Learning lessons from regulation changes in the mortgage market

© 2013 Grant Thornton International Ltd. All rights reserved.

AM F&I Conference

18th November 2014

Tony MoroneyDirector – Banking & Mortgages,

Financial Services Business Consulting

© 2014 Grant Thornton UK LLP. All rights reserved. 2

Grant Thornton UK LLP

Our Financial Services Business

Consulting (FSBC) practice

harnesses the skills, knowledge

and experience within our

Financial Services Group

FSBC provides market-leading

consulting and advisory and

assurance services to the

Financial sector

We align our core competencies

to industry challenges to ensure

the services we offer match the

challenges our clients face


1. The UK Mortgage Market

© 2014 Grant Thornton UK LLP. All rights reserved.

UK Mortgage Market

£-

£50.00

£100.00

£150.00

£200.00

£250.00

£300.00

£350.00

£400.00

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

£bn

• Q3 2014 was the highest quarterly house

purchase lending level since 2007

• Total advances estimated £56.1bn

• The Top 6 Lender's

typically account for

c.70% of mortgage

advances

Source: CM L


UK RETAIL

BANKING

UK RETAIL

BANKING

CUSTOMERSCUSTOMERS

CHALLENGER

BANKS

CHALLENGER

BANKS

TECHNOLOGYTECHNOLOGYREGULATIONREGULATION

ECONOMICECONOMIC

Expect more transparency and

more digital /mobile channels.

Increased scrutiny from

regulators but also the

media and politicians

Pressure on

traditional revenue

streams and costs

Decrease the cost of service

and differentiate service levels.

Attractive for retailers with

a loyal customer base and

large distribution network.

5

Competitive and Dynamic Landscape

Intense

Rivalry


With wider and more intrusive Regulation

Business Model

ConductFCA

PrudentialPRA

Business Strategy

Governance and Control

MI, Customer Feedback and Evidence of Compliance

• Risk Management

• Stress Testing• Resilience• Horizon Scanning

• Individual Accountability

• NPD• Customer Focus• Customer

Outcomes

Market Stability• Customer protection• Transparency• Market Integrity

Risk ManagementReg

ula

tio

nB

usi

nes

sEqual

Standing

Evidence


And Record Levels of Fines

• Over the next two years, Morgan

Stanley predicted that banks will have

to earmark another $69.9bn for

misconduct fines, including those

related to mis-selling mortgage-

backed securities and payment

protection insurance

• Added to the $232bn put aside or

paid out for misconduct and other

regulatory fines since 2009, this

would bring the banking industry’s

total bill for misbehaviour to $300bn

• Recent FCA Fines are as follows:

– 2013 £474,138,738

– YTD £1,427,943,800

FCA 2014 YTD £m

FCA 2013 £m


2. Mortgage Market Review

- What it means for mortgage lenders


• all forms of interactive dialogue, whether face to face, telephone, social media, or online propositions

Distribution

(All Advised Market)

• those giving advice through the system must comply with minimum standards

Distribution

(Approved Persons)

• asses the repayment strategies of borrowers through putting clear policy and controls in place along with the requirement to check repayment vehicles during the term

Interest Only

• lenders must verify income and be able to demonstrate that the mortgage is affordable, taking in to account of the impact of future interest rate increases

Responsible Lending

The Key to MMR


The Market Impact

• Critically, customers are still able to get mortgages, albeit there has is still much

reported confusion over the whole issue of affordability

• Some consumers have been adversely impacted by the new responsible lending rules

e.g. interest-only, the self-employed, self-certify and those with a poor credit record

• Associated products i.e. add-on sales must also meet customers needs

• Transition rules are a "bone of contention" in terms of treatment existing customers

• Significant investment has been made by lenders in training and systems and a

number of lenders have embraced new technologies as a means of optimising scare

mortgage adviser capability - execution only sales have essentially disappeared

• The ability to discuss a mortgage real time has also disappeared with long delays before a

customer can see an adviser; the mortgage interview itself has moved out to c. 3 hours

