Mortgages - An FSA update
Speech by Jonathan Fischel, Head of Mortgage and Credit Unions
at the Mortgage Expo
15 May 2008
Good morning and I'm delighted to have the opportunity to speak to you today.
I would like to start by saying thank you to our hosts AMI, who do a sterling job in representing you and your firms on a whole host of regulatory and industry matters, and to congratulate AMI on its fifth anniversary as an association.
Working with key stakeholders such as AMI is vital to ensuring that we remain alert and ready to respond to existing and emerging developments affecting the mortgage sector. I would also like to congratulate AMI on the very good work it has done in developing guidance and case study material for small firms on TCF and MI.
I am Jonathan Fischel, Head of the Department in the FSA's Small Firms & Contact Division, responsible for the supervision of over 3,000 small mortgage intermediaries. I have recently taken over from Mandy Spink, who spoke at this event last year. She has just moved to take on an important role in managing our FSA-wide supervisory enhancement programme. Prior to moving across, I spent a couple of years as Head of the Department responsible for supervising around 5000 small financial advisers. I hope that my knowledge and understanding of small firms, plus some past experience of supervising mortgage lenders, will help equip me for my current role and the challenges we all face in the months ahead.
I would like to give a brief introduction to my colleagues who are on the Panel, Kathy Taylor and Alan Drainer. Kathy has over 20 years experience in the mortgage market and is the lead person on mortgages within the FSA's mortgage sector team where, amongst other things, she manages the very good relationship we have with AMI. Alan has 14 years of industry experience and has specialised in the small intermediary mortgage sector since 2004. This has included leading on a number of key mortgage related projects including the original self-certification project and the first Mortgage Quality of Advice Processes project. Both Kathy and Alan have significant experience speaking and presenting at various external events and FSA roadshows so between us I hope that we will be able to answer any questions you have. I will be speaking for approximately 30 minutes and then we have a further 30 minutes for questions, so the panel and I are looking forward to a healthy and lively discussion. In addition we have a further strong policy and supervision representation on the FSA stand, and the team there would be very pleased to answer any more detailed queries or questions relating to your own firm during the rest of today.
Current Market Conditions
Our Chief Executive, Hector Sants, spoke to the The Building Societies Association Conference last week and outlined the difficult market conditions for both lenders and intermediaries. A key focus of my speech today is the impact these difficult conditions are having on intermediaries, especially around the issue of dual pricing, and to outline what the FSA is doing in response and how we are working closely with AMI.
In 2007 over 70% of all mortgages were sold by intermediary firms and as you know lenders worked hard to develop and maintain that intermediary business. However, due to reduced levels of wholesale funding and as lenders seek to retain greater control over their distribution and credit quality, intermediary firms are finding it much more difficult to place mortgage business. It is probably fair to say that we have seen the clock turn back 10 years in just a few months as the distribution dynamics continue to change and the reality of the current market conditions starts to bite.
Over the last few months we have seen the virtual closure of the sub prime market. The majority of sub-prime and specialist lenders who relied on wholesale funding have either completely pulled out of the market or are no longer offering sub prime products. We estimate that the number of sub prime products has decreased by around 80% since July 2007.
Then, as a result of lenders trying to contain volumes, we have seen examples of products being withdrawn and re-priced at very short notice (21 minutes to get the business to the lender is the shortest period of time that we have been advised of).
A more recent development has been lenders either withdrawing from the intermediary market completely, or the introduction of dual pricing where some lenders now offer better priced products for direct business. I will explain our position on this shortly, including our response to the work AMI has been doing on your behalf as a result of your concerns.
Working with AMI to find solutions
First I would like to take the opportunity to tell you a little bit about our liaison with AMI, including working with AMI to find solutions to your concerns. This liaison is led by the FSA's retail intermediary and mortgage sector team which is headed by Lesley Titcomb, Director of Small Firms & Contact Division. Sharon Campbell, who was here at Mortgage Expo yesterday, manages the team, and Kathy plays a pivotal role within the team as regards the mortgage sector. By working closely with internal and external stakeholders the sector team tries, as early as possible, to identify and assess the major risks that might arise in the retail and mortgage sectors; thus working for the benefit of the industry and consumers alike.
