Lenders take many factors into consideration when agreeing whether to lend on any given application. Many of these are nuanced and represent the proverbial ‘secret sauce’ of a lender’s underwriting criteria.

Other considerations are more universal, although the importance of any one of these varies between lenders, depending on their approach to risk management, credit assessment, and the products they offer.

For example, some lenders take a firm credit-orientated approach, heavily weighting applicants based on the quality of their historic use of credit and a score generated by a third-party provider.

Other lenders take a lighter touch to credit assessment on the basis that a borrower’s plans are more important than previous credit performance, focusing more heavily instead on the rationale for the loan and the strength of the proposed exit strategy.

What all lenders must have in common to succeed and to survive during a down economic cycle, is a sensible and robust approach to LTV ratios. This is as mutually beneficial to the lender as it is the consumer.

In the mainstream mortgage space, there is a valid argument that credit risk assessment is as important, if not more, so than LTV ratios. This is backed by a huge quantum of data. Defaults and forfeitures in the mainstream mortgage market are less likely to be driven by market corrections resulting in negative equity scenarios in a low interest rate environment.

Further regulation performs a vital control function in this market ensuring there is a direct correlation between affordability and leverage; the latter being a direct construct of the former. People do not hand back the keys to their homes merely because their equity has been eroded by macro-economic conditions if they can continue to afford the mortgage payments. They simply ride out the 1980s and 1990s and wait for the early 2000s.

While the risk of non-performing loans is less governed by LTV as a risk factor in the mainstream market, it remains a high risk to the lending institutions in question. If, and/or when, there is a market adjustment, those lenders who provide high LTVs can find themselves with a portfolio of loans in negative equity. This represents a loss. This adversely impacts the balance sheet of the institution. It can also impact its capital adequacy ratios resulting in the need for capital injections.  In a severe case these conditions could threaten the survival of the institution itself.

Therefore, while LTV in the mainstream mortgage market is less important as a means of controlling default, it’s critically important as part of a larger risk and capital management strategy for high-street lenders who wish to remain viable.

Now, when one ventures into the specialist lending space, be that buy-to-let or bridging finance, the role LTV plays is even more critical. The risk of default and forfeiture is more closely correlated in this market to higher LTVs. In the event of a market correction, investors are more likely to walk away from a project or a property where it is in negative equity.

Downward pressure on rents, coupled with a higher cost of credit and no visibility on a capital gain, creates a commercial disincentive. Factor in the elimination of relief by the previous government and you have a perfect storm. Defaults and foreclosures increase. This is even more immediately dangerous to the specialist market where smaller institutions are more susceptible to failure with smaller balance sheets less capable of absorbing the real losses caused by foreclosures.

LTV ratios are a snapshot in time. They represent a percentage based on a value captured on a day and are invariably, over the term of a loan, susceptible to swings in both directions. With a very real risk of significant levels of unemployment as we head into the winter of 2020, it would be foolish to anticipate anything but an adverse economic climate which will have a direct impact on the property market.

The extent to which this then impacts any of the lenders operating in the market today, will be in no small part determined by that lender’s approach to LTV.

Joshua Elash, director, MT Finance