• For many lenders however, the cost is too prohibitive and their new business efforts have

been re-directed towards the intermediary market

• Growing recognition that "Conduct Risk" remains regardless of how a lender goes to

market


Post Implementation Thematic Reviews

• The first phase of the FCA discovery thematic work is on advice and includes:

– whether the lender has executed a cohesive, joined-up mortgage advice strategy

– whether the lender has a well-designed mortgage advice process – one where the

staff are well-trained and capable, and act in the consumers’ best interests, and

– whether the lender has a robust monitoring and oversight procedure in place in order

to be able to identify poor outcomes such as providing unsuitable advice

• FCA undertaking consumer research, mystery shopping, file reviews and lender visits

• The next phase which will focus on responsible lending and the FCA will be adopting a

very similar approach and will have the same aims and objectives

� Are lenders confident that their advice strategy is delivering the

right outcomes for consumers and do they have the right quality

assurance process in place to provide the FCA this comfort?

� Are lenders satisfied they have the right approach to determining

affordability and can they re-create and stand-over the

affordability decision at a future date?


3. Conduct Agenda- What it means for mortgage lenders


Conduct Risk

“Conduct risk is any action of

an individual financial provider or

the financial industry that

leads to customer detriment or

negatively impacts market stability”


'Fairness', ‘Customer Centricity’ and ‘Conduct Risk ’

Marketing &

Acquisition

• Access to a holistic picture

of the customer through

Single Customer

View/CRM system

• Targeted marketing focused

on ‘suitability’, segmenting

customers using flexible

analytics and modelling

tools, backed up with rich

customer data

Product

Design

• Products demonstrably

satisfying a market or customer

segment need

• Sophistication level appropriate

to the individual customer

requirement/need

• Profitable but not to the

detriment of the customer

• “Fair” open & transparent

charging structure

• Ongoing product reviews that

validate market, charging

structure and profitability

Risk, Fraud, and Compliance• Revised risk model that is consistent with an FCA Conduct Risk environment

• Automated MI and audit trails of logic and supporting data to evidence suitability through the lifecycle

Relationship

Management

• Improved understanding of

customer needs throughout

the lifecycle using better

real-time customer data

with “softer information”

on behaviour and attitude

• Automated identification of

lifestyle events to prompt

suitability review

• Clear policies and

procedures for dealing with

customers in difficulty

Sales & ServiceDistribution

• Enhanced decisioning

ensuring products match

latest customer needs

• Automated triggers/ alerts

for main servicing events,

driven off up to date

information

• Optimised channels

balancing customer need

with cost to serve

• Increased self servicing

through customer access to

supporting tools

Supporting Functions - Business Services, Technology Services, Finance, HR etc.• Financial models that reflect the revised product/customer set and suitability based forward projections

• Remuneration model based on customer satisfaction, with roles in place to assure adherence to FCA Conduct Risk principles


Conduct Risk Policies

1. Measure Conduct Risk - risk methodology and risk profile

2. Demonstrate due care - Is the customer eligible and is it suitable for their needs?

3. Formally document the intended Customer's needs at the beginning of the Product

Development Lifecycle - mandatory evidence of repayment capability and plausibility.

4. Undertake frequent product reviews to confirm products still meet their objective and

that those objectives still meet intended customer needs

5. Incorporate Root Cause Analysis from Customer Complaints and Arrears in to the

design of new products and use it to alter and/or remove products

6. Train all staff at all levels of the organisation, not just customer-facing staff, and have

an appropriate governance and controls framework supporting Conduct Risk.

7. Evidence, Evidence, Evidence

• How did we consider the customer when designing the product?

• How have we ensured our risk policy is appropriate and delivering the right customer outcomes?

• How have we ensured the right customers end up with the right products?


