Equity is not liquidity

A common argument run by borrowers and their representatives at mortgage possession hearings is that there is sufficient equity in the property to redeem the charge, such that the Claimant’s position is adequately safeguarded. It is often argued therefore that there would be no prejudice to the Claimant if the proceedings were to be adjourned, instead of there being a possession order granted.

The same reasoning is often raised by judges by way of justifying ordering an adjournment in mortgage possession proceedings.

Sometimes this point is considered to be ‘unanswerable’, because the equity would pay off the outstanding balance under the mortgage. This write-up seeks to scrutinise this line of argument and provide some responses.

The starting point is the contractual promises which the borrower made at the outset. The vast majority of mortgage loans within England and Wales are on a capital repayment basis. The borrower promises to pay back the lender over the term, by monthly instalments. The lender slowly recovers the money lent, plus interest, on a month-by-month basis.

The entire point of the security is to guard against the breaching of the terms and conditions of the contract. The borrower entered into the contract and due to the seriousness of the transaction, the disposition occurred by deed, in writing and signed. The borrower consented to the rules. They were aware of the consequences for a failure to maintain monthly instalments. Besides the express terms within the contract itself, it is a requirement of lenders that they publicise the risk of the property being repossessed very clearly within their marketing materials. The borrower already signed up to the promise that the consequences for failing to pay monthly instalments would be a possession order, and promised that the contractual terms would govern the relationship between the parties.

If borrowers cease paying on a monthly basis, then the lender’s liquidity suffers. The build-up of unrealised equity within the property is not an equivalent to the lender because it does not appear as liquid capital on the lender’s books. Equity is not liquidity.

It is wholly circular to argue that the Claimant will be able to enforce those promises made by the borrower, if the court is being invited instead to postpone or prevent the enforcement of those obligations.

In law, if the entitlement to possession has arisen, it is no response to point to the very asset – the sale of which is the legally-promised remedy – and say that at some point, if sold, then the charge would be redeemed. Firstly, the argument is often made despite the absence of any formal, up-to-date valuation of the property by an expert surveyor. Even if such evidence were produced however, this is not a guarantee that the property will in fact sell for such a price. Nor is it any sort of timetable for when the asset will in fact be liquidated. An adjournment is precisely the opposite of a step towards the liquidity the lender seeks as a remedy.

If two football teams agree to adhere to the Laws of The Game but then one side loses and argues that in fact the consequences (gaining zero points) ought not to flow as previously agreed, such an argument would be given short shrift. Before the loss, the parties all agreed up front upon the rules which would govern their relationship. In a similar vein, it is no response to point to the bricks and mortar of a property and expect the lender to accept this as a substitute to the obligation to pay liquid sums on a monthly basis.

The Financial Conduct Authority requires lenders to maintain a certain level of capital resources to be able to cope with market downturns, and to meet their liabilities – that is, an adequate Loan-to-Deposit Ratio. These requirements have been tightened up in the aftermath of the Global Financial Crisis of 2008. Lenders are required to maintain sufficient liquidity at all times. The idea that a borrower reneging on a promise to service a maintain a lender’s liquidity has no effect is totally ignorant of the necessity for there to be cashflow as between.

It is immaterial that the court’s discretion under Section 36 of the Administration of Justice Act 1970 does not arise in situations of negative equity (Cheltenham & Gloucester Plc v Krausz [1997] 1 WLR 1558). The fact that the charge might be redeemed is not an argument that it is in fact going to be so redeemed. This position simply begs the question as to why that very remedy is being delayed and denied.

Because a delinquent loan shows up on a lender’s balance sheet as being in arrears, the strength of that balance sheet is weaker by virtue of any borrower being in arrears. The regulatory body (the FCA) does not tolerate a plethora of borrowers being in arrears, and the consequences for the lender are very severe if they permit such a situation to obtain.

If the lender is owned by shareholders, then those shareholders will take a dim view of the fact that many of the lender’s customers are in arrears.

The increased risk to which the lender is exposed also has a knock-on effect for the job security of employees of the lender.

The notion that due to equity, there is no prejudice to the lender, if the court declines to order possession (or permit the execution of a possession order), is therefore patently false.

In sum, it is impossible to equate notional equity that might exist within a residential property, with the liquidity that all lenders are required to maintain, in order to function as going concerns.

Taken to its logical conclusion, if every borrower who was in arrears could point to the existence of the Claimant’s security as justification for there being no possession order granted – or to suspend a warrant of possession – then all lenders would simply become insolvent.

The argument that equity in a property protects a lender is sorely wanting and smacks of a fundamental lack of understanding of the financial services industry.

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