Oh Dear! - Margin Calls On Btl Investments

[Havoc]

Interesting report on an often ignored clause in a rising property market could strangle B2L investors badly should values go south.

http://www.moneyweek.com/file/36564/could-...to-letters.html

I appeared on BBC Breakfast last week with a buy to let investor who was convinced he was very rich. He had, he said, made £8m out of the buy to let boom. Further chat revealed that he had properties valued at £8m but £5.5m worth of debt. So he is on paper ‘worth’ £2.5m. You might think that sounds like a reasonable margin of error but I’m not sure its enough: property can turn nasty fast. Many of the reasons not to invest now (the main one being the fact that yields are lower than interest rates) have been widely discussed but here’s one more reason to steer clear. Buy to let mortgages deals tend to contain little read covenants regarding the loan-to-value ratio of the mortgage. In a rising market this isn’t the kind of thing borrowers take notice of but in a falling market they may find that it is the ruin of them.

It works like this. The loans allow lenders to periodically revalue properties (at the borrowers expense naturally). If the value has fallen and the loan to value ratio has, as a result, risen above the level required by the mortgage (say from 80% to 85%) the lender can then ask the borrower to come up with more cash to get it back down. The result, says my lawyer friend, will be that as capital values drop, buy-to-let investors will start to receive letters from the lenders along the lines of "Dear Mr Bloggs, I should be grateful if you would restore your loan to value ratio by sending us a cheque for £25,000

This, most mortgaged-up-to-hilt investors will be utterly unable to do. The result? Panic selling and not just from the market’s new entrants. People who have been in the market for more than a few years are keen to suggest that they will be immune from any drop in prices thanks to the equity they have built up. But most of them – the man I met on the BBC sofa included - have also bought new properties in the last year. If margin calls – for this is what they are - start coming in on these how are they going to come up with the cash? No one’s immune.

[A.steve]

If margin calls – for this is what they are - start coming in on these how are they going to come up with the cash? No one’s immune.

The best bit is that the BTL investor can't likely sell off a couple of his commodity properties he bought to let - as that would have a downward effect on the value of the rest of the portfolio - hence increasing margin calls yet further. The investor likely has a "nice" house - that they live in as owner occupier - this is likely to be the asset they need to sell (and fast) in order to avoid bankruptcy. Delicious.

[Uriah Heap]

Is there any evidence that lenders will actually do this? I wouldn't if I were them, or at least not unless a particular customer was already giving me cause for concern.

[yameesh]

nice post. And of course what all these self proclaimed investment gurus don't appreciate in their climax of greed is that this paper profit can disappear pretty sharpish. In a sense, the strategy of maintaining high leverage by re-investing all your paper profits is doomed to certain failure, all that's needed to wipe the whole lot away is a significant decline in property prices at some point. The timing is not relevant, if a property crash occurs at any point, your fortune is all gone

[DoctorJ]

The best bit is that the BTL investor can't likely sell off a couple of his commodity properties he bought to let - as that would have a downward effect on the value of the rest of the portfolio - hence increasing margin calls yet further. The investor likely has a "nice" house - that they live in as owner occupier - this is likely to be the asset they need to sell (and fast) in order to avoid bankruptcy. Delicious.

yum yum. This bear food is especially juicy and succulent.

I can't wait to see how this one plays out

[bleakhouse]

Is there any evidence that lenders will actually do this? I wouldn't if I were them, or at least not unless a particular customer was already giving me cause for concern.

This is a fascinating nugget of information.

Wouldn't it give a lender cause for concern if the borrower had exceeded his leverage ratio?

In these days of tightening credit and fear of toxic loans wouldn't a lender be just a little motivated to act on this?

I wold have that it would be possible to sell a few properties to fulfil the margin call, (given there's market liquidity to do so). If not then I would agree that lenders probably won't do it.

[crash2006]

Is there any evidence that lenders will actually do this? I wouldn't if I were them, or at least not unless a particular customer was already giving me cause for concern.

If you can afford to pay they will not, if you can't they will and it doesnt matter because the BTL will pay the difference between what the bank sold it for and what you borrowed, it would mean you would be forced to sell another property to pay for the one that the bank forced you too sell, however if depends on how much you owe and if you can afford to pay it back, and if yeld of the other properties will be able to handle it.

