The mortgage sector has until very recently avoided the waves of technological disruption seen by virtually every other industry involving financial and asset transactions.
This is now changing, prompting industry observers to believe the market is primed for consolidation.
As technology sweeps the industry, allied to a revitalised growth in specialist lending, we should expect these twin trends to have a significant impact on the sector and lead to a further uptick in mergers and acquisitions (M&A).
There was healthy deal activity among specialist lenders last year, reaching some £5bn in deal value. In 2019, there could be higher deal flow, as larger providers look to snap up more nimble entities, while smaller lenders seek to achieve greater efficiency and bolster their scale.
Specialists and challengers
We are yet to see the broader impact of specialist lenders, with mainstream providers generally content to allow them to operate within their own market niche.
But as these types of lenders grow their impact on the sector is likely to be significant.
Specialist lending is currently experiencing a resurgence, with growth in gross lending by challenger banks and specialist lenders increasing by nearly 20% between 2016 and 2017. This growth trend is set to continue.
This has largely been driven by the self-employed, reflecting the growth of the gig economy and those in part-time employment – essentially those whose credit profile may prohibit them from being approved by a mainstream mortgage lender.
Despite the slowdown of buy-to-let due to tax and regulatory pressures, which will have some bearing on specialist lenders, the sector has grown past its dependence on buy-to-let with specialist residential and bridging loans becoming increasingly popular.
This is complemented by an upsurge in mortgage equity release, with recent figures from the Equity Release Council showing a year-on-year growth rate of circa 25 per cent.
We see strong potential for this to increase as Britain’s growing elderly population provide a key borrower base.
End of cheap funding
Within the specialist lending sector, M&A is being driven by a number of factors.
Funding schemes designed to increase competition in the banking sector have encouraged a rise in new challenger banks and specialist lenders since the 2007 financial crisis.
However, these banks now face tougher times given the recent slowdown in economic growth and the Bank of England’s decision last year to stop its cheap funding schemes, which were designed to encourage lending growth.
All of this is further driving M&A in the sector as shown by the recent buyout of Charter Court by OneSavings Bank for £800m creating one of the UK’s largest specialist lenders.
While specialist lenders have continued to be supported by solid securitisation markets, challenger banks have suffered most from the evaporation of cheap funding as they cannot draw upon the huge retail deposit base that high street names can leverage.
Rating agency Moody’s estimate that banks would have to pay more than £800m in extra interest costs as a result of losing this funding.
Benefits of M&A
Competition from larger banking groups such as HSBC, which is expanding rapidly in the UK mortgage market, makes it harder to charge borrowers more, putting further pressure on margins.
Many are looking to achieve greater efficiency through volume and scale by sharing substantial capital investments, such as costly software and electronic platforms, as well as expanding and complementing their credit products’ universe and expertise.
Also, with specialist funding becoming so diverse and lenders spreading their geographical appetite across the UK, potential M&A deals allow London-based lenders to grow quickly in the regions.
They can also hone new skill sets in different specialisms by acquiring teams to complement and enhance the existing representatives.
The continued uncertainty around Brexit, with housing and mortgage activity continuing to drop, also means that it will become difficult to sustain the number of specialist lenders currently operating without consolidation, as well as the larger providers looking for growth in markets which are not materially expanding at the moment.
M&A involving larger lenders
With regard to technology, recent developments in open banking and automated-advice are set to transform the traditional lender-borrower relationship, representing the most immediate threat to the status quo in the industry.
Driven primarily by borrower demand for simplicity and greater control over the process, this will prompt mainstream lenders to either adjust to the new reality, or lose customers.
Open banking is set to further improve the customer experience, with its streamlining features set to expedite the underwriting of transactions.
These changes will not only simplify the mortgage process, but will put more control of the process into the hands of the borrower, cutting out intermediaries and increasing transparency.
The need for mainstream providers to compete against likely larger specialist lending groups as a result of M&A in the sector, and their need to adapt to the impact of technology more broadly in the sector, is likely to lead to more M&A involving the larger mortgage providers too.
This will reshape the sector and lead towards greater competitiveness and efficiency. It will be better placed to provide the finance that customers need in these uncertain times.