Sub Prime Crisis – What Does It Mean for BMV Investors?

Those who think that Northern Rock crisis is over are wrong. Also wrong are those who think that property prices are to stabilise in UK in the near future.

First, Northern Rock – lots of issues are still unresolved. E.g. it may still end up in administration and no one yet knows how much tax payer will have to pay to keep it afloat.

Besides, no one still knows how many more skeletons are looming in Britain’s banking cupboards as a result of the so-called sub-prime crisis. FSA maintains that all other banks are safe but they would say that to hold market’s nerves. Besides, FSA would not want to handle more than one crisis at a time.

Now on to property prices: some property forecasters reckon that the property prices in UK should remain stable in medium term as opposed to dropping. May be they are right… but remember, it is just a forecast and not definitive.

The problem is: this thought does not take into account the fact that the UK residential assets have already seen much higher inflation in the last 20 years than any other developed country in the world. In real terms (i.e. excluding inflation or consumer price index), property prices have doubled since 1995. This increase has been far higher than, for example, in USA. And USA is now witnessing a sharp downturn in property prices.

Some people argue that British prices are sustainable because of rising demand due to population growth, increased migration and a limited supply of land. True, but this argument also assumes that housing is to remain affordable for people stepping on the housing ladder so that they will continue to buy as more new houses become available. We know that this is not true even today as majority of first time buyers and almost all key workers are unable to raise finance large enough to buy a stater home of their own. The assumption that migrant workers will stay in UK and continue to require housing even if UK economy hits breaks, or worst enters into recession, also needs correcting.

Besides, what good these factors if people cannot have easy access to credit to buy the houses in the first place? Banks are already tightening their lending criteria and getting choosier on whom to lend. If this trend continues then less houses will sell because fewer people will be able to raise necessary finance to buy.

An increasing number of people are already struggling on how to pay their mortgages or service other debts. Looking at statistics, the amount borrowers have to pay to the bank (mortgage) as a percentage of their disposal income is back to where it was at the peak of 1980s property boom. In those days, high interest rates (astronomical by today’s standards) were responsible for their higher payments. Although interest rates have come down now, it is the size of their overall borrowing as a result of higher asset prices that requires higher payment every month to keep bailiffs at bay. Which incidentally also demonstrates that the salaries have not risen in real terms at the same rate as asset prices have despite the fact that borrowers have been able to take on a lot higher level of debt than ever before.

What about the BMV market then?

Many BMV investors are encouraged by the fact that the number of repossessions is still less than the peak of mid 90s. Surely that is a good sign? May be. Or it could be due to the fact that banks are less rash and more rational as well as PR savvy today than they were back then. From the market conditions, there will be more repossession orders in near future, not less.

However the bad news is that the factors that discourage easy ride of BMV bandwagon are likely to come into force sooner rather than later. Regulators are keeping a close eye and already exploring ways to decrease the occurrence of, or even prevent, distress selling of houses by current owners. Leading banks are also looking at creating an agreed set of practices to prevent repossessions. Some are even looking at ways to enter into shared ownership with current owners so that the payment commitments will reduce without owner having to sell the house. This is not new but the new solution will have to be a lot more friendlier to the home owner than what currently exists for it to succeed.

Some banks are even looking for an inspiration from budget airlines. As we all know, these airlines work on a model that incentivises those who plan ahead and buy tickets in advance, and penalises the ‘last minuters’. Can credit industry work on those lines too?

Borrowers who have genuinely good credit histories but fallen on hard times for no fault of their own could be offered friendlier payment terms even midstream (e.g. payment holidays without having to buy insurance) so they do not have to sell the house to get out of trouble… or bank could buy part of their house (similar to govt’s shared ownership schemes for key workers). Banks will have to come up with creative solutions to keep their reputation intact with their consumers rather than seen as ‘lenders of last resort’.

In fact Dan Cruickshank came up with similar recommendations in his report back in 2000 (“Review of Banking Services in the UK“). He asked banking industry to consider charging utility rate of return (rates adjusted for those who need the credit most and vice versa rather than a blanket rate for every one). Banks did not like this model then. Perhaps they will revisit it now.

Overall, I do not think that BMV industry is going to disappear any time soon. As the real impact of sub prime fiasco on various banks’ finances becomes clearer, and as the economic conditions unfold in UK, BMV investors can expect more, rather than less, inflow of ‘leads’. But they better watch out too because their conduct alone will dictate how severely regulators come down on their practices. If govt is forced to introduce licensing in this industry then it will be because some BMV operators have been acting greedier than they ought to.

In most industries, professionals survive a lot longer than cowboys. BMV industry will be no exception.
[tags]sub prime, property prices, interest rates, below market value, bmv [/tags]