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Margin calls

Paul Thomas reports on why banks have decided to widen the margins on their mortgage products

Many high-street banks have increased the margin charged on their mortgages compared with levels seen before the credit crunch.
Earlier this month, Lloyds Banking Group posted half-year profits of £1.6bn. Royal Bank of Scotland made £1.1bn and Barclays £3.95bn.

Research conducted by Moneyfacts reveals banks have raised their mortgage margins which contributed to the profit figures.

Under normal market conditions, the rate at which mortgages are priced tracks swap rates closely. However, the margin between two-year swaps and the average two-year fixed-rate mortgage has been steadily increasing. Since June 2007, the margin has risen from 0.1 per cent to its current level, 3.14 per cent.

Moneyfacts spokesman Darren Cook says there are a number of reasons behind the wider margins.

He says: “Lenders are more careful about who they lend to now and high loan-to-value mortgage deals are more expensive.

“It is unfair to call it profiteering. There are far too many factors involved to call it that. You have heightened risk, issues in the wholesale markets, raising capital and, yes, they have to repair their balance sheets after the damage over the past few years.”

Cook says bank rate movements are likely to be the critical factor in determining margins.

He says: “I think the big trigger will be when the base rate changes because it is very influential in terms of savings rates.

“Savers will be happy because savings rates should go up. It is possible that mortgages could do the same as well.”

The British Bankers’ Association says the lack of a thriving wholesale market means banks have to increase their savings rates to attract customers so they can fund new lending, which leads to higher mortgage rates.

A BBA spokesman says: “The money that mortgage providers lend to their borrowers comes from two main sources – the wholesale money markets and deposits from customers. The securitisation market, which enabled banks to convert parts of their mortgage book into attractive financial products for big investors, so providing cash for new mortgages, effectively closed with the credit crunch.

“Lenders are now required to finance themselves more from deposits and less from the wholesale market. The interest rates they offer savers are significantly higher than the base rate, and as banks compete for savers’ funds, the cost of this funding is pushed even higher.

“Put simply, the credit crunch brought an end to the easy credit era where loans were plentiful and cheap.”

First Action Finance head of communications Jonathan Cornell agrees and cites funding problems as the main factor for the margin increases.

He says: “Lenders do need to make a profit and they do need to repair their balance sheets but there are more factors to it. Funding is the centrepiece of all of the problems our industry faces.

“The problem at the moment is that lenders are very cautious about their funding. There is just very little competition and there is a finite pot of money to lend. In a normal market, with funding freely available, when swap rates come down fixed rates should come down but now there are a few links missing from the relationship, with funding being the biggest.”

Cornell believes movement in the Bank of England bank rate will have little effect on mortgage pricing.

He says: “The actual level of base rate is fairly irrelevant. Base rate does not determine how much banks pay for their money. Once they have got some money and are ready to lend, then clearly swap rates will determine the level at which they price products.”

Abacus Financial director Matthew Fleming-Duffy believes new rules on capital may also be a factor. He says: “Banks have to prove they have deeper pockets than in the past. Capital adequacy rules are now stipulating that banks have more money on deposit, so making bigger profits fits in with that.”

Both Fleming-Duffy and Home Funding chief executive Tony Ward think current margins are where they need to be.

Ward says: “In June 2007, the pricing was clearly wrong. I would say a 3 per cent margin is not far off where it should be. I would say fixed rates, based on the data, are simply coming in line with the margins on variable rates, and that is where they need to be.

“Widening margins is also a way to ration business if you do not want to lend too much.”

Fleming-Duffy says: “If you go back a couple of years, the market was based on low-margin business, securitisation and big stream borrowing. The fault lies more in what was happening then as opposed to what is happening now.”

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