So in theory you could loss all your properties as the prices of the properties drop, ie it becomes the reverse in relation to how you started the BTL empire.

Edited October 18, 2007 by crash2006

[Uriah Heap]

nice post. And of course what all these self proclaimed investment gurus don't appreciate in their climax of greed is that this paper profit can disappear pretty sharpish. In a sense, the strategy of maintaining high leverage by re-investing all your paper profits is doomed to certain failure, all that's needed to wipe the whole lot away is a significant decline in property prices at some point. The timing is not relevant, if a property crash occurs at any point, your fortune is all gone

This is theoretically true - though it is also the case that if you continually reinvest all your profits you never get to spend them - so you might as well not have them in the first place.

As even a property speculator has to live they must be drawing at least the minimum wage out of their profit pot so at least some and probably a fair bit of the paper profit must be going over time.

[benj]

Is there any evidence that lenders will actually do this? I wouldn't if I were them, or at least not unless a particular customer was already giving me cause for concern.

If the lender allows the LTV to rise above the original agreed level, they are effectively shouldering more risk. Not more risk of default, but a risk of higher losses in the event of default. If we've learned nothing else from the subprime crisis and Northern Rock debacle, it's that efficient pricing of risk is essential to keeping businesses functioning.

And if the mortgage book of a publicly quoted lender starts to look riskier because of falling prices, their shareholders will demand that the management do something about it, or else they will vote with their feet. That might mean margin calls like this, or perhaps an increase in the interest rate charged (since typically for new mortgages, the higher the LTV the higher the interest rate).

I expect the exact details will vary from lender to lender, since they all have different contracts. They wouldn't have had these terms written into the agreements if they were not seriously expecting to use them.

At the end of the day, mortgage lenders have a business to run and they will safeguard their profits in whatever way they can. There is a game theory aspect to this too, I think. If none of the lenders blinks and makes a margin call, then everything stays as it is. But if one individual lender starts to call in its loans and forces some investors to start selling their assets, all the other lenders will lose out as their customers' LTVs start to shoot upwards. By this logic, it would appear that the sooner a lender starts to make these calls, the less they have to lose relative to their peers. Such actions would tend to exacerbate the forced selling, and thus the mark-down in prices.

[madasafrog]

Interesting report on an often ignored clause in a rising property market could strangle B2L investors badly should values go south.

It works like this. The loans allow lenders to periodically revalue properties (at the borrowers expense naturally). If the value has fallen and the loan to value ratio has, as a result, risen above the level required by the mortgage (say from 80% to 85%) the lender can then ask the borrower to come up with more cash to get it back down. The result, says my lawyer friend, will be that as capital values drop, buy-to-let investors will start to receive letters from the lenders along the lines of "Dear Mr Bloggs, I should be grateful if you would restore your loan to value ratio by sending us a cheque for £25,000

Without any prior evidence of this, then this article is groundless.

The only time I can see the LTV being an issue in a falling market is when they come to remortgage at the end of a fixed rate period. If prices fall they may not be able to attain the LTV of 85% required and will therefore be hit by the increased costs of servicing the mortgage on the higher Standard Variable rate.

Merryn Somerset Webb, who wrote this article was obviously put off by this spiv so is clutching at straws to shoot him down.

If anyone has some credible example of what she is claiming on a BTL, then please come forward. If it is true, then it could have dire consequences the BTL industry in a falling housing market. If, as I suspect, it is totally groundless, then its just another piece of bear food thats full of additives.

[OnlyMe]

The LTV ratios, both for internal risk assessment and also for all the repackaged and sold on trash are meaningles in a bubble. Might as well not even bother. Prime/subprime/whatever is increasingly relevent as high debt load can ony be supported by people earning high salaries persistently and with spare funds to bridge breaks in employment, the further the income multiples are stretched the associated default risk will balloon.

In the past 3x multiples have bee historically affordable and resilient to side effects in the main.

5x/6x and you are asking for a heap of trouble.

[HousePriceLottery]

Without any prior evidence of this, then this article is groundless.

