The challenges facing the mortgage intermediary sector
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Speech by Lesley Titcomb, Director of Small Firms and Contact Centre, FSA
Mortgage Business Expo
12 & 13 November 2008
I am delighted to be here today. This is my first speech to mortgage intermediaries since the role of FSA mortgage sector leader was added to my responsibilities earlier this year.
I am especially glad to make this debut at an AMI-sponsored event, as I have enjoyed working with Chris and his team over the past few months. Mortgage intermediaries have had a tough time of late and AMI have worked hard in the interests of their members during this difficult past year.
The creation of a mortgage sector at the FSA reflects not only the importance of mortgages to the wider financial landscape, and to the country as a whole, but also the significant challenges the mortgage industry faces. It is my job to pull together FSA policy and action on mortgages in response to identified risks – both for intermediaries and lenders – and to make sure we are listening to the market and working together to get better outcomes for consumers, with soundly managed, well capitalised firms.
This fits together well with my role as the FSA director responsible for small firms as most mortgage intermediaries fit the FSA definition of a small firm – in fact more than three-quarters of the 3,000 directly FSA-authorised mortgage intermediaries have between one and two advisers, but its worth noting that the new sector role also requires me to have involvement with the lenders too.
I want to go on to talk to you about some of the challenges and risks we see mortgage intermediaries facing today, and what we at the FSA are focusing on. But first, I should give some context. I am speaking to you at a time of great challenge – for intermediaries, for lenders, for consumers and for the FSA. We are all feeling the effects of the correction of the credit and housing bubbles. The resulting credit crunch has hit the mortgage industry harder than most.
This was the bubble created by the securitising of mortgages and reliance on the wholesale funding markets. No longer did lenders rely solely on retail deposits to fund their lending. A lot more money was available and this allowed consumers access to cheap credit, which helped fuel a consumer boom that gave us many years of uninterrupted economic growth.
The confidence that underpinned all of this has now gone. People can debate whether we are currently in recession in the real economy, but we definitely are in the mortgage market.
Consumers are feeling the effects. Not only is it harder for consumers to find a mortgage – especially for first-time buyers – but the figures we released last month showed a rise in arrears and possessions. The number of people who had their homes repossessed in the second quarter of this year increased by 71 per cent. 11,054 homes were repossessed in the three months to the end of June, compared with 6,476 during the same three months of 2007. We are working with lenders to make sure they are treating customers in arrears fairly and to make sure that each case is treated on its individual merits, with possession only a last resort.
And tighter lending criteria by lenders and a desire to keep their business in-house has reduced the business available to you. Mortgage business now accounts for around 57% of intermediaries’ income, down from around 70% a year ago. Over half of brokers expect their income to fall even further over the next 12 months, with 17% expecting decreases of more than 25%. Gross mortgage lending was 21% lower in the first half of this year compared to the same period last year – and our hosts AMI predict gross lending for the whole of this year to around two-thirds of last year’s amount. Depressing figures for all involved in the mortgage industry.
And some markets – such as subprime – have collapsed altogether. Many intermediaries heavily reliant on subprime business have already cancelled their FSA permissions.
So we are all in a new world, of reduced lending, much tougher trading conditions and a deteriorating economy.
There is no doubt that during the boom years the number of mortgage intermediaries grew to levels that we can all now see, in hindsight, were – like some of the lending that resulted – probably unsustainable. Wholesale market funding and lenders’ desire to grow and keep growing resulted in large numbers of brokers, networks and packagers.
Of course intermediaries are feeling the effects of the difficult situation the lenders find themselves in.
We have been working hard with our partners in the Treasury and the Bank of England throughout the last year to deal with the wider issues we face with lenders.
Most of what we do goes on behind the scenes, but if we just look at the publicly available information – and reflect that between 17 September and 13 October we saw the proposed merger of HBOS and Lloyds TSB announced, another mortgage bank – Bradford and Bingley – nationalised, and two of our largest companies – Royal Bank of Scotland and Lloyds TSB – receiving a significant injection of taxpayers’ money – we know we are living through unprecedented times.
The package of measures announced by the Chancellor last month are an important step in dealing with the immediate issues. Clearly, the FSA needs to do all we can to prevent the recurrence of such extreme events and to ensure that we and the other authorities are better equipped to deal with banks and building societies in the event we were again to encounter such severe difficulties. As you may be aware, legislation is currently going through Parliament, to put in place better arrangements for dealing with troubled banks.
But this is a global crisis with its origins in a set of global circumstances over which a national regulator’s influence is limited. There are, however, undoubtedly lessons we can learn. We have introduced already many changes to the way we supervise the highest-risk firms with our Supervisory Enhancement Programme, and we will complete these by the end of the year.