More widely, recent developments show how important it is to align the FSA's prudential and conduct of business policy and supervisory approaches in relation to mortgages, and to do this in a strategic way that is sensitive to the rapidly changing economic climate and market circumstances. It is part of the sector team's role to develop a cohesive mortgage strategy which promotes clear strategic objectives and aims to ensure that activity within the FSA is directed to achieving them.
The team also acts as a channel that can be used for communicating concerns, priorities and objectives to and from the FSA, by acting as a focal point, listening to views and gathering intelligence. So, for example, it was AMI who alerted us to the acute difficulties dual pricing posed for intermediaries who wanted to recommend better branch based products to their customers and who were concerned about the impact on Treating Customers Fairly. We know this is an issue which has frustrated many of you and which has received considerable trade press coverage over the last week. So let me reiterate our position on dual pricing as set out by Hector Sants in his speech to the Building Society Association last week.
Lenders are not obliged to deal through intermediaries. How lenders choose to price and distribute their products is a commercial matter and, contrary to some claims, lenders are not in breach of FSA rules if they choose to go down this route. There have always been certain lenders who choose not to offer their products through intermediaries, and others who differentiate pricing depending on the channel, for example those offering ‘exclusives’ to certain mortgage clubs or special interest-only rates. It follows from this that not every product on the market will necessarily be available to any one intermediary – something which our definition of whole of market takes into account. If certain lenders decide to offer their direct customers cheaper deals, we do not see that customers’ best interests would be served by preventing this.
Following this statement of our position we have been working with AMI and our policy team on two key issues arising which have needed further clarification. One is about the obtaining and content of the KFI, and the other relates to the responsibilities of a whole of market intermediary.
We know that some of you would like to be able to make recommendations on products that are not available to you but that the requirement to provide the customer with a KFI has prevented you from doing so because most sourcing systems do not have details of direct products. We are aware that AMI have been looking at potential solutions and will continue to discuss this with them.
On the content of the KFI we have been asked for our view on the fact that any broker fee charged for the advice will not be included in the lender's KFI or offer documentation (because it is a direct KFI). Our view is that, in such a scenario, the adviser fee would not need to be included in the lender KFI/offer. What the lender is illustrating is the cost the customer needs to pay in order to obtain the credit on offer. The advice fee is not part of that. It so happens that the customer has paid that fee as part of their route to the product, but it is not a necessary condition for the credit. Therefore, the adviser fee does not need to be included in the APR or section 8 of the KFI produced by the lender.
Clearly, the customer is going to be receiving two KFIs in these circumstances: one from the adviser and one from the lender. As well as showing differences in fees, there may also be a difference in section 2, as the lender may be selling the product on a non-advised basis. These differences are in line with the rules, and will accurately reflect the different parts being played by the two firms in the transaction. However, the potential exists for some confusion on the customer's part, and the adviser may be able to manage this by explaining the different roles the firms are playing and the resulting differences in the disclosures they will provide. Also, it is perhaps worth reiterating that the adviser is fully responsible for ensuring their KFI is accurate (within the given tolerances).
The second issue arising from dual pricing on which we have also had some questions is about our expectations on whole of market intermediaries under current conditions. Clearly this is a complex issue in a changing environment with different firms operating different advisory models. Some mortgage brokers have stated that they wish to be able to access all deals available in the market (and the KFI solution AMI have developed will allow them to do this). Others remain content in being able to offer a wide range of generally available intermediary products. And there are those who may decide to change their business model to offer products from a limited range of lenders.
Market conditions are changing very rapidly as Richard has indicated this morning. We can’t possibly make rules to cater for this, nor would we want to under our principle-based approach to regulation. We think that, as whole of market advisers acting in the best interest of your customers, you need to consider thoughtfully how to handle the situation with your customers.
I’m happy to say what we think, but I’d be very interested to hear what you think. And I must emphasise this is not regulation by speech. What we want is a common sense principles-based discussion of the rapidly changing situation.
We think the crucial point in all of this is ensuring that consumers are made very clear about the service being provided. So for example, if a customer goes to a whole of market intermediary, and the intermediary recognizes that, in current market conditions, there may be more competitive products in the market other than those available to the intermediary, that may be of interest to the customer, we think that there must be acknowledgement of this. We think that in such cases the intermediary should clarify to their customer that, while they are not tied to a particular set of providers, there are certain deals only available direct from lenders; and that if they want to investigate that sector of the market for themselves they may find more competitive products - but we don't expect the intermediary to point to a specific product or provider, and we would have no difficulty in the intermediary drawing attention to different levels of service.
