Keeping an eye on things
You saw it here first. At 10:00 yesterday we published the news that the PRA had delayed the implementation of CP 13/18 until at least the end of December 2019. The impact was dramatic, with a certain firm’s share price leaping by nearly 30% at one point.
Mr Market still doesn’t understand, if you ask me.
Our postbag is bursting its seams with comments, largely critical, about how we have misunderstood the ‘two balance sheet’ approach used by Just group. We have claimed that Just were (past tense) using an implied deferment rate of minus 2.75% for both their IFRS and Solvency II balance sheet. Our critics say that, while the firm are using that rate for the IFRS balance sheet, they are (present tense) using a rate of 0.5% for Solvency II purposes. See their 2017 Solvency report, p.54.
We are wrong, and must apologise immediately!
A spokesman for UKAR got back to me saying I got the numbers wrong in this post. I said that the total loan value of the book bought by Rothesay Life, i.e. the original amount lent accrued at the loan rate is somewhat north of £1bn. Apparently not, for that value, which they call ‘unpaid balances on portfolios sold’, is £860m, hence somewhat south of £1bn. So there are five different values to choose from:
Fans of linear algebra will spot that there are still too many unknown quantities to make any sense of this.
There was much talk about the UKAR ‘bad bank’ selling a portfolio of ERM loans to Rothesay Life, an insurance company once owned by the good bank. See e.g. this report by Ralph and Pooley.
Today is the 10th anniversary of Lloyds TSB acquiring HBOS. An awful lot has been written about this, but there has been comparatively little about why a regulatory approach that was implemented in early 2008, and which was meant to protect the bank from losing its capital with a probability of 1 in 1,000 years, failed so spectacularly only 9 months later. What went wrong?
Just’s quarterly results presentation on September 6th was a hoot. I couldn’t help noticing the cancelled dividend and the auditor (KPMG) suggesting that the final outcome of CP 13/18 could constitute a material uncertainty that may cast significant doubt on the Group’s ability to continue as a going concern. These look like red flags to me but I am not an analyst and may have missed the finer points.
One point however that did jump out at me was its innovative “NNEG loss shortfall” metric. This metric appears to be the loss that occurs when the loan is repaid and the house price is below the loan value. This metric sounds plausible at first sight and sure does make the NNEG risk look small.
Unfortunately this “NNEG shortfall” as used by the company tells us nothing about the valuation of the NNEG or the riskiness of the firm’s equity release portfolio.
As discussed in yesterday’s post, the Just Group auditors stated that the final outcome of CP 13/18 could have a materially negative effect on the regulatory capital position and financial condition etc. of the Group, and constitute a material uncertainty that may cast significant doubt on the Group’s ability to continue as a going concern. You might have thought that was clear enough, but lest you should have been misled, Rodney Cook (Group CEO) clarified matters at a presentation. [1:11:00]
“Let me just cover off the word ‘doubt’, that is an auditing and accounting and statutory set of words, and that is why it is in there.”
That makes sense. ‘Material uncertainty’, ‘significant doubt’, ‘going concern’ etc do not have their usual English meaning, but are merely accounting and auditing technical terms, signifying nothing in particular as Mr. Cook notes.
Just Group’s interim results were published this morning (6 Sep 2018). As has been widely reported, they did not declare a dividend. ‘In light of the uncertainty created by Consultation Paper 13/18, the Board has deferred any interim dividend declaration until the position is clarified’.
Most UK Equity Release mortgages1 involve a no-negative equity guarantee (NNEG) by which the lender guarantees that the borrower (or their estate, if they have passed away by then) will never need to pay back more than the value of their house when the loan is repaid.
The valuation of these NNEGs has become an issue in light of recent reports – Howard Mustoe’s BBC story “Home equity release may cost pension firms billions” and my Adam Smith Institute report, “Asleep at the Wheel: the Prudential Regulation Authority and the Equity Release Sector.”
In particular, our reports claimed that Equity Release firms are undervaluing their NNEG guarantees – and to a considerable extent.
So how big is the NNEG valuation ‘problem’ across the Equity Release sector?
Continue reading “How Big is the NNEG Across the Equity Release Sector?”
My work with Kevin Dowd on the pricing of equity release mortgages has been illuminating. It has been an interesting pricing question for us geeks, of course, but also interesting was the insight into how efficiently the market acquires information that is public domain, or which can be acquired from public domain information ‘by persons exercising diligence or expertise’, as the 1993 Criminal Justice Act puts it. My impression from our recent work on pricing is that the market isn’t very efficient at all.