The UK non-conforming mortgage market will not suffer from the same problems that have caused a virtual meltdown of the sector in the United States, which in turn triggered nerves on global stock markets and sent share prices tumbling worldwide. That’s the response of the UK lenders, brokers and city analysts that Mortgage Introducer spoke to as America’s mortgage woes shifted from the finance pages to front page headlines across the world.
While the growing number of mortgage defaults in the US has hit lenders across the Atlantic hard, pushing a number of banks close to collapse, experts on this side of the pond believe conditions in the mortgage industry and the state of the property market mean that such a major collapse is unlikely to happen here in the UK.
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Ian Giles, director of marketing at Kensington Mortgages, echoes the views of many when he says: “Despite the sentiment on the markets, the UK adverse lending market remains in good shape. It is in all our interests to point out the differences between the UK and the US, and to stay firm.”
A long-time coming
In truth the problems in the United States have been a long-time coming. Last week America’s Mortgage Bankers Association (MBA) released figures that showed late or missed mortgage payments rose to 4.95 per cent in the last quarter of 2006. However, with the US’ non-conforming sector, that figure rose to 13.3 per cent, the worst mortgage delinquency rates since the MBA started collecting records 37 years ago. According to US lenders, repossession actions have started against more than one in every 200 borrowers.
Gina Martin, an analyst with Wachovia Securities, pointed out that as these figures hark back to 2006, the problem is far from over. “Unfortunately, it appears delinquency rates will likely worsen before they improve,” she says. “The delinquency data only reflects the state of mortgage markets as of the end of 2006. No wonder the equity market is unhappy.”
Last week the UK’s FTSE index fell by over 100 points due to fears over the US economy, stoked further by the country’s ailing mortgage market. New York’s Wall Street also suffered, with the Dow Jones falling by more than 240 points, with markets in Japan, Hong Kong and India quickly following suit.
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While some investors have taken the US problem as a sign to get out of financial services across the board, other analysts believe that what is happening in the global market is more of a correction, pointing out that last month there were similar concerns following fears of the introduction of tough new tax laws in China.
What is clear, however, is just how badly US lenders are suffering. Non-conforming lender Accredited Home Lenders Holdings saw its value drop by 28 per cent and then a staggering further 65 per cent a few days later. New Century revealed that it was being investigated by the US regulator after it stopped lending and its shares were suspended, while Countrywide Financial, the biggest US mortgage firm, announced 100 job cuts.
A bullish stance
In the UK lenders remain bullish about their position and the local non-conforming market, suggesting that economic conditions are much worse in the US. Giles explains: “At Kensington we don’t feel the need to worry that this US trend is going to cross the Atlantic. There are several crucial differences between the UK and the US. Adverse lending has grown by 400 per cent in the US in recent years, whereas in the UK is has grown by 100 per cent. In the US rates have risen from 2.50 per cent to 5.25 per cent, which has resulted in a huge increase in people’s monthly repayments in the last two years. It’s not surprising that US borrowers are suffering.
“Also, in the US bankruptcy figures are 600 per cent higher than in the UK and Americans spend 20 per cent more of their disposable income on their repayments, which means they are closer to the edge, their finances are more volatile and there is no margin for error.”
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Giles says that while the UK has seen a dramatic growth in the number of specialist lenders in the last few months, this is nothing compared with the growth of pure non-conforming in America. “Another crucial difference between the two markets is that in the US supply outstrips demand, whereas here in the UK there is more demand than supply,” he says. “US lenders are a lot more aggressive. They make most of their profit upfront – if it doesn’t come in, then they go bust. The UK market is very dynamic and very different to the US.
“US lenders offer much higher loan-to-values (LTV) on adverse loans, usually 100 per cent and sometimes even higher. In the UK the highest LTV will be 90 per cent, and that will be on light adverse, with the average being 80 per cent LTV. In addition, the US market offers low-start mortgages, which mean that the borrower’s repayments do not cover the interest in the beginning.”
The trend for low-start mortgages not only means that US borrowers could suffer from payment shock when the real interest rate kicks in, it also means that lenders are running the mortgage at a loss in the early days. If that loan then does not perform because the borrower defaults, it can be impossible for the lender to make any money out of the customer. Multiply this across hundreds of borrowers per lender and you begin to see where the problems lie. In addition, property prices in the US are falling, so even if the lender repossesses a property, there is no guarantee they will get all their money back.
Regulatory protection
Financial Services Authority (FSA) legislation is a key factor in preventing a US-style meltdown in this country. Giles continues: “Regulations in the UK are stricter than the US, so practices are tighter here. That doesn’t mean that the US is out of control, but it doesn’t have the same controls as we do.
“Kensington has more controls. We undertake AVMs on virtually every property to assess the asset quality, so we can mitigate borrower risk. We also have responsible lending criteria and lenders, along with intermediaries, follow the FSA’s strict compliance procedures.
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“Lender systems are also better here. In the US lenders do not operate direct debits, so borrowers make their repayments by cheque. In the UK we operate direct debt, so if a monthly payment does not go through we are alerted immediately and make contact with the borrower to find out if there is a problem. In the US, if the cheque doesn’t clear, it will be a while before the lender discovers there is a problem.”