We do not think this an overly onerous disclosure; and indeed believe that intermediaries would want to make such a disclosure, in a positive and pre-emptive way - they run the risk of complaints and damage to their reputation if the customer subsequently discovers a better deal on the high street.
I would like to stress that where the adviser is confident, given his knowledge of the whole market, that the product he can sell the customer is the most suitable of those generally available to the customer, then nothing further would be required.
As I have already mentioned, we are continuing to work with AMI on this point and others.
Treating Customers Fairly
I now want to say a few words on Treating Customers Fairly, which underpins the delivery of our statutory consumer protection objective and is of key importance in these times of market turbulence when consumers need protection the most.
In this ever more challenging economic environment, arrears and possessions are set to increase, albeit from a very low base and concentrated in specific sectors of the market. We expect lenders to meet the requirements on the treatment of customers in payment difficulties as set out in our rules - including to have in place, and operate, a written policy and procedures for dealing fairly with customers in arrears. For new mortgages, lenders must continue to consider the borrower's ability to repay and lend responsibly. Similarly for intermediaries there is a continued emphasis on assessment on affordability and providing suitable advice – especially in relation to new TCF related issues which are cropping up as a result of changing market conditions.
Our work on TCF has been determinedly principles-based. We have recognised throughout that there was value in giving space to management to think afresh and in a new framework about what they needed to do for consumers – space in terms of allowing them to develop their own best ways of achieving the outcomes for consumers that we want, and space in terms of the time needed to deliver any necessary behavioural change within their firms.
I will come on to talk about the help we are giving to small firms to make faster progress on TCF in a moment but first I want to outline some of the key risks which we believe intermediaries may be facing at present, so that you are able to assess any risks present in your own firms and take action to mitigate them.
- As intermediaries see a reduction in the volume of transactions with a resultant knock on income, the emphasis placed on the fair treatment of customers may reduce as the focus on maintaining profits and meeting targets come under the spotlight more than ever before. In the current economic climate, some firms may rely on their existing customer base for a continued source of income and, for example, this could result in some firms, or individual advisers within firms, encouraging their customers to remortgage during early repayment charge periods.
- Intermediaries may look to reduce costs in areas of the business such as compliance and reduce other costs that are inherent in the sales process. We are already aware that a number of small firms have effectively downsized since September 2007, by reducing the number of advisers and support staff. We could even see firms placing more reliance on temporary contractors to carry out administrative functions or making advisers self-employed. This downsizing increases the risk of firms not employing a sufficient number of competent advisers or support staff to cope with the amount of business they generate. In turn, this could lead to less oversight and control in firms, a decline in the quality of advice being provided by advisers and an overall decline in standards of professionalism, to the detriment of the customer. This could also increase the potential for fraud to occur, and my colleague Bob Ferguson spoke yesterday about the changing nature of fraud risks in the current market climate.
- And firms should continue to be alert to continuing areas of weakness that we have recently highlighted in the self-cert market, and in assessing affordability generally.
- In late 2007 we published findings of thematic work looking at the sale of self-certified mortgage products. Our results found that only one third of the client files reviewed demonstrated that the customers' needs had been met and that a self-certification product rather than a full status product was appropriate. The proportion of the sampled files which did not make clear the reason for recommending a self-certification product, and those which did not contain sufficient Know Your Customer information, had increased in comparison to the 2005 findings.
Our thematic work showed that these products were used by some intermediaries for clients outside the intended target market, as a means to an end of securing a loan that allowed the client to purchase the property they want. More detailed discussions around affordability and the customer's ability to repay the loan, whilst potentially impacting on the intermediary's income, may have actually resulted in consumers making more appropriate decisions around the level of debt they could comfortably afford to manage.
In the current market conditions, consumers who have previously been encouraged to self-certify their income may find that, at the end of their current rate period, they are unable to remortgage because lenders will no longer accept their application without proof of income. In these cases, consumers will have little choice other than to remain with their existing lender potentially on a higher interest rate. This could lead to a rise in the number of complaints against intermediaries by consumers who feel the risks associated with their mortgage product were not adequately explained to them at the time of the original sale.