The more challenging and difficult task will be modernising the global regulatory framework. There is no question that this has been a global failure and that all elements of the framework, need to be looked at. We will play our role, working closely with colleagues around the world.
So we are working hard with banks and building societies and our partners, but we also looking at the lessons we can learn – and we are committed to being a learning organisation to improve how we work.
In terms of current issues with mortgage brokers
We are constantly looking at firms and assessing the risks in their business, the likelihood of them occurring and their impact, and what can be done to address those.
Of relevance to you are the five key risks we see in the mortgage intermediary sector.
I should stress that this does not mean that we see all these in every firm. What it means is that if we take into account the evidence we see from our firm-facing supervision and project work, and what is going on in the macro-economic environment and what we know about consumers, we see these as the key risks to our objectives at the FSA.
The five risks are :
- Inadequate standards of competence and professionalism.
- Unsuitable advice.
- Inadequate financial resources and business model sustainability.
- Inadequate management oversight.
- Inadequate fraud systems and controls to prevent and detect mortgage fraud.
We are addressing these risks through our day-to-day supervision of firms, and specific projects, and also through our programme to assess all small firms on treating customers fairly over the next two years, which is backed up by our roadshow and communications programme to offer help and support.
So it is clear that all firms – particularly intermediaries – have a lot on their plate at the moment. But I don’t want to see people lose their focus on their regulatory responsibilities. Meeting these becomes even more important during a difficult trading environment.
This is for two reasons.
- The first is that during an economic slump potential risks are greater for firms with poor systems and controls.
- And secondly firms that focus on addressing the risks are more likely to survive and prosper once the recovery begins.
On the first point, we have seen brokers’ income from mortgages fall, and so many of you are looking at ways to diversify your income. There is nothing wrong with this, but we are concerned where firms switch to selling products outside their area of expertise and where they switch to selling riskier products. One such product is equity release, which is one of the areas where intermediaries are seeing growth and where they outsell direct business three to one. New equity release business was up 10% in quarter 3 of this year compared to quarter 2. This can be a good product for some, but one that needs careful and balanced appraisal by both the consumer and the intermediary and is one of the many areas we are keeping a close eye on.
We are also looking out for firms that seek to maintain their profit margin by cutting corners, putting consumers at risk. Most of these were highlighted in our project looking at the quality of advice processes in intermediaries earlier this year. This was a follow up to work we did last year that found weaknesses in important areas.
Our findings were disappointing, especially when you consider this was our second review, and we had already told the industry what we found in the first review, and what needed to be put right.
Over three-quarters of firms we contacted did not have robust processes throughout the areas of their business associated with giving advice. This leads to a high risk of unsuitable advice being given, as, not surprisingly, good processes generally sit behind good quality advice, and vice versa.
We expect to see improvements especially on establishing the affordability of mortgages, including gathering better evidence to support the reasons for advice, and doing more to take customers’ existing outgoings into account. This is key to demonstrating the affordability of the products you sell. And let me emphasise that in the present market, where lenders are requiring ever-lower loan-to-values, the fact that a customer can offer a 40 or 50 percent deposit does not of itself demonstrate affordability.
We have detailed the important action we expect firms to take if they need to on our website and included case studies from the quality of advice processes project. Each month we are issuing a factsheet to show brokers more of the key findings – last month it was about assessing affordability; this month it will be communications with clients.
So, my message is to make sure you have the basics right before you expand into new areas. It is obviously a difficult market and intermediaries will be looking for ways of diversifying in order to survive the crunch but you need to be careful about what you diversify into, especially if there are weaknesses in your business already.
Surviving the current market
AMI published an excellent report a couple of months ago called The Credit Crunch One Year On. Most interestingly for me, it looked at how mortgage intermediaries can adapt to the new environment.
It showed that getting your regulatory responsibilities right will stand you in good stead. And this fits in with the second point I mentioned earlier – that firms that focus on addressing the risks inherent in their business are more likely to survive and prosper once the recovery begins.
AMI’s report concluded that relationships are key. Small firms with good customer relationships may well be more likely to survive than larger firms that have relied on a more transactional relationship with their customers.
It said that lenders will favour intermediaries whose portfolio of customers have high retention rates, and who have good processes and paperwork , with the highest standards of compliance.
I agree with this. I strongly believe – like the report – that having good systems and controls and taking TCF seriously will help you get through the current difficult conditions and be best placed to prosper once things get better.
