Institutional investors are beginning to look to the equity release market as a source of long-dated cashflows to meet their liabilities. Sebastian
Cheek finds out more.
“[Lifetime mortgages] could become a very significant part of the market and we would not be surprised if the market became £5-8bn annually in four-to-five years’ time.”
Olivier Defaux
A new market is developing which allows investors to make use of retirees taking lifetime mortgages. These loan products, a form of equity release, have been used by insurers for a while, but are beginning to find traction among other institutional investors for their ability to offer long-dated cashflows and decent spreads.
However, there are risks around the uncertainty of these cashflows, longevity and the reputation of these products to be considered before investors move in.
A lifetime mortgage product allows homeowners – usually over 55 (the average age is 69) – to raise a tax-free cash lump sum or loan against the security of their home while continuing to own and live in the property for life or until they enter long-term care, at which point repayment of the capital, and usually the interest, occurs. The loans are commonly fixed rate but are sometimes RPI or CPI-linked.
Proponents are quick to point out the reputational issues and reports over mis-selling have been to do with the other two equity release products on the market: shared appreciation mortgages and home reversion schemes. Most lifetime mortgages however, carry a no negative equity guarantee meaning borrowers never have to pay back more than the value of the home.
According to the Equity Release Council, more than 10,000 new equity release plans were agreed in each of the last four half-year periods from H2 2013. In 2014, the total value of equity release lending reached £1.38bn – the largest annual figure since 1992.
This is, however, just a drop in the ocean considering there are £1.4trn of UK real estate assets held by over 65s which is potential capital for lifetime mortgages, according to figures from the English Longitudinal Study of Ageing, quoted in a report published last year by the International Longevity Centre UK.
One of the driving forces behind equity release is a wall of interest-only mortgages due to mature in the coming years, also known as the interest-only prisoner problem. This refers to those people who have insufficient funds to repay their interest-only mortgage on maturity and are likely to find themselves locked out of the borrowing market by banks loath to lend to people in retirement. Their only choice therefore, other than to default, will be to take a lifetime mortgage to release some cash and pay down the interest-only mortgage.
According to the Financial Conduct Authority, 2.6 million interest-only mortgages are due for repayment over the next 30 years with 10% of borrowers (260,000 people) not yet having a strategy to repay them. Elsewhere, industry estimates put this wall of interest-only mortgages at £5bn.
“There is a peak of these borrowers needing to refinance their mortgages in 2021/22,” says Blackrock head of European mortgage strategies Olivier Defaux. “It could become a very significant part of the market and we would not be surprised if the market became £5-8bn annually in four-to-five years’ time, from industry projections of £1.8-2bn this year.”
Elsewhere, lifetime mortgages have become particularly attractive through a combination of record low interest rates and high house prices. Retirement income provider Age Partnership found the average rate for a lifetime mortgage had fallen to a seven-year low of 5.82%, down from 6.7% in 2009 when it started tracking rates. At the same time, average property prices in the UK reached a record high of £272,000 in August, according to the Office for National Statistics’ House Price Index.
The case may be strong but do the investment characteristics back it up? Both insurance companies and pension schemes have long-dated liabilities but find it hard to locate long-dated assets to match. Annuity providers tend to have fixed-rate liabilities, while property and casualty insurers often have very long-dated healthcare liabilities, and pension funds commonly have index-linked liabilities.
This is where Blackrock’s Defaux believes the long-dated and index-linked or fixed-rate nature of lifetime mortgages offers a solution.
He says: “Pension buyout companies have the same type of liabilities as pension schemes which tends to be a mix of CPI, RPI and fixed-rate, making an inflation-linked product such as this of interest.”
Blackrock claims it is the only asset manager in the UK that offers lifetime mortgage solutions for institutional investors through segregated accounts. It only accepts mandates above £100m because the fixed cost of managing anything smaller impacts performance and diversification benefits. At the moment fixed rates in the current market range between 5-7% with most written around 6.2%. Currently demand is mainly for CPI and fixed rate lifetime mortgages, according to Blackrock.
Redington senior vice president, investment consulting, Conrad Holmboe believes current spreads on lifetime mortgages look attractive on a relative value basis. He also says they give investors exposure to longevity because as people live longer their loan amount accrues which provides the longevity hedge pension funds need to hedge their own liabilities and longevity risk.
“New players like pension funds are looking at this asset class, but the products had been tailored to insurance companies so there is scope to come to the market with new products which could be more attractive to borrowers,” says Holmboe. “Pension funds have pensioner liabilities and they are lending to pensioners so you’d think there was some alignment in what they both want.”
However, he adds investors should be wary of the lumpy cashflow profile because it is difficult to predict when someone will die or go into longterm care. There is also the potential of residential property risk, which is when the value of the property at maturity is not sufficient to cover the loan repayment. Other risks include illiquidity and the typically high upfront origination costs which can mean paying a premium upfront.
However, according to a Nobel Laureate in Economics, lifetime mortgages offer “a practical solution” to the growing challenge of funding retirement.
In a recent speech at the BI Norwegian Business School, Robert Merton, a professor at the MIT Sloan School of Management said people should use assets that are already being created more “effectively and efficiently”.
He said: “The largest single asset the family has is the house, it is often larger than the pension accumulation. If we can use that big asset more effectively we can have a material impact in addressing this [retirement] problem. That is a much more practical solution than changing people’s fundamental behaviour.”
And if it is good enough for a Nobel Laureate, surely it’s worth further investigation?
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