Kevin Dowd 16 August 2018
Adam Williams had an interesting article on this issue in the Daily Telegraph (14 August 2018) .
It’s a good question.
Let me quote from his article and add some comments:
‘What happens if my equity release provider goes bust? (Adam Williams, 14 Aug 2018) … ‘your fears are not unfounded. A report issued by the Adam Smith Institute, a free market pressure group, said the equity release market could be sent into meltdown if house prices were to fall substantially in future’.
The report referred to is Asleep at the Wheel: The Prudential Regulation Authority and the Equity Release Sector published on 7 August by the Adam Smith Institute. My report did not say that the equity release market could be sent into meltdown if house prices were to fall substantially. What it said was alarming enough, however: it said that the sector is already in deep trouble because of hidden losses due to under-valued No-Negative Equity Guarantees (NNEGs).
It also presented the results of some stress tests that suggested that firms’ losses could be considerably greater in the event of a major house price fall.
‘It warned that such an event would cause some providers to become insolvent, potentially leaving thousands of customers in the lurch.’
Not quite. After taking legal advice, the report was purged of any references to individual firms and terms like “bankruptcy” and “insolvency” were removed. The report did however give some illustrative numbers and a chart, reproduced below, that indicates that NNEG under-valuations were likely to be substantial.
Rental Rates and NNEG Valuations
The q rate in the chart is the net rental rate, which is the key driving parameter in the valuation model. Firms appear to be using a negative rental rate – which makes no sense because it implies that rents are negative! – whereas a reasonable net rental rate might be in the region of 2% to 3%. If we took the lower of these net rental rates, then my model suggests that for a plausible illustrative case the value of the NNEG could be about 52% of the amount loaned. If we took the higher net rental rate, my model suggests that the NNEG could be 67% of the amount loaned.
‘David Burrowes, of the Equity Release Council, a trade body, poured cold water on these claims and said the equity release firms are required to hold enough resources to withstand economic shocks.’
But the key question is whether firms’ capital even now is sufficient to take account of their NNEG under-valuations.
Whether firms’ capital is enough to withstand a housing shock as well is another and more challenging issue.
‘Mr Burrowes said that customers would also continue to receive safeguards such as the no negative equity guarantee, even if their lender had closed to new business.’
Mr. Burrowes is right on this last point at least. From the customer’s perspective, the NNEG provides perfect protection. Whether the lender subsequently goes belly up or not makes no difference to the borrower: if their lender goes into bankruptcy, they might eventually get a letter in the post saying that their account had been transferred to another firm, and it might not even come to that if their lender is merely taken over.
So the answer to Mr. Williams’s question is crystal clear: borrowers have nothing to worry about.
Lenders and investors in Equity Release firms might not be so fortunate, on the other hand.