Author: db

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“How scam values on equity release loans affect leaseholders”

An article of mine has just been published by Leasehold Knowledge Partnership, which campaigns for a better deal for leaseholders. The introduction is by Seb O’Kelly, in his inimitable style (he used to be a journalist at the Daily Mail). The point of the article is that the deferment rate used to value equity release mortgages is the same as the rate which would in theory be used to value a leasehold extension. Lower rates favour landlords, higher rates favour leaseholders. The PRA seems not to have spotted the connection between the two political issues. In coming in with an apparently unevidenced 2%, they are imposing a valuation model that affects the interests of a whole bunch of people that they haven’t so far consulted. Now is the time. If you think you may be affected, write to the CP (CP13_18@bankofengland.co.uk), asking for the PRA to make its thinking clearer, and for a place at the table, if you wish.

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A house of many mansions

Eumaeus is dedicated to keeping an eye on the house, but this house has many dwelling places. Kevin Dowd’s ‘Asleep at the Wheel’ took the PRA to task for having dozed off a bit while deciding on how to price a put option, but there are also other regulatory or standard-setting bodies who are directly or indirectly responsible for valuing financial instruments correctly.

The exam question is, given the number of such bodies, why has none of them identified or addressed the problem that some firms apparently cannot value an elementary put option1 correctly?

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From the postbag

A reader writes questioning my claim in the 7 August BBC interview that Matching Adjustment is fake equity. Compare a gilt and a perpetuity issued by an insurance company, he says. Assume the gilt is highly liquid and can be sold in the secondary market, but the perpetuity is not. Then if the two instruments are priced the same, shouldn’t I choose the gilt every time? And doesn’t this, by implication, suggest that they cannot have the same value?
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No comprende

The spate of publicity surrounding ‘Asleep at the Wheel’ unleashed a torrent of nonsense into the printed media and the internet. It will take some time to unravel this, although Kevin has already posted on the subject. See here, on Baroness Altmann’s mistaken idea that he was publishing a risk-model, rather than a valuation model, and here, on the Equity Release Council’s misconception that ‘price trends’ are in any way relevant for pricing or valuing the NNEG.
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Hidden in plain view

All investors accept, or should accept, the importance of corporate transparency. The purpose of governance structures, including statutory reporting supported by independent external audit, is to ensure that minority shareholders receive reliable information about the value of firms and that company managers do not cheat them. Management should also be motivated to maximize firm value rather than pursue personal objectives (Bushman and Smith, citing Black 2000).

In my previous post I puzzled about what impact the current PRA proposals on Equity Release valuation would have on the capital of Just Group, finding that their own figures suggest a hit of nearly £1bn, in fact over £1bn if we add on the PRA expectation of a minimum 1% deferment rate. Where is this number to be found? Just’s regulatory report states that the regulatory capital has gone up, not down.  Altissimum est negotium et maioris egens inquisitionis. Let us investigate this deep mystery further!
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The ermpire strikes back

The equity release lobby has begun to respond to the Adam Smith Institute report. All the indications are they haven’t actually read it. Robert Sinclair of the Association of Mortgage Intermediaries has dismissed the parallel drawn between equity release and the Equitable Life affair, saying that Equitable Life was based on two different scenarios: they were invested badly and there were guaranteed annuities which they couldn’t afford to repay’. Did you say ‘guarantee’, Robert? The summary of the ASI report, i.e. the bit you don’t have to read very far to get to, says ‘This scandal is similar in nature to the Equitable Life scandal of nearly two decades ago – it involves the under-estimation of opaque long-term guarantees’.

Sinclair adds: ‘The risk is the gap between the current valuation and the longevity risk which is a judgement on how much house prices rise.’ He clearly hasn’t read either the ASI report, or the PRA’s own consultation document on equity release, CP 13/18, for neither is about risk management, but read on.

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Just what is the value of Just?

The share price of Just Group has been in freefall since 24 July following a statement by the firm about proposals by the Prudential Regulation Authority (PRA) which, if implemented, would result in a ‘reduction in its regulatory capital position’.

The proposals concern the valuation of the ‘no negative equity’ guarantee embedded in equity release mortgage assets. The PRA is fretting that firms are undervaluing them. But how much is the undervaluation, and how much would the reduction in capital be? Analysts have been scratching their heads for weeks. One estimated a loss of no more than £50m, another thought it could be as much as £500m.

Nobody seems to know. How large is the impact, and why is it so difficult to tell from regulatory reports, given the more transparent, risk-based and dynamic era of supervision ushered in by the Solvency II insurance capital regime?

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I would refer you back to the Equitable

Transcript of the Treasury Select Committee hearing, 11 July 2018, on Equity Release, 15:19:50.

Witnesses: Sam Woods, Deputy Governor for Prudential Regulation and Chief Executive Officer of the Prudential Regulation Authority , Sarah Breeden, Executive Director, International Banks Supervision, Bank of England, and David Belsham, External member of the Prudential Regulation Committee.

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Welcome to Eumaeus!

Nothing to see right now, but this is something about Eumaeus and what it is here for. It’s pronounced ‘You-my-us’.

This is us.

Following the Dowd report ‘Asleep at the Wheel’, our first post will be on August 8th, lifting a bit more of the lid on the strange world of insurance valuation.

We hope to see you again soon.