Mortgage lenders prepare for battle

News Analysis: House-buying customers may be smiling, but Halifax's launch of its lowest ever fixed-rate home loan signals tough times ahead for the banks

THE PRICE war in the mortgage market reached a new level of intensity this week when Halifax launched its lowest-ever fixed-rate mortgages.

In a move interpreted by some as a sign of desperation, the country's biggest lender is offering to fix customer's payments for two years at a rate as low as 4.45 per cent.

The aggressive offer - which, of course, has catches - reflects an increasingly hard-fought price war in the mortgage market, which is beginning to change the way mortgage lenders operate.

Standard Life, normally thought of as an insurer, has declared its macho intention to grab 10 per cent of new mortgages within a year. With a standard variable rate of 6.55 per cent, 0.9 points below other lenders, it might achieve it.

Legal & General is offering mortgages at 6.55 per cent, initially discounted to 4.8 per cent. And building societies, unhampered by the need to pay dividends to shareholders, are keeping their variable rates below those of the mortgage banks.

The price war is increasingly fought in public and through the press. No longer do lenders restrict their business to customers buying a home.

With the number of housing transactions tumbling by 10 per cent last year, that would mean competing for fatter slices of an ever-diminishing cake.

Instead, they publicise hard-hitting, headline-catching rates with the aim of luring borrowers away from other lenders.

Societies such as the Scarborough will go as far as offering a rate of 1.35 per cent for the first year of the mortgage - the catch is a whopping redemption penalty, 6.25 per cent of the amount repaid if you redeem the loan in the first six years.

For lovers of cash, Northern Rock will give customers 8 per cent of their loan in an upfront cash lump sum.

Abbey National and Alliance & Leicester entered the fray yesterday with similarly stunning deals.

In a copycat riposte to Halifax, Abbey is advertising "some of its lowest rates ever". It is offering a rate capped at 6.25 per cent for seven years, which allows customers to avoid paying more and means they could end up paying less. Chase De Vere, a mortgage specialist, is offering 10-year fixed rates at just 5.79 per cent.

Customers no longer stick to one lender for 25 years - they switch lenders to get their payments down. Luring customers is made easier by the fall in long-term interest rates.

Lenders can go to the money markets and get a tranche of long-term money at such a low rate of interest that it can be lent on, at a profit, at 5 or even 4 per cent.

All this spells gloom for the big mortgage banks. Halifax, which still lends 19 per cent of the country's existing mortgages, saw its share of new mortgages sink to a third of its normal level last year. Lesser falls were experienced at rival banks such as Abbey National.

While Halifax struggled, building societies enjoyed a bumper year, capturing unprecedented levels of new business from Halifax and others.

Conversion to plc status, once heralded as the way for lenders to expand and diversify, has been of questionable value to Halifax's business. Customers have left in drovesand Halifax experienced a net outflow of pounds 462m in the first half of last year.

Worse, conversion means Halifax must please the City - something it is signally failing to do. Mike Blackburn, Halifax chief executive, retired in December amid widespread rumours of a rift with Jon Foulds, the chairman.

Its strategy of becoming the UK's top financial services group, by buying insurers and investment houses, has foundered. Market valuations are too high, Mr Blackburn used to say, to justify an acquisition. And far from having too little access to capital - a prime justification for conversion - the lender now has too much. Its surplus capital stands at pounds 3.8bn.

In a report on UK banks, Salomon Smith Barney, the investment bank, said: "Attention will again focus [this year] on the deployment of surplus capital. The group desperately needs to address its chronic over-reliance on the mortgage and savings market."

With 77 per cent of its profits coming from mortgages and savings, Halifax first needs to stem the outflow of funds. James Crosby, the new chief executive, is trying to regain its market share by competing for re-mortgages with better rates.

But the low rates are a double-edged sword. Because Halifax is pressed by public opinion to offer them to everyone, its own customers could switch to the new deals en masse.

Because the new deals are less profitable, that means smaller margins. For Halifax, the battle for market share looks unprofitable even if it wins.

The smaller converted societies - Alliance & Leicester, Woolwich and Northern Rock - are starting from a much smaller base than Halifax, but their share of the market also shrank in 1997, the year they converted.

With the housing market beginning to slip, prospects for the market do not look good. Analysts point out that the market is not being driven so much by demand for mortgages but by the low cost of credit.

The mortgage price war could get worse. Salomon Smith Barney predicts the banking sector will see a decline in earnings this year as the economy enters a technical recession.

Bad debts are likely to rise by 50 per cent, according to Salomon. With them will rise repossessions - a public relations headache for lenders.

"With pounds 800bn of customer advances, even a modest [recession] will severely damage the sector's profits. We believe the sector's earnings forecasts will come under substantial pressure," Salomon's said in its report.

With profits under pressure, lenders would normally be expected to be very cautious about offering cut-price deals. But competition is so tough that lenders are forced to offer lower rates just to hang on to their customers.

In today's mortgage market, customers are the only ones laughing.