The only time I can see the LTV being an issue in a falling market is when they come to remortgage at the end of a fixed rate period. If prices fall they may not be able to attain the LTV of 85% required and will therefore be hit by the increased costs of servicing the mortgage on the higher Standard Variable rate.

Merryn Somerset Webb, who wrote this article was obviously put off by this spiv so is clutching at straws to shoot him down.

If anyone has some credible example of what she is claiming on a BTL, then please come forward. If it is true, then it could have dire consequences the BTL industry in a falling housing market. If, as I suspect, it is totally groundless, then its just another piece of bear food thats full of additives.

There can be no prior evidence since BTL loans simply did not exist during the last period of house price falls.

There is plenty of evidence the banks will foreclose on business they feel are in trouble, to effect a quick sale of assets before they run into more.

A BTL loan is a business loan. They aren't running scared of bad publicity by heaving people out onto the street.

So it is entirely conceivable banks may look to liquidate their biggest exposures sooner rather than later. Avoiding fire sales is of course in their interest if they believe the client can stay solvent. They do have a responsibility to maintain their LTV values on their books.

The long and short of it is we don't really know how lenders will react, but if they come down on BTLers like normal businesses in trouble, it could lead to what Merryn suggests.

[crash2006]

It's called: Easy come, Easy Go

can't really call it Easy come, Easy go, its more like , Easy come ( easy to build up because of cheap credit )easily lost all ( lost more than what i gained)

[piece of paper]

Could this be re-packaged and put onto one of the BTL sites by 'Concerned'. I'm sure it would provoke some frantic rifling through old paperwork

p-o-p

[madasafrog]

Deleted double post

Edited October 18, 2007 by madasafrog

[madasafrog]

There can be no prior evidence since BTL loans simply did not exist during the last period of house price falls.

There is plenty of evidence the banks will foreclose on business they feel are in trouble, to effect a quick sale of assets before they run into more.

A BTL loan is a business loan. They aren't running scared of bad publicity by heaving people out onto the street.

So it is entirely conceivable banks may look to liquidate their biggest exposures sooner rather than later. Avoiding fire sales is of course in their interest if they believe the client can stay solvent. They do have a responsibility to maintain their LTV values on their books.

The long and short of it is we don't really know how lenders will react, but if they come down on BTLers like normal businesses in trouble, it could lead to what Merryn suggests.

If the BTL LL looks like they are in trouble by missing payment, i can expect a bank to want to look at the assets of the business and assess that its security is in place. If the LL is servicing his debts, i cannot see why they will interfere.

There needs to be more evidence of lenders being tighter in the market place on BTL as so far they are pretty lose. You only have to look at the money lent on new developments that are overvalued. Until we see certain signs of tightening on that part of the market, then we have to take this story with a pinch of salt. Do you like salt on your bear food?

[pimperne1]

What a pointless thread. As if any lenders is going to undermine a customer who is paying their mortgage by resorting to this measure. Merryn is scraping the barrel here.

[REP013]

What a pointless thread. As if any lenders is going to undermine a customer who is paying their mortgage by resorting to this measure. Merryn is scraping the barrel here.

OK not entirely the same but what are they doing with credit cards and overdrafts for certain people?

I pay my CC in full every month and my wages have risen since I had my last credit limit set. Still they have done their annual check and guess what, they have reduced my limit.

Lenders will resort to strange measures under differing financial circumstances just look at the BoE and Northern Rock example.

[HousePriceLottery]

If the BTL LL looks like they are in trouble by missing payment, i can expect a bank to want to look at the assets of the business and assess that its security is in place. If the LL is servicing his debts, i cannot see why they will interfere.

There needs to be more evidence of lenders being tighter in the market place on BTL as so far they are pretty lose. You only have to look at the money lent on new developments that are overvalued. Until we see certain signs of tightening on that part of the market, then we have to take this story with a pinch of salt. Do you like salt on your bear food?

What a pointless thread. As if any lenders is going to undermine a customer who is paying their mortgage by resorting to this measure. Merryn is scraping the barrel here.

No I'm sorry you both miss the point.

LTV is the measure of risk inherent in a loan. When the risk goes up they either have to reduce that risk by restoring the LTV or be compensated for it by increasing the interest rate.

That is the nature of banking. If the risk goes up and they don't take that money back from the customer the bank has to assume that risk itself, which incurs a cost on their balance sheet one way or another.

