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RR RUEHBL RUEHED
DE RUEHLO #1285/01 1281635
ZNR UUUUU ZZH
R 071635Z MAY 08
FM AMEMBASSY LONDON
TO RUEHC/SECSTATE WASHDC 8521
INFO RUEHED/AMCONSUL EDINBURGH 0924
RUEHBL/AMCONSUL BELFAST 1040
RUEATRS/DEPT OF TREASURY WASHDC
RUENMEM/EU MEMBER STATES

UNCLAS SECTION 01 OF 03 LONDON 001285 
 
SENSITIVE 
 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ECON EFIN UK
SUBJECT: UK MORTGAGE LENDERS OK FOR NOW; HOUSING PRICES FALLING 
 
 
Summary 
------- 
 
¶1.  (SBU) Recent announcements of lenders withdrawing mortgage 
products from the market incorrectly suggest that UK mortgage 
lenders are in crisis.  As a group, mortgage lenders are solvent 
with significant equity cushions in their mortgage portfolios and 
default rates remain low.  Building societies are flush with cash as 
savers transfer out of equities to deposits.  The industry is under 
stress, however.  The liquidity shortage in the general banking 
sector also affects mortgage lenders that are finding it difficult 
to meet the demand for new mortgages.  Wholesale interbank markets 
remain essentially closed limiting the funds available for new 
mortgages.  The buy-to-let market for mortgages is effectively shut 
down.  The securitization market remains closed further limiting 
other lenders' ability to write new mortgages.  For more than six 
months, industry representatives have argued for Bank of England 
(BOE)intervention to increase liquidity in the mortgage industry in 
order to meet mortgage demand and slow the rising cost of mortgages. 
 On April 21, the BOE unveiled a GBP 50 billion special liquidity 
plan that will permit lenders to swap illiquid assets for easily 
tradable assets.  Industry reaction to the plan was positive but 
cautious, and an industry spokesman said he regrets the lack of 
greater transatlantic cooperation.  It is too soon to assess the new 
plan's overall impact. 
 
¶2. (SBU) Similar to the U.S., UK real estate values have been rising 
steadily for over a decade.  Amid the global financial crisis and 
declining economic growth forecasts, UK housing prices have begun to 
decline.  In April, house prices suffered their first yearly decline 
since 1996, and some are forecasting house price declines of up to 
30% over the next few years.  The solvency of mortgage lenders as a 
group is not in jeopardy since mortgage debt currently totals only 
40 percent of real estate value due to the long period of escalating 
prices.  Notwithstanding, many argue that continuing declines in 
house values would adversely affect consumer spending and drag down 
overall UK economic growth and adversely affect the mortgage 
industry.  End Summary 
 
¶3. (U) In recent weeks, numerous press articles have painted a 
picture of a deteriorating UK mortgage industry.  HSBC projected the 
number of mortgage transactions in the UK would drop by 30 percent 
in 2008.  The Financial Times reported that the last of 20 banks 
offering 100 percent loan to value (LTV) mortgages at the beginning 
of March had withdrawn from the market.  On April 9, Halifax 
reported that UK home values had declined 2.5 percent in February, 
and the BOE reported April 29 that approvals for new mortgages fell 
by 11 percent to 64,000 in March. 
 
UK Mortgage Industry Not In Crisis, YET 
--------------------------------------- 
 
¶4. (U) Lower growth forecasts and recent property value declines 
make the outlook for the UK mortgage industry more challenging. 
However, the industry is not in crisis, Adrian Coles, 
Director-General of the UK Building Societies Association (BSA) told 
Econoffs.  He said that the withdrawal of 100 percent LTV loan 
offerings had little impact since such loans are a very small 
portion of mortgage lending.  Among Building Societies, loans 
greater than 95 percent LTV have never represented more than 2 
percent of lending.  Building societies currently are flush with 
cash as risk-averse customers switch from stocks to savings 
deposits.  Coles said HSBC bank was moving to gain market share in 
the industry by matching existing terms on mortgage rollovers, 
albeit only for selected buyers and for a limited time.  Michael 
Coogan, Director General of the CML confirmed the views of Cole. 
CML members account for 98 percent of all UK mortgage lending, of 
which BSA members account for about 20 percent.  However, Coogan 
also said that demand for mortgage funds continues to exceed supply, 
and government intervention was needed to add liquidity to the 
market. (NOTE: the BOE intervened April 21 with a special liquidity 
plan - see below). 
 
¶5. (U) Because building societies are flush with cash from new 
deposits, they are still making mortgages.  However, Coles said they 
traditionally source 25 percent of their funding in the wholesales 
markets (i.e., interbank market or securitized borrowing), and these 
sources are effectively closed.  Accordingly, while mortgages are 
available, lenders are being very selective.  Coogan added that even 
BSA members with large deposit inflows were being cautious about 
increasing lending in the current market where liquidity concerns 
are paramount. 
 
¶6.  (U) Although the overall industry is healthy, there are 
exceptions.  Buy-to-let mortgages,(that is, mortgages to buy 
properties to lease them out), have largely been discontinued. 
Coles said Paragon, the second largest UK buy-to-let lender, told 
him it could no longer raise any money in the wholesale markets and 
 
LONDON 00001285  002 OF 003 
 
 
was effectively out of business for the moment as it offers 
buy-to-let mortgages exclusively.  Also, those that relied on 
securitization as their principal source of funds, such as GMAC, 
Lehman Brothers, and Morgan Stanley, have been hit by the shut down 
of the securitization market. 
 