Safe and securitisation
If sentiment has impacted on the share prices of non-conforming lenders in the US and the UK, it certainly has not affected the nerve of securitisation investors, those people buying bonds backed by UK non-conforming mortgages. Last week Bloomberg reported swift business for three securitisations: Merrill Lynch, the US bank that owns Mortgages plc and Freedom Funding; Lehman Brothers, another big US bank that owns SPML; and Kensington.
Sales of securitisation so far this year have increased 156 per cent over the same period last year. Miray Muminoglu at Barclays Capital, who handled the Kensington sale, said: “The non-conforming market is in solid shape. There’s no fear of contagion from the US and further proof that the UK is a different market.”
“This is the real proof of the pudding,” Giles says. “Our latest securitisation got the same price as we did 12 months ago, whereas in the US, prices are much lower. This shows that the appetite for securitisations by UK lenders is still high. Sentiment on the stock markets is the issue, but it is important to separate out sentiment from the reality of the situation, which is the continued profitability of UK lenders.”
In the US, GMAC, which operates in both the home and car loans markets and is owned by car manufacturer GM, has reported a fourth quarter loss, losing $651 million in the first quarter of 2007 compared with a $118 million profit 12 months ago.
However its UK business, GMAC-RFC, remains calm. Julie Gaskin, corporate relations manager for GMAC-RFC said: “GMAC-RFC in the UK had a fantastic year in 2006 and we achieved record growth of 75 per cent over the previous year and outgrew the mortgage market average by four times. In 2007 we plan to go from strength to strength.
“The size of non-conforming in the UK market depends on your definition of non-conforming. However, excluding buy-to-let and ‘vanilla’ self-cert, we estimate it’s about 9 per cent of the UK market, which was approximately £30 billion of lending last year. What this illustrates is that there is a wealth of opportunity for lenders to grow in this area, which is why we are seeing more of the high-street lenders starting to move into the non-conforming mortgage arena.”
Gaskin points out that US lenders are working under different conditions. “I am not able to comment on behalf of our US business. However, in general, post-9/11, the US reduced its interest rates to 1 per cent and then increased them 17 times consecutively to their current level. Non-conforming lending in the US is at a higher LTV than in the UK and its low start products have contributed to the problem. These are similar to UK deferred interest rate mortgages and are not readily available in the UK.
“The US property market is struggling as prices continue to fall due to over-supply. In the UK the opposite is happening – we have a shortage of supply and house prices continue to remain steady and increase in certain geographical areas. In the UK we are closely regulated, particularly from a ‘Treating Customers Fairly’ (TCF) perspective. Our non-conforming borrowers in the UK are not of the same profile as the US.”
Calming the nerves
While some City analysts might be running shy of all non-conforming lenders, those with more insight are not so nervous. Maya Imberg, a financial services analyst at market researcher Datamonitor, says: “It is highly unlikely that the UK will suffer the same problems as the US because there is much less exposure to adverse credit in the UK and UK lenders tend to be stricter with their lending criteria. US lenders went after market share and offered credit to high-risk borrowers. UK lenders are more hesitant about the risk they take on.
“The housing market is also very different in the US. Datamonitor feels that one more interest rate is likely in the UK, then it will slowly decline. In the US interest rates climbed quickly and took consumers by surprise.”
Imberg feels that UK lenders should look closely at the causes behind the current problems in the US. She says: “I certainly think the situation in the US sends out a warning and UK lenders should take note of what has happened in the US. Lenders should remember not to just go after customers. UK lenders should also look at their risk models.”
Ray Boulger, senior technical manager at John Charcol, agrees: “There is every reason to think that we won’t see anything as bad as the States over here – but it would be foolish to think that it won’t have an impact on the UK.
“The US is a very different market to the UK. There has been a triple whammy there: property prices have fallen by 9 per cent in recent years; the typical type of mortgage is a short-term, low-rate starter product with very high LTV; and interest rates have increased, at one point they were rising 0.25 per cent every few weeks. People took out a mortgage, then remortgaged on a cheap rate to access the equity. But they can’t do that anymore and now they have nowhere to go.”
Although lending is more tightly controlled in the UK, Boulger believes a combination of higher rates and lower property prices could be dangerous. “If the same conditions occurred here then we could see a similar problem,” he says, “particularly if property prices fell. But I don’t think we will see a fall in property prices – they are only likely to fall if interest rates go up to 6 per cent, but even then, it will only be a problem if they rise quickly and borrowers see repayments soar. ”
An end to the influx?
So does this signal the end of the influx of overseas lenders looking for a slice of the UK’s non-conforming and specialist mortgage sectors? Boulger believes it does, for the short-term at least. He says: “Many of the players in the non-conforming market in the UK are owned or funded by US banks, and these are the same banks that are suffering in the US at the moment.
“They are likely to be reassessing their appetite for other markets now. They could take the view that because of the problems at home it would be a good time to expand into overseas markets, but it is more likely that they will be cautious and not expand in case these conditions spread elsewhere in the world.”