And please also continue to take into account our findings in late 2007 on affordability more generally, where we found weaknesses in the assessment of affordability in four key areas; where the mortgage term runs into retirement with no consideration of affordability after that date ; use of irregular income (such as bonuses) as guaranteed income; outgoings simply not stacking up (1 in 5 firms told us that they accepted business without making further enquiries even when they doubted the information provided by the client); and interest only mortgages being recommended on the grounds of affordability without a plan of repayment.
Treating Customers Fairly is an existing regulatory requirement, and moving the market to achieve this standard has been a regulatory priority for several years now. It is, therefore, vital that you do not lose sight of TCF especially given the December 2008 deadline is fast approaching which requires every firm to be able to demonstrate through management information that it consistently treats its customers fairly.
Increased supervision and help on TCF for small firms
This section is directly relevant and very important for those smaller mortgage intermediaries in the audience who are supervised by my department. If you are a larger firm with a supervision relationship manager, this section isn't directly relevant to you – I'm sorry about that but I will keep it short!
Last year we concluded that we needed to increase the rate of progress small firms, including mortgage intermediaries, were making towards treating their customers fairly. This led us to re-examine our approach towards small firms and we announced last October new measures to intensify our efforts to identify those firms most in need of regulatory attention. Building on our current risk-based strategy, we have introduced an ongoing programme of structured visits and telephone interviews to carry out assessments into how a firm's management approaches TCF. The first assessments kicked off in Northern Ireland in January this year and the next region to be assessed is the North West including Manchester.
The assessment will look at the relationship the firm's management has with its staff, how it communicates TCF to its entire staff (not just advisers), and what controls it has in place to demonstrate that it, and its staff, are delivering fair outcomes to its customers. Most importantly, we want to see if, and how, the firms' efforts are being translated into improved outcomes for its customers.
We have set ourselves an ambitious programme and will be assessing approximately 11,300 small intermediary firms as part of a three year regionally-based assessment programme. This includes all small mortgage intermediaries. Whilst it is key that we identify those few firms not engaging with us and treating their customers fairly, we are also strongly committed to helping those many firms who are trying to do the right thing.
We want to work with as many firms as possible, so even if firms haven’t made sufficient progress, if the management is willing and the culture/behaviours within the firm is right for change, then we will work with those firms to raise standards. Early findings from Northern Ireland are that the assessments have helped to improve the understanding within firms of our expectations and how to achieve the outcomes we are seeking. This is good news and complements the help and guidance we already provide via numerous channels.
To explain the assessment process and our expectations regarding TCF to firms we have introduced new, interactive roadshows linked to the regional assessment programme. Firms will be able to find out more about how to meet their TCF obligations, work through real TCF issues that may affect their firm, and learn from other firms about how they approach TCF.
Communicating to firms through roadshows is an integral part of these new measures which we are confident will contribute towards smoother assessments and higher levels of compliance. The aim of these events is to deliver messages to firms during a period where they are preparing for and being assessed. We hope this will maximise the opportunity for messages to be acted upon and for firms' thinking and behaviours to be challenged, and changed if necessary. I hope many of you here today attended our roadshows the week before last in Bolton and Liverpool – we are delighted at the feedback you gave us. 90% of attendees said they understand more about TCF after the roadshow and 68% of firms said they will definitely make changes within their firm as a result of what they learnt during the interactive case studies.
I firmly believe that the vast majority of firms are run by decent, honest people who are genuinely trying to do the right thing and treat their customers fairly. However, I must also make clear that those few firms failing to make any effort to engage with us will find themselves facing tough regulatory action including the possible use of enforcement. Whilst enforcement is an important component, it is not the sole element, of a credible deterrence policy which also includes effective supervision and risk mitigation. We think this new approach to assessing TCF in smaller firms provides sufficient contact to ensure that those few firms who are wilfully trying to evade our regulations believe there is a reasonable chance of being found out in that we are likely to be alerted to indicators that help us identify them.
Conclusion
In conclusion I would like to thank AMI for working so constructively on many issues to find market led solutions including the dual pricing issue which is affecting many of you. I hope that what I have said today and the clarification we have provided helps you to continue to provide valuable advice to your customers.
We believe that a healthy market is one where consumers have a choice in how they purchase a mortgage, either direct or via an intermediary who can shop around and advise the customer to help get the right deal. We hope that the current market developments do not make it harder and more expensive for customers to get advice on what is one of the most important decisions of their lives.
Finally do remember that the FSA team will be available on the FSA stand for the rest of the day and we look forward to meeting you.