While UK and US mortgage lenders have been moving increasingly into each other’s markets for the past decade, cross-border expansion has ramped-up significantly in 2006 and 2007. This is in part due to the fact that the UK and US mortgage markets are at opposite ends of the lending market cycle with respect to interest rates, lending volume growth, house prices, and credit risk. New research from TowerGroup finds that lenders who are considering cross-border expansion must determine whether the differences between the two lending cycles will enable them to balance out mortgage revenues and risk – or whether recent negative housing market developments in the United States are poised to hit the United Kingdom in the near future.
In 2006 and early 2007, the US mortgage market experienced a massive shakeout as gross lending volume plummeted an estimated 18%. However, mortgage lending volume in the UK has continued to rise, hitting an all-time high of GBP380 billion in 2006. TowerGroup believes that UK lending volume has been less cyclical than US volume because of both interest rate trends and loan product types (i.e., more shorter-term, variable-rate mortgages that reprice automatically, causing remortgaging to occur more consistently across interest rate cycles). TowerGroup’s estimation of UK and US lending volume by segment may be downloaded and viewed.
“The current state of the US mortgage market is an early warning sign that UK lenders should fine tune their own in-market strategies as well as carefully evaluate before expanding into the United States,” said Craig Focardi, research director of the Consumer Lending practice at TowerGroup and author of the research. “Because the UK and US mortgage markets are in different cycles for interest rates and credit risks, lenders can potentially diversify and smooth out mortgage segment revenues and profits by engaging in cross-border expansion. But they must assess these benefits in the context of the potential for decline in UK house prices and the rising loan default rates on the horizon.”
Highlights of the research include:
• The current interest rate/home price cycle in the US is working in reverse with rising interest rates – reducing affordability for new buyers, slowing growth house prices, and driving up mortgage payments for those with adjusted rate mortgages (ARMs). Uncertainty over growth in future house prices is further clouding the picture for US lenders and consumers alike, with many experts saying that a large number of homes on the market are overvalued.
• In contrast, the UK housing market looks brighter – with UK house prices rising a strong 10.2% during the fourth quarter of 2006.
• However, even if UK house prices and lending growth continue to rise throughout 2007, UK lenders as well as foreign lenders contemplating entry into the UK mortgage market should look to the warnings signs coming from the US. This includes diversifying their lending portfolios, maintaining rigor in the underwriting processes, regularly assessing portfolio risks, and updating their collections strategy and IT systems.
“As more subprime lenders fail and equity capital is lost, the mortgage market will continue to be a drag on the US economy and stock market, but will not severely threaten it financially,” said Focardi. “TowerGroup believes that the US mortgage market is resilient and will find market-based solutions to resolve its problems. UK lenders, in turn, need to replace today’s irrational exuberance with rational exuberance, and then likely with sober reality, given the potential for a decline in UK house prices along with a rise in nonconforming and subprime loan default rates.”
Focardi added, “The UK has an advantage in seeing the effects of overheated housing and mortgage markets in the US, and should heed the US experience instead of claiming that ‘we’re different, and it can’t happen here.’”
The new report by Focardi, titled “Opportunities and Risk in Cross-Border Expansion Between the UK and US Mortgage Markets,” examines cross-border mortgage lending expansion opportunities, risks, product innovations, and technologies in the United Kingdom and the United States. It also compares and contrasts recent developments in mortgage lending volume, house prices, product innovation, subprime loan product risk, and loan delinquencies.