Keeping an eye on things
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’.
Probably the most laughable commentary on the Equity Release scandal arrived yesterday from Tom Moloney, corporate partnerships manager at the utterly neutral Age Partnership, writing for the completely independent Mortgage Finance Gazette.
In Asleep at the Wheel, I set out a base case No-Negative Equity Guarantee (NNEG) valuation based on a bunch of assumptions. Suppose I am 70 years old, have a house worth £100 and get an equity release loan of £40. Suppose too that the risk-free interest rate is 1.5%, the net rental rate is 2%, the loan rate is 5% and so on.
In this base case, my NNEG model comes up with a NNEG valuation – this valuation is the same as the cost of the NNEG to the lender – of £20.8, which is 52% of the amount loaned.
Remember too that we value the NNEG using information available now. As Dean and I have explained in various places (see here and here), our NNEG valuation is not dependent on a forecast of any future variable.
Continue reading “A bet on the house”
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.
Kevin writes (28 August 2018)
A less extreme case is where the property is uninhabitable and repair would be uneconomic, but the land itself is valuable. Parts of Detroit come to mind as Dean has suggested here. You could then say that the net rental proceeds were negative for the current property, but this situation would not last. In this case, the property would be sold off and demolished, and the site redeveloped. A positive rental stream would then eventually be restored.
True, and the picture above (Charleston St, Detroit) illustrates this nicely. Many of the derelict streets in Detroit still look like the picture on the left. Houses abandoned or burned out, gardens reverting to the wild. But some parts have regenerated, getting new life by arising from the ashes of the old life, like the Phoenix. See the right hand part of the street in 2013.
The new houses will sell for a price greater than zero.
Kevin Dowd 28 August 2018
A number of our readers continue to be puzzled about why Dean and I have been insisting (see, e.g., here, here and here) that the net rental or q rates used for NNEG valuations should be positive.
This point matters because we are interested in how NNEG valuations are affected by deferment property prices.
Continue reading “Net Rental Rates and Deferment Prices”
Is the Bank of England pandering to freeholders over punitive lease valuations? Read all about it here, by Leasehold Knowledge, who have spotted the connection between the deferment rate consultation by the PRA, and the issue of leaseholder exploitation by large vested interests. A copy of their letter to the Guv’nor, and a nice picture of Kevin too.
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.
Continue reading “Just in spotlight”
Kevin Dowd 27 August 2018
Why do we use the Black ’76 model (Black, 1976) model to price the put options in No-Negative Equity Guarantees (NNEGs) instead of the better-known vanilla Black-Scholes (BS) model (Black and Scholes, 1973; Merton, 1973)?
Continue reading “Why Black’ 76?”