Oliver Ralph of the FT has a piece ‘just’ out, on fears about the impact of proposed new PRA rules on Just Group’s capital base.
The PRA’s consultation paper suggested tougher treatment for these type of mortgages, to take account of the risk created by the no negative equity guarantees.
That’s not quite right, as we have pointed out here and elsewhere. The PRA’s consultation paper CP 13/18 (02 July 2018) is not about the risk of such mortgages, i.e. capital requirements, which the PRA has so far been silent about, but rather their valuation, which impacts capital available or ‘capital resources’ as the regulator calls it.
The puzzle is why there has been such as ‘welter of research’ speculating about how big the reduction could be. Credit Suisse have dropped their target price from 170p to 94p. Numis and RBC are more upbeat, however, although Numis holds the curious view that the NNEG is not an option
We are unsure why the PRA want to value NNEG guarantees using an option pricing formula.
Guys, most firms (including Just) already say they are using an option pricing formula anyway, see e.g. page 163 of their 2016 financial report, which clearly says they are using a ‘variant of the Black-Scholes formula’, so it’s not merely the PRA ‘wanting’ to value using an option formula. The analyst could easily have found this out by reading any of the financial statements, which he is surely paid to do. Furthermore, the NNEG guarantees that the amount payable at exit is the compounded loan value or the sales-adjusted property value, whichever is the lower. That ‘whichever is the lower’ is the hallmark of an option, whatever name you give it.
As for the amount of the reduction, there are at least two ways of getting there. In this post I used Just’s stated sensitivity to changes in deferment rate, plus a number from their financial reports which implies what the old deferment rate would have been, to arrive at an estimate. The firm has apparently questioned my figures, but I am only using the figures stated in their own reports.
The second way is to replicate the option model that Just say they are using, and reprice the NNEG at different deferment rates using that model. This comes up with a larger number, but we will be reporting on that later.
The underlying issue is the transparency of financial reports and their usefulness to shareholders and analysts. Not transparent, and not useful, given the welter of speculation. Clearly we don’t know what the PRA decision will be in December. That’s the probability part of risk analysis. But the other part is impact. What happens to available capital if CP 13/18 is implemented as stated? Surely shareholders have a duty to know this now? I mean, the firm’s financial reports state market sensitivity to falls in interest rates, rise in credit spreads, change in mortality and all that helpful stuff. Why are they being so coy about the sensitivity to regulatory reform?
I asked both KPMG and the firm’s financial officer to explain the meaning and derivation of some of the numbers in their reports, in particular the ‘other valuation differences’ of a cool £1bn which I discuss here. I was met by, in effect, a point blank refusal. Will the firm discuss this in their business update early next month? Who knows. But we really should be told.