Mortgage Lenders Are Solvent-But Need Funding 
--------------------------------------------- 
 
¶7. (SBU) Currently, UK mortgage lenders and building societies in 
particular are financially sound.  Coles and Coogan both said the 
average mortgage is only 40 percent of value.  Even after forecast 
declines in real estate values, there will be ample equity to 
collateralize their mortgage books.  According to recent statistics 
from the Financial Services Authority, mortgage arrears also remain 
low.   Repossessions are running below the current CML forecast rate 
of 0.38 percent (45,000 repossessions).  Notwithstanding, the CML 
has argued for BOE intervention to increase liquidity for mortgage 
lenders.  Without it, the industry argued it could not meet mortgage 
demand and mortgage costs would spiral upward to ration the 
available supply. 
 
Government Action 
----------------- 
 
¶8. (SBU)  On April 9, Chancellor Darling announced the creation of a 
Mortgage Finance Working Group (MFWG). 
http://www.hm- treasury.gov.uk/newsroom_and_speeches/press/2 008. 
Coles and Coogan both said the MFWG was a positive development. 
Coles added, however, that it was not clear what the UK government 
could do on its own to improve the mortgage-backed securities market 
as a stable source of mortgage finance over the medium and longer 
term.  Further, Coles said, the UK practice of including significant 
prepayment penalties on 25-30 year fixed-rate mortgages (often 3 - 5 
percent) makes it hard to see what the MFWG could do to further its 
objective of enhancing the supply and demand for them. 
 
¶9. (U)  On April 15, PM Brown met with leading UK bankers and heard 
their concern over the lack of liquidity in the mortgage market. 
Then, on April 21 the BOE announced details of a special liquidity 
plan designed to increase liquidity by allowing banks to finance 
part of the overhang of currently illiquid assets on their balance 
sheets.  Banks will be able to exchange illiquid assets for up to 
three years for more easily tradable assets.  For details, see the 
latest BOE Financial Stability Report: 
http://www.bankofengland.co.uk/publications 
/fsr/2008/fsrfull0804.pdf 
 
Reaction To The BOE Special Liquidity Plan 
------------------------------------------ 
 
¶10.  (SBU) Privately, Coogan told Econoff that the CML had cautioned 
for the past six months that if additional liquidity were not made 
available, lenders would be forced to ration mortgage lending by 
tightening lending criteria, increasing price, or withdrawing 
selected mortgage products altogether.  This could exacerbate the 
decline in property values which would adversely impact economic 
growth.  He also said he believes illiquidity in the mortgage market 
is an international issue that requires coordinated action by 
central bankers, including the U.S. Federal Reserve, and there is no 
indication in the current BOE plan of transatlantic coordination. 
Publicly, the CML quickly issued a statement welcoming the facility 
that is expected initially to total GBP 50 billion while reiterating 
the following cautions.  First, the plan will benefit only issuers 
of mortgage backed securities (MBS).  Only five building societies 
have issued MBS so smaller building societies and specialist lenders 
will not benefit directly.  Second, the plan will increase 
liquidity, but it is not clear that there is any means of ensuring 
that lenders will recycle the funds into mortgage products or 
reduced pricing.  The muted industry response reflects uncertainty 
that it will significantly increase liquidity available specifically 
to mortgage lenders. 
 
¶11. (SBU)  Speaking April 30 at a Debt and Personal Finance All 
Party Parliamentary Group meeting, Coogan's comments regarding the 
benefits of the new liquidity plan were less positive than in the 
initial CML response.  He echoed BOE Governor Mervyn King's April 29 
comments to the Treasury Select Committee and emphasized that the 
special liquidity plan is designed to improve liquidity in the 
banking system, not to support the housing market.  Coogan said also 
that he expects some of the added liquidity will be recycled into 
the mortgage market, albeit with uncertain timing and scope. 
 
¶12. (U) Regarding the special liquidity plan not being directly 
available to smaller building societies who do not issue MBS, Sir 
Callum McCarthy, Chairman of the Financial Services Authority (FSA) 
testified May 6 to the Treasury Select Committee and said that the 
FSA had been extensively consulted in developing the current 
 
LONDON 00001285  003 OF 003 
 
 
liquidity plan and he was confident there will be a transmission 
mechanism to provide small building societies access to the plan. 
The BOE has not yet reported on usage of the new facility. 
 
Downturn In The UK Housing Market Is Worsening 
--------------------------------------------- - 
 
¶13. (SBU) Although the UK mortgage market is healthier than many 
commentators suggest, Coles cautioned that the 2.5 percent decline 
in property values in February was troubling.  The downward trend 
continued in March, and in April house prices fell below their value 
a year earlier for the first time since 1996(1 percent below a year 
earlier according to an April 30 report by the Nationwide Building 
Society).  Coles said that the BSA officially still projects 
property values will decline by only 3-5 percent in 2008, but he 
privately told Econoff that he believes values will decline further. 
 Coles said he expects property values will then stabilize but not 
increase in real terms (net of inflation) for several years 
thereafter.  Like Coles, Coogan said he expects property values will 
decline farther than most have forecast officially.  He said that a 
10 percent decline this year was likely.  Current funding is the key 
issue for both Coles and Coogan since with aggregate mortgage debt 
currently totaling only 40 percent of real estate value, there's 
plenty of equity cushion to protect lenders. 
 
¶14. (U) Speaking on his own behalf to the Royal Society in Edinburgh 
on April 29, BOE Monetary Policy Committee member David Blanchflower 
said that house prices may drop by a third over the next three 
years.  Separately, the BOE chief economist said he is sanguine 
about the implications of any fall in house prices for consumer 
spending, but Coles, Coogan, and others argue that falling home 
values over an extended period will hurt consumer spending, drag 
down overall economic growth, and adversely affect the mortgage 
industry.