The battleground is now ‘near-prime’, accounting for approximately 60 per cent of specialist lending. But is this moving to prime? How will specialist mortgage lenders compete with the mainstream?
While it had existed in a more shadowy and lesser form for many years previously, the accepted wisdom is that specialist mortgage lending started in the UK in 1995. It was not known as ‘specialist lending’ at the time. That came later. Although to the frustration of those of us who have seen the sector mature and evolve beyond all expectations, its original tag and stubborn misnomer – ‘sub-prime’ – continues to hold currency with too many otherwise well-informed commentators.
Whether we describe it as specialist, non-standard or non-conforming lending – all far more accurate descriptions – we generally understand what this means, i.e. lending to individuals likely to be refused credit by mainstream mortgage or loan providers.
Its modern origins can be traced back to the recession of the early 1990s. This saw thousands of individuals lose their jobs, businesses and, in many cases, homes. However deep and traumatic it was for some, the effects were not particularly long-lasting. Reacting to the monetary liberation brought about by Britain’s exit from the Exchange Rate Mechanism, rates soon dropped to lower levels. This fed through to the wider economy and had a positive effect on overall growth, confidence, employment and prices.
Recognising the
opportunities
While recovery was swift, the recession left in its wake a large number of individuals with blighted credit histories. Where once they had been impeccable, many now possessed records tarnished by mortgage arrears, defaults, county court judgments and, in some cases, bankruptcy orders.
A new generation of entrepreneurially-minded lenders were quick to recognise the opportunities on offer. Many, if not most of the recession’s economic casualties, were not the serial defaulters or borderline impoverished borrowers of the past. They were victims of circumstances that, in many cases, were simply beyond their control. Given the opportunity, they would once again get their financial lives back on track. The specialists, bringing a different approach to risk assessment, were prepared to offer this opportunity. In contrast, the mainstream providers, many of whom had been badly hurt by the recession, remained open only to those mortgage and loan borrowers able to satisfy their more conservative lending requirements.
The non-standard population at this time was reckoned to be between eight and nine million. This was a sufficient pool to get the specialist lenders started and consumer demand for non-conforming products, i.e. those designed for borrowers with medium to heavy adverse credit records, was high. Many consumers saw this as their route to what we now call ‘credit repair’. A growing economy and rapidly rising house prices helped them achieve this, while also making the specialist lenders’ more adventurous business models viable and sustainable.
Hand-in-hand with economic recovery came significant shifts in social and demographic patterns. These included a move away from the job-for-life model to more flexible contract-based employment, a resurgence in the self-employed sector, rising divorce levels and the growing appeal of property as an investment opportunity. Given their attitude to risk and the nature of their intermediary-based partnership models, the specialist lenders were better able than their mainstream counterparts to take advantage of the opportunities this offered.
As a result, the specialist sector has opened up beyond its non-conforming roots to cater for a range of individuals from those with light through to medium and heavy adverse credit histories. Within these broad-brush risk categories, lenders can accommodate specific borrowing needs including purchase, remortgages, self-certification, buy-to-let and right-to-buy. This has helped the sector grow to a size where it is believed to be worth in the region of £30 billion annually, or between 9 and 10 per cent of the overall UK mortgage market.
One step further
In recent months, however, it has become evident that the sector has taken a further step in its evolution. As before, this is largely in response to changing economic and demographic circumstances, and has created a position whereby specialist and mainstream lenders are increasingly competing in the same space for market share.
The initial impetus for this came a few years ago when a number of UK-based mainstream providers recognised the benefits offered by a maturing and stabilising specialist market – including improving customer quality, higher margins and liquidity efficiencies through securitisation. This encouraged some of the more far-sighted players to make acquisitions to add to their traditional retail-based propositions.
This led many commentators to believe that the mainstream sector would ultimately absorb its younger specialist counterpart, a view given credence by the onset of statutory regulation and the inherent additional burdens it would bring. And while it is true that the contemporary specialist sector is characterised by the emergence of new lenders – usually backed by global financial services businesses – the key indicators suggest that the UK mortgage market will continue to be polarised.
Some might be surprised by this given the emergence of ‘near-prime’ as the new battleground for mainstream and specialist providers. Defined as serving the needs of consumers who fall between prime and pure non-conforming lending, near-prime borrowers are a growing population and the creation of a society in which debt is both prevalent and accepted.
Typically, a near-prime customer will have avoided serious debt problems but will have a minor, usually past, blemish on their credit record. Anecdotal evidence and our own experience strongly suggest that near-prime now accounts for upwards of 60 per cent of today’s specialist lending market. Given its lower risk profile and the portfolio quality advantages this brings, it is small wonder that near-prime bridges the mainstream-specialist gap for mortgage lenders keen to grow volumes and market share.
Gaining the lion’s share
But which of the two lending sectors is best placed to win the lion’s share of this important market? Equally, does the growth of near-prime signify a further and imminent shift to prime and, as a result, the demise of niche lending? A quick look into recent events can help us find the answers to these questions.
Some traditional lenders have clearly shown an increased appetite for risk by moving into specialist lending. These include the Derbyshire, Cheshire and West Bromwich building societies. Others, however, have been less bold preferring instead an indirect approach. These include Northern Rock and Alliance & Leicester, both of whom have formed affinity relationships with established specialist lenders. In the meantime, banking giant Royal Bank of Scotland (RBS) has ruffled feathers by remarking that intermediaries – a traditional source of specialist business – represent a less important channel than its own branch network. The jury could therefore be said to be out regarding just how hungry mainstream lenders are to get involved with niche lending.
On the other hand, an increasing number of specialists are choosing to get involved in the prime sector. They see opportunities arising from consumers with clean credit records but whose lifestyle circumstances preclude them from mainstream borrowing. They will helped in this by advances in technology that include online offers and automated valuations. However, it would be a step too far to suggest this represents a ‘reverse takeover’.
Significantly, recent market data confirms that an increasing number of households and individuals are struggling with their debts. While keeping this in context and ignoring the histrionics of certain parts of the national press, it is serious enough to warrant a re-appraisal of current attitudes, needs and processes. It is also likely to cause many lenders inexperienced in specialist lending to re-assess their position.
In doing so, they may be missing out. Datamonitor recently reported that 2005 was a turning point for the non-standard population, with 9.1 million individuals refused credit by mainstream lenders. Using neutral forecasting, Datamonitor believes the size of this population will increase to nearly 9.5 per cent by 2010. Using pessimistic forecasting, this rises to 9.87 million. Given the recent surprise hike in interest rates, rising personal insolvencies and the amount put aside for bad debts by the big banks, the pessimistic forecast is looking the more realistic of the two. However, and as confirmed by Datamonitor, experienced specialists, buttressed by increasingly sophisticated and reliable risk assessment and account management techniques, are more likely to see this as an opportunity than a challenge.
These and other developments point to a continuing polarisation in the mortgage lending sector. There will inevitably be areas of cross-over, including prime and near-prime, but providers of mainstream and niche products will continue to operate predominantly in their respective comfort zones for the foreseeable future. This is not to suggest that it will be boring. Far from it, as I expect the new opportunities to continue to attract new entrants, fresh thinking and continuing inspiration.
