The Bank of England has hiked interest rates four times since December, with the market pricing in a further six increases expected before the middle of next year. My view differs from this.
Understandably, much of the focus so far has been how those rate rises have and will affect borrowers.
But the increase in interest rates and swap rates over the past few months has also created problems for lenders, particularly non-banks, which have fewer funding options than the big banks.
In a nutshell, mortgage rates have fallen since Covid. But while they are beginning to rise again, they are still lower than they were pre-pandemic.
Simultaneously, there has been a huge increase in swap rates – the rate at which banks will swap fixed and floating rates with each other – over the past year or so, alongside a slight widening of securitisation spreads.
Some have suggested that the slight upward movement in securitisation pricing is a sign that non-bank lenders are failing, but I disagree.
In fact, market funding costs have not moved much at all. Recent non-bank securitisations priced at around 110 basis points, which is just 10-15 basis points higher than we saw last year.
Therefore, it is not the cost of securitising that is impacting non-bank lenders. For me, the biggest challenge facing non-bank lenders at the moment is the asymmetric relationship between mortgage pricing and swaps.
The current situation is not sustainable and, quite frankly, something needs to change.
If you look back to 1 January 2020, just before the pandemic, Bank Base Rate was 0.75% and five-year swaps were 0.84%. Fast forward a year to 1 January 2021 and Base Rate had been cut to just 0.1% and five-year swaps plummeted to less than 0.2%.
Since then swap rates have increased by roughly 200 basis points, interest rates have increased by 90 basis points but mortgage rates have fallen by 15 basis points.
This combination has squeezed non-bank margins, which are currently too small for many lenders to make a profit.
Funders, banks or non-banks can’t live with zero margin. A year ago, funder would have made about 1.1% margin on a on a portfolio of securitised mortgages. Today it is around 20 basis points.
Therefore, I am certain funders are starting to have conversations with their lending partners about rate rises, if they haven’t already.
And while I believe the UK’s non-bank lenders can probably live with the margin squeeze for now, the situation needs to change to guarantee their long-term health.
I don’t expect margins to return to pre-pandemic levels but it’s likely we will see specialist lenders increase their rates further this year.
That is especially true if market expectations of interest rate rises leads to a subsequent hike in swap rates. If lenders raise mortgage rates enough, though, that margin pressure should dissipate.
Of course, not all non-bank lenders are in the same position. Some will benefit from higher margin lending further up the risk-curve that can compensate for the loans with a lower net margin.
However, I don’t think we can escape the fact that mortgage pricing in the specialist sector as a whole will rise over the coming months – and perhaps quicker than many people expect.
As I have said before, this isn’t a problem with the securitisation market, and so I expect we will continue to see non-bank lenders coming to market with new issues this year, which will fund new lending.
Investors like the asset class and it works well for pension funds and others with ongoing obligations to pay out given the amortisation profile of securitisations.
At the same time, I think we will continue to see innovation from non-bank lenders and we should see the first securitisation of product transfer mortgages, which could be a game changer.
Market conditions may not be ideal for non-bank lenders at the moment, but they will adapt and thrive. Of that I’m sure.
Elise Coole is managing director of specialist buy-to-let lender Keystone Property Finance