To date this hasn't really been applied to residential loans purely due to the bad press it would incur. This does not imply it won't happen to business loans. You are making an inference, whereas Merryn is simply pointing out simple fact as per their contracts.

Your point that they may currently be servicing the debt makes no difference. Unlike residential customers past servicing of the debt does not provide the same comfort levels of future servicing of debt since it is dependent on them finding customers for their service.

Edited October 18, 2007 by HousePriceLottery

[madasafrog]

No I'm sorry you both miss the point.

LTV is the measure of risk inherent in a loan. When the risk goes up they either have to reduce that risk by restoring the LTV or be compensated for it by increasing the interest rate.

That is the nature of banking. If the risk goes up and they don't take that money back from the customer the bank has to assume that risk itself, which incurs a cost on their balance sheet one way or another.

To date this hasn't really been applied to residential loans purely due to the bad press it would incur. This does not imply it won't happen to business loans. You are making an inference, whereas Merryn is simply pointing out simple fact as per their contracts.

Your point that they may currently be servicing the debt makes no difference. Unlike residential customers past servicing of the debt does not provide the same comfort levels of future servicing of debt since it is dependent on them finding customers for their service.

What about the fact that they have normally wrapped this up this debt and sold it off to our pension funds with a AAA rating?

The only point that LTV will become an issue is at a time of remortgaging or if the borrower is running into trouble.

This bear food is tasteless

[piece of paper]

What a pointless thread. As if any lenders is going to undermine a customer who is paying their mortgage by resorting to this measure. Merryn is scraping the barrel here.

I don't agree. Exposure to risk is a big factor in a bank's decisions. It will not necessarily wait for things to go wrong. It's responsibility is to the shareholders, not the customer.

p-o-p

[pimperne1]

No I'm sorry you both miss the point.

LTV is the measure of risk inherent in a loan. When the risk goes up they either have to reduce that risk by restoring the LTV or be compensated for it by increasing the interest rate.

That is the nature of banking. If the risk goes up and they don't take that money back from the customer the bank has to assume that risk itself, which incurs a cost on their balance sheet one way or another.

To date this hasn't really been applied to residential loans purely due to the bad press it would incur. This does not imply it won't happen to business loans. You are making an inference, whereas Merryn is simply pointing out simple fact as per their contracts.

Your point that they may currently be servicing the debt makes no difference. Unlike residential customers past servicing of the debt does not provide the same comfort levels of future servicing of debt since it is dependent on them finding customers for their service.

Well if you take comfort from believing that then who am I to argue.

[bomberbrown]

Interesting report on an often ignored clause in a rising property market could strangle B2L investors badly should values go south.

http://www.moneyweek.com/file/36564/could-...to-letters.html

I appeared on BBC Breakfast last week with a buy to let investor who was convinced he was very rich. He had, he said, made £8m out of the buy to let boom. Further chat revealed that he had properties valued at £8m but £5.5m worth of debt. So he is on paper ‘worth’ £2.5m.

<Snip>

Err, fellow HPCers, am I the only one to conclude Havoc = Merryn Somerset-Webb? If so, Merryn, you were brilliant!

Doh! Seems like I was the only HPCer that posted before reading the article. Didn't realise the following text was the quoted article.

Edited October 18, 2007 by bomberbrown

[piece of paper]

What about the fact that they have normally wrapped this up this debt and sold it off to our pension funds with a AAA rating?

Could someone who knows with some certainty clarify this? My understanding is that the lender has to undertake to buy back any defaulting loans (at least for a period of time).

p-o-p

[huw]

The best bit is that the BTL investor can't likely sell off a couple of his commodity properties he bought to let - as that would have a downward effect on the value of the rest of the portfolio - hence increasing margin calls yet further. The investor likely has a "nice" house - that they live in as owner occupier - this is likely to be the asset they need to sell (and fast) in order to avoid bankruptcy. Delicious.

Collectively, yes, but one or two sales by a single BTLer will not have a significant impact. So a kind of 'tragedy of the commons' will emerge whereby the overall interest of BTLers as a whole will not align with their individual interests, and they will dump rental properties. I saw it last time around and I expect to see it again.