And I am sure conditions will get better. While many things have changed, some have not. For good or bad, we have a national obsession with home ownership that isn’t likely to go away. The main financial aim of most young people is still to get their first foot on the property ladder. And as the number of households increases each year, there will always be a demand for property ownership and mortgages. One of the few positives from the current market is that as house prices come down, affordability improves, which will be a good thing for first-time buyers.
Perhaps we will not see again the exuberance of recent years. And perhaps it will take a while to get back to a more balanced market. But while lenders closed some distribution channels in their initial reaction to the credit crunch, wanting to keep business in-house or restrict growth, I do not believe we will see a long-term switch away from the use of intermediaries. Intermediaries will remain a key route to market for lenders. And they will continue to be an important source of impartial advice for consumers. Certainly we at the FSA want to see intermediaries continue to play an active role in the mortgage market.
But the current market conditions will be a severe test. A test of both your business model and your firm’s ability to adapt it to market conditions.
Phoenix firms
One recent phenomenon that I know is of concern to a number of you is what we call phoenix firms.
Those of you who have operated in the investment advice market, may recall that a few years ago we had a problem with these firms.
This happens when the directors of one firm seek to close that firm and transfer the business to a different entity in order to avoid past liabilities. The same directors then appear in the new firm, often at the same address, with the same customers and staff. The new firm rise from the ashes of the old like the mythical phoenix.
The only things that don’t move across are the liabilities and this is the reason people try to do it.
We saw off that particular problem by taking strong action.
It is sad to say that we have seen evidence – albeit on a small scale – of phoenix firms rearing their ugly head in the mortgage market.
Some firms are attempting to walk away from commercial debts. Others from mis-selling claims. We have even seen firms seek to shut down in an attempt to deflect attention away from possible fraudulent practice, with the individuals concerned planning to re-enter the market as appointed representatives.
Either way, they tarnish the reputation of the industry as a whole, and when they pass on liabilities to others – via the compensation scheme – cost good firms money.
This is obviously something that we are determined to nip in the bud.
What we want to see with firms that plan to cancel is that they are willing to work with us in ensuring that consumers are protected when there is a change of legal entity.
Although we cannot prevent firms becoming insolvent, we can take steps to minimise the impact. These include:
- asking directors to sign undertakings to honour the liabilities in relation to customer claims on their previous business
- encouraging firms to 'ring fence' funds to be held by the departing firm to meet any further potential liabilities and avoid future claims
- refusing the application for authorisation of the new business where the directors of the departing firm will not make reasonable arrangements for claims arising out of their previous business, or cannot show that they shut down their previous business in an orderly manner
- referring individuals to our enforcement team if their actions have actively disadvantaged customers.
And we work closely with liquidators to investigate the conduct of directors.
We remain determined to prevent firms who attempt to phoenix and ask for your support by letting us know when you suspect it happening. And we ask for any of you that are networks to be extra careful in the due diligence you do on new appointed representatives as you don’t want to have a phoenix firm on your hands.
But please beware that often – like our work with lenders – the action we take will go on behind the scenes. We tend to only make public announcements about individual firms when there has been a decision made against them in an enforcement case such as a fine.
Enforcement action and mortgage fraud
I am sure some of you have noticed that we have been busier in enforcement action against mortgage intermediaries this year than ever before. Mostly on mortgage fraud – but also where we have seen poor quality of advice, poor treatment of customers, and poor systems and controls.
Some in the industry have complained about the constant stream of these FSA enforcement cases against mortgage intermediaries.
I am tempted to say that we are doing what we are supposed to do. But I realise that we have to achieve a balance here. And that we have to target the rogue firms without tarnishing the reputation of the industry as a whole, and keep our approach proportionate. I can appreciate that reading about a new enforcement case each week might leave your industry feeling as if the FSA is beating it up.
We put out the cases as they happen. We could try and hide the action we are taking, or bury the action on our website. But we want the cases to have an effect.
We want the good guys to know we are doing something about the bad apples.
And we want the bad guys to know that we will find them and that we will take strong action – such as a fine or ban from the industry – when we do.
FSA enforcement action is a key element of our credible deterrence package, through which we hope to deter bad behaviour and promote high standards.
One particular area we have focused on this year has been mortgage fraud. We want to send out strong message here that we will not tolerate mortgage fraud. We have published action against 20 intermediaries already this year – and as always there has been a lot more going on behind the scenes with some firms leaving the industry after some gentle persuasion from us.
We have been helped by the scheme we launched with lenders where they tell us about intermediaries they have removed from their panels because of fraud. This is the imaginatively titled Information From Lenders scheme. And to balance things up we have the equally imaginatively titled Information From Brokers, where you can tell us about poor practice among lenders. We know that poor controls at both ends of the distribution chain can make life easier for fraudsters.