4. The Sector Parallels


Similar Risk Landscape

Credit RiskCredit Risk

Operational RiskOperational Risk

Conduct RiskConduct Risk

Market RiskMarket Risk

Reputational RiskReputational Risk

Technology RiskTechnology Risk

Risk of losses in positions arising from market price

movement

Risk arising from (lack of) stakeholder confidence

and trust

Risk arising from inadequate or failed

information technology asset

Risk that a borrower will default on a debt

obligation

Risk of loss from inadequate or failed

process, people, system or external event

Risk to the FSA’s statutory objective of consumer Protection


With Increasing Scrutiny

In the six months since the FCA began regulating consumer credit they have:

• issued 9 section.166’s,

• frozen the bank accounts of 7 firms to protect client monies,

• forced 14 firms to stop taking on new business &

• several investigations on-going

Skilled Person Reviews Q1 12/13 Q2 12/13 Q3 12/13 Q4 12/13 Q1 13/14 Q2 13/14 Q3 13/14 Q4 13/14 Q1 14/15 Q2 14/15

Personal Investment 2 4 4 1 2 1 0 1 1 0 16 8.4%

Investment Management 4 4 0 1 1 1 1 2 0 0 14 7.4%

Securities & Futures 4 4 2 4 5 1 2 1 0 0 23 12.1%

Banks & Building Societies 7 21 8 16 3 6 3 5 5 4 78 41.1%

Insurance Companies 2 3 3 9 6 2 2 1 2 0 30 15.8%

General Insurance Brokres 2 1 2 0 1 1 2 0 1 0 10 5.3%

Home Finance / Mortgage 0 0 0 0 0 0 1 0 0 1 2 1.1%

Professional Firms 0 0 0 0 0 0 0 0 0 2 2 1.1%

Credit Union 1 0 0 0 0 0 0 0 0 0 1 0.5%

Consumer Credit 2 7 9 4.7%

Other 1 1 2 0 1 0 0 0 0 0 5 2.6%

23 38 21 31 19 12 11 10 11 14 190


Leadership &

ManagementEvidence

Focus must be on Customer Outcomes

Good Customer Outcomes

Culture

Customer focus

Business Controls

Prevention/

Assurance

Product Sales Service

Financial modelling and pricing


Connectedness

Understanding

Insight

Supported with Right Data & Right Insights

Evidenced

Based

Action


5. Conclusion


Regulatory Compliance is not Enough

1. Have you an established conduct risk appetite? Is this reflected in your customer and business strategies?

2. How do you identify the areas of your business that conduct risk has the greatest impact?

3. Can you quantify the conduct risk for your current products and back book – and how are you mitigating it?

4. Are your staff aware of their regulatory obligations to your customers?

5. How is conduct risk identified and managed within your overall risk model?

6. How far does your Treating Customers Fairly framework help to mitigate your conduct risk exposure? Have you a

clear action plan covering how, and where, your Treating Customers Fairly framework may need to be improved?

7. What customer feedback do you gather? How does it support your conduct risk management performance?

Definition and Impact

Communication and Understanding

8. Do your new product development activities robustly support the FCA’s conduct requirements?

9. How do you show that your marketing and customer segmentation activities meet conduct obligations?

10.Are you clear on your conduct risk obligations where your products are sold by third parties?

Impact on Business

11.How do complaints and root cause analysis of complaints and arrears to ensure improvements for customers?

12.Aside from in complaint handling, are you undertaking root cause analysis on other sales and servicing activities?

Prevention


Closing Thoughts

• All lenders must focus on all the traditional elements of risk, however, there a real

emphasis now on responsible lending – and there is no going back!

• Yet credit risk is only one of the lenses a lender should use when dealing with retail

customers; Conduct Risk is of paramount importance

• Lenders who take a narrow compliance approach will struggle to provide the evidence

now required by the FCA both in terms of responsible lending and their conduct

• Boards and executives must apply the same level of rigour in reviewing customer

outcomes as they do to monitoring the financial performance of the business

• This includes the need to review new and existing products and services – managing

the product lifecycle opens the way for much more retrospective action and

reputational risk and as such, must be taken seriously

• “good profits” come from making sure products are suitable for the people they’re being

sold to; easily understood and provide appropriate value for money

• Set the right tone at the top and embed a culture of doing the right thing by customers,

clients and other counterparties


THANK YOU

Learning lessons from regulation changes in the mortgage market

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