Funding Issues in the UK Mortgage Market

As defaults on US sub-prime mortgages rose and the global mortgage-backed securities (MBS) market froze, Northern Rock was unable to secure funding, triggering debate on UK lenders' funding models that rely upon wholesale funding and securitization in particular.



Report Highlights
In order to ensure that they can lend at any time, mortgage lenders require constant access to funds. Traditionallyand still accounting for around two thirds of fundingmortgage lenders have relied upon retail deposits. However, providers that do not have this luxury are forced to look elsewhere, usually to the wholesale markets instead. The highly competitive nature and diversity of the UK mortgage market is a direct result of the development and heavier dependence on non-retail funding, and in particular, securitization. This financial development allowed new and innovative lenders into the marketplace during the 1990s and early 2000s. Not all lenders are being impacted to the same degree by the liquidity shortage and securitization freezeindeed, it will be lenders in the specialist sectors (sub-prime, self-certification, and buy-to-let) who will be impacted more as these tend to rely on wholesale markets and securitization to a greater extent.


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DATAMONITOR VIEW 1
CATALYST 1
SUMMARY 1
ANALYSIS 2
The Northern Rock crisis has brought the issue of mortgage funding to the fore 2
Mortgage funding via the wholesale markets has become more popular in the UK in recent years 2
Securitization in particular has become much more common because of its benefits to lenders 3
The UK mortgage market has become highly sophisticated because of non-retail funding and securitization 4
Starting the troubles, defaults in the US sub-prime mortgage market led to a disruption of credit markets 4
This, in turn, led to a crisis in liquidity, which Northern Rock suffered from 5
Northern Rock's funding model, as well as other lenders', have now come into question 5
Some UK lenders, mainly specialists, are now particularly exposed to liquidity shortages 6
Lenders in the specialist sectors are going to be impacted to a greater degree than diversified banks 6
Difficulties are being played out, particularly in the sub-prime mortgage market 7
All lenders will nonetheless face higher wholesale funding costs and a slower mortgage market 7
Should the wholesale markets continue to be difficult in the long term, many more lenders will suffer 8
Diversified banks may not be exposed on the funding side, but many are on the investment side 8
However, this type of funding will continue being relied upon as it is a strong model 9
Funding by wholesale markets and securitization has worked successfully for many years 9
Loose US lending standards and securitization's opaque nature is more responsible for the current crisis 9
There is no going back to retail-only funding as a large portion of the mortgage market would disappear 9
The market will be repaired, but safeguards should be put into place so that this situation does not re-occur 10
APPENDIX 12
Supplementary data 12
Definitions 14
Bank of England base rate 14
Buy-to-let mortgage 14
Collateralized debt obligations (CDOs) 14
Mortgage-backed securities (MBS) 15
Non-standard 15
RMBS 15
Sub-prime 15
Methodology 15
Further reading 15
Ask the analyst 15
Datamonitor consulting 15
Disclaimer 16

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Table 1: Major UK banks' wholesale funding as a proportion of total funding (%) 12
Table 2: UK major banks' issuance of RMBS (£bn) 12
Table 3: Northern Rock balance sheet growth and liability structure (£bn) 13
Table 4: Major UK banks' customer funding gap (£bn) 14


Figure 1: UK banks have turned increasingly towards wholesale mortgage funding in recent years, 2000-07 2
Figure 2: The UK market for residential mortgage-backed securities has grown substantially in recent years, 1999-2006 4
Figure 3: Northern Rock has been increasingly dependent upon wholesale funding, particularly securitization, June 1998-June 2007 6
Figure 4: Major UK banks and others would face a significant funding shortage were they unable to access funding through securitization and the wholesale markets, 1997-H1 2007 10


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