the appropriate level of Bank Rate would not be far from where it is today because of these headwinds.
Moreover, even when these headwinds have fully abated, the appropriate level of Bank Rate is likely to remain materially below its pre-crisis average for some time.
That’s because higher capital, liquidity and other prudential requirements can be expected to lead to higher spreads between borrowing rates and Bank Rate than before the crisis.
And at the global level, the imbalance between saving and investment which drove global long-term interest rates down before the crisis appears no smaller now than it was then.

Source: INFLATION REPORT PRESS CONFERENCE, Wednesday 13 August 2014, Opening Remarks by the Governor

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Also remember the size of the gap between base rates and the mortgage rates represents the size of the "free money" subsidy to the banks,

In a normal market the banks were making fairly thin margins , though you'd expect they'd also have their won capital and so wouldn't be trading everything on the difference between bases rates and mortgage rates.

In the new paradigm the banks are basically given free money (well 0.5%) and can then charge 2.5-6.5% for it.

I'd call that a massive subsidy for a bankrupt industry.

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Also remember the size of the gap between base rates and the mortgage rates represents the size of the "free money" subsidy to the banks,

In a normal market the banks were making fairly thin margins , though you'd expect they'd also have their won capital and so wouldn't be trading everything on the difference between bases rates and mortgage rates.

In the new paradigm the banks are basically given free money (well 0.5%) and can then charge 2.5-6.5% for it.

I'd call that a massive subsidy for a bankrupt industry.

Yup, and it follows the lead set by Govt on student loans.

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From Carney's opening remarks at the Press Conference for the August inflation report - he's trying to sell us the idea that these spreads are permanent, (emphasis added):

Source: INFLATION REPORT PRESS CONFERENCE, Wednesday 13 August 2014, Opening Remarks by the Governor

They also keep expecting wages to rise.

Mervyn King did all-knowing smugness far better than MC. He just appears to be making it up as he goes along.

Mervyn might have been making it up too but just disguised it better.

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So is this large gap in pricing, this bigger margin pure profit or is it taking into account the now higher risk of falling property prices or risk of greater numbers of future defaults?

Edited by winkie

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From Carney's opening remarks at the Press Conference for the August inflation report - he's trying to sell us the idea that these spreads are permanent, (emphasis added):

Source: INFLATION REPORT PRESS CONFERENCE, Wednesday 13 August 2014, Opening Remarks by the Governor

Wasn't there a BoE report just a couple of weeks ago that showed that when the Base Rate rises they thought the spreads would narrow - with the effect that mortgage rates would go up much less than the increase in the Base Rate? I think I saw a graph posted on here.

Edited by oldsport

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Wasn't there a BoE report just a couple of weeks ago that showed that when the Base Rate rises they thought the spreads would narrow - with the effect that mortgage rates would go up much less than the increase in the Base Rate? I think I saw a graph posted on here.

It looks like it was actually an OBR report from July. I can't post it because it's in a spreasheet. But it predicts the spread between the average mortgage rate and the Base Rate will narrow so that when the Base Rtae goes up 2.5% mortgages will only go up 0.8%.

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