The specialist lending market has been dynamic and innovative from the start and it continues to evolve. Specialist lending is now a well-established UK mortgage sector, supplying the vast majority of niches that high-street lenders do not cater for in general. Far from being the ‘Achilles heel’ of the mortgage market as it was once referred to some time ago, it has been the fastest developing sector in terms of lenders, products and distribution channels.
The first non-conforming lenders entered the UK market around 10 years ago. Following a period of high interest rates, high levels of repossessions and a property market collapse, many consumers who had experienced financial problems found difficulty getting a high-street mortgage because credit scoring systems – designed to screen out any business that was not an acceptably ‘low risk’ – were declining them. Non-conforming lending, designed to cater for individuals that could not get mainstream mortgage loans, was well established in the USA and US lenders (including SPML’s original parent company) saw the opportunity to bring the US experience and expertise successfully to the UK.
Well-designed products, skilled underwriting and effective collections systems could ensure this higher-risk lending would be able to perform well, in order to ensure the ability to securitise the loans. Successful securitisations (i.e. turning the loan book into bonds that are sold on the international bond markets to raise more money to lend) depend on well-managed and well-performing loans. The new breed of lenders honed their risk management and product development skills, aiming to offer products that could satisfy the largest possible proportion of demand for mortgages from borrowers who were excluded from the high-street.
Looking for growth
Having become established in their original sub-prime and niche lending areas, the non-conforming lenders were looking for growth. To achieve this, they started to extend the range of credit profiles to which they would lend, together with gradually lending at higher LTVs and higher income multiples. A balance must always be struck between risk and reward. Extending product criteria to include heavier adverse credit can result in good profit margins if it is done responsibly and successfully. But it will always be low volume business. Overall, the vast majority of mortgage lending is done in the prime sector. So, if the non-conforming lenders wanted to increase their volumes considerably, they had to look at lending in areas nearer the prime end of the spectrum. The non-conforming lending model is not geared to pure prime lending which is still the domain of high-street branch lenders dealing direct with the public.
However, large volumes can be generated in light-adverse and near-prime business, where borrowers are having problems getting a mortgage from the high-street and they visit a broker for help.
This last part of the jigsaw is important, because almost without exception, specialist and non-conforming mortgages are distributed via brokers. The expertise of non-conforming lenders has always been concentrated in credit risk evaluation, product development, skilled underwriting and effective collections systems. At start up, they were not interested in dealing direct with the public, or in dealing with high volumes of individual brokers.
Fast and accessible
From the outset, non-conforming lenders wanted to receive fully packaged cases to feed into their systems, so they could write more loans and do it quickly. In effect, this created a role for packagers, who could then offer individual brokers a route into introducing non-conforming business, combined with competitive products and market knowledge. Fast-developing IT capabilities are starting to make the mortgage application and decision-making process very fast and more easily accessible to individual brokers. Many specialist lenders are developing systems that only require borrower information to be keyed in once, which then populates KFIs, DIPs and application forms. However, the vast majority of non-conforming business still flows through packagers and, at SPML, more than 95 per cent of our business is from our packagers. Packagers not only perform the administrative packaging role, but they provide a pool of knowledge and experience that can be invaluable to individual brokers in the specialist market.
10 years on from the start of specialist lending, many of the first generation of lenders are now owned by large financial institutions, which gives them the financial confidence to continue to grow their businesses. At the same time the market is experiencing a number of new entrants. Deutsche Bank with the ex-TMB management team and Oakwood, headed up by the former managers at BM Solutions, have yet to announce their products and start lending. Victoria, Beacon and Unity are all lending in the non-conforming market, with the last two using the distribution strength of packager associations (RAMP and PMPA respectively). Mainstream lenders are also launching into the market – for example, the Derbyshire Building Society launched its ‘Salt’ brand at the end of 2005. Hardly a week goes by without fresh speculation about changes of ownership and the possibility of more specialist lenders coming on stream. From most market-watchers’ viewpoints, this is the sign of a healthy and confident sector.
Peaks and troughs
The smaller new entrants are offering some products at higher LTVs and adverse credit that can fill current gaps in the market. However, they will have to weather the peaks and troughs of business demand and still keep service levels high to retain broker loyalty. Is there room for everyone? Looking at the market conditions for the non-conforming market, this seems more than likely.
The CML does not produce statistics that distinguish prime and non-conforming lending, but business information specialists, Datamonitor, researches and produces annual reports on the non-standard and sub-prime lending market. The latest Datamonitor update on UK non-standard and sub-prime lending, published in November 2005, estimates that nine million people in the UK fall within the definition of ‘non-standard lending’. This definition is: ‘An individual who is systematically refused credit from mainstream lenders (banks, building societies and large finance houses), whatever the size and nature of their application.’ This will include those who have difficulty proving their income and those with a chequered credit history, across all secured and unsecured lending. The market for non-standard secured lending (first and second mortgages) is estimated to have reached £41.2 billion in 2004
The non-conforming mortgage market caters for people who have had credit problems in the past, and these problems can be caused by a number of factors. As a nation we now have over £1 trillion of secured and unsecured debts – that’s around £23,000 for every adult. Although in general this debt is being well serviced, it is estimated that any rise in interest rates could cause arrears and bad debt to escalate. The Registry Trust has reported that CCJs in the first half of 2005 rose by 57 per cent over the same period in 2004. Repossession orders reached a level of 32,000 in the first six months of 2005. IVAs and bankruptcy are both rising substantially with Grant Thornton predicting 66,000 bankruptcies in 2006. Pricewaterhouse Coopers estimates that 6 per cent of consumers owe more than their entire gross salary in unsecured debt. They also researched the 1,257 IVAs registered in July and found that 75 per cent of these debtors cited living beyond their means as the cause of their difficulties
Unemployment is on the rise, with 72,000 more people out of work in the three months to October 2005 bringing the total number of unemployed to 1.49 million.
Sudden unemployment for debtors with little or no savings and possibly under-provided with payment protection insurance could begin to see a rise in people starting to encounter credit difficulties. Divorces are also at their highest level since 1996, reaching more than 167,000 in 2004. When relationships split up, the individuals who formerly shared accommodation and living expenses have to pay the full cost themselves. Divorce is therefore another situation in which people become vulnerable to credit problems. In addition, high levels of debt are not confined to those of working age. Figures from Age Concern Enterprises show that UK residents over the age of 65 owe £8.4 billion in mortgage, loan and plastic card debt.
Appetite for debt
Looking to the future, the appetite of UK borrowers to incur high levels of debt, and the likelihood they may experience difficulty in managing it at some point, indicates there will be a market for non-conforming products for the foreseeable future.
Competition among lenders in an expanding marketplace should ensure a good supply of innovative and competitive products to fit the majority of credit profiles. IT improvements are enabling lenders and brokers to offer wide product choice and excellent service to customers, offering them a mortgage ‘experience’ that’s probably faster and less stressful than ever. Putting all this together, the picture shows that non-conforming lending via intermediaries is in a very healthy position and should continue to grow well in a moderately stable property market.
John Prust is sales and marketing director at SPML