We are also collaborating with the police and other law enforcement agencies. And we take information from whistleblowers, both within firms and from other brokers. All of this gets used and we investigate, build cases and take action where we have proof of fraud.
But in order to get the bad guys we continue to rely on your help. We want you to continue to support us here. We all want a clean, fair market and we want to maintain the reputation of your industry.
Other regulatory developments
One area that has had some bad press recently has been sale and rent back schemes, where in some cases vulnerable people have suffered at the hands of unscrupulous firms.
This area is currently unregulated by the FSA, and amid all the market turmoil, some missed the recent government announcement that they are consulting on whether the FSA should regulate these schemes.
We share the government and Office of Fair Trading’s concerns about this market and we will be looking to improve consumer awareness of the pitfalls of many of these schemes and will be considering a range of other measures to make sure we can act quickly if regulation does come our way.
In the meantime, currently regulated firms need to remember that while sale and rent back may not be regulated yet, we expect all FSA-authorised firms to exercise a duty of care to their customers. And we will be watching this part of the market closely.
And in April next year, as announced in Policy Statement 08/9 we will extend what we call the ‘common platform’ to mortgage intermediaries. The ‘common platform’ is a term we use to cover chapters 4 to 10 of our Senior Management Arrangements, Systems and Controls rules, which includes business continuity, risk control, outsourcing and conflicts of interest.
This is an important element of our efforts to drive up standards among mortgage intermediaries – bringing requirements in to line with the majority of other regulated firms – and I’m aware that it has not been picked up as prominently as we would have liked. We don’t expect that well-run firms will need to make any major changes overall, but you should familiarise yourselves with the common platform, and in particular look at the outsourcing requirements, which are the most important change for intermediaries.
Also likely to happen next year will be an announcement on our review of the existing mortgage conduct of business rulebook. It is too early to say where we will end up, but we will be looking at what is working well in relation to our MCOB rules, and what needs improving. If there are any areas we can make things clearer, or particular practices that we need to address, one way of doing it will be to tighten up some of our rules.
We did this last year with our insurance conduct of business rules, where we stripped down our rulebook, adding in some high-level rules to replace many pages of text, while adding in additional requirements in areas where we saw consumers most at risk – in particular for payment protection insurance sales.
Contact centre and website
We are also making improvements to some of the services we offer you.
On Tuesday we relaunched our small firms website. Not only does it look a bit nicer and is easier to navigate, but the content is better, with more use of plain English, more targeted information and 60 new one-minute guides to the most common regulatory issues. And, yes, we have tested it with some small firms.
And over the past year we have been revamping our contact centre as part of our efforts to offer you an improved service over the phone.
The contact centre is the main point of contact for most of the firms we regulate, so it is very important that it offers a first class service.
We’ve listened to feedback from firms on issues around the quality of responses on Handbook queries, for example, and we have taken action based on what you have told us.
We recognise that sometimes in the past we have either taken too long to answer questions or have been too eager to point people to areas on our website or Handbook, rather than engage on an issue.
The improvements we will make will also fit in with more principles-based regulation, where some of what we want firms to do cannot be looked up in a rulebook. We want firms to think about a principle and then work out what it means to their firm, and sometimes firms like to talk through the grey areas that can crop up.
So we no longer want our contact centre to be a place where you only go to ask where to find a certain form on the website, or ask them when you have to send in your RMAR, although we are happy to still help with these enquiries.
We want to offer you a better quality of service, where you are given a greater level of support and advice for your particular circumstances.
And we're aiming to deliver the kind of service that you want. Our new model will offer you:
- More technical specialists, so you will more often be able to have your question resolved on first call.
- We will have more emphasis on helping you with principles-based regulation questions. We’ve piloted this approach with questions about the new high-level ICOBS rules for general insurance intermediaries and they have gone well.
- We will move to give you answers more tailored to the particular circumstances of your firm and guidance to help you meet your regulatory outcomes.
This is key to us delivering principles-based regulation in a way that you can understand and apply to your own businesses and help you treat your customers fairly.
Please let us know what you think – your feedback, negative or positive, is very helpful and always welcome. And the more specific you can be, for example about the date, and time of the call, the better.
I hope this shows that we are willing to listen to what you have to tell us and we are always happy to work with you to help you get good outcomes for your customers and your businesses.
Thank you for the chance to canter through some of the issues that we think are important for intermediaries at the moment. I am happy to take any questions and while I have your ears, I’d like to give a quick plug for the FSA stand at the expo, where we’ve got two staff on hand to offer help on any regulatory issues you have.