It is clear that there are a number of forces at work, shaping financial services companies. Globalisation, regulation, customer relationship management, IT and consolidation are just some contributors.
Consolidation is perhaps the most visible structural change in the financial services industry and it seems likely that this will be mirrored in the non-conforming market.
With one major player having already floated and another having been taken over by a building society, rumours are abound concerning ‘who is next?’ So, what does the future hold for the sub-prime sector?
The market has at last been legitimised, as many people working in the sector have been predicting for a long time. Sub-prime lenders have been at the forefront of discussions regarding regulation and transparency since 1996 and have been keen to promote the intermediary sector, where the majority of sub-prime lending is originated.
The definition of sub-prime has also been clarified ‘ it is not just people that have poor credit histories, as some suggest. This market covers specialist business, such as contract workers, short-term self-employed and self- certification products.
The lines between prime and sub-prime are also beginning to blur, meaning margins are coming down. Virtual prime products have appeared with major players dipping their toes in the sector ‘ resulting in better deals for the borrower.
There are also more opportunities for intermediaries to sell a wider range of mortgages than ever before. This is good news, particularly for intermediaries, where opportunities to sell traditional investment and life products have been rapidly disappearing under a mountain of mis-selling scandals and unwieldy regulation.
The so-called specialist market is now mature enough to warrant attention from some mainstream lenders who see the margin advantages of a pricing for risk model, together with a greater widening of products to help secure and retain more customers. But there are still lenders that are unwilling to be seen in the specialist sector, even though there is no doubt that it is now the fastest growing area of the mortgage market.
The actual size of the specialist sector has not yet been accurately established with various commentators quoting anywhere between £5bn and £25bn. And there is no doubt that there are some lenders who have been lending in the sub-prime sector for years but will not admit it, despite having lent self-certification, non-status or credit impaired products for longer than the sector has been in existence. The reason for this is probably because they are unwilling to be associated with what has been labelled as the risky end of the market ‘ where the borrower profile does not fit with the image of the lender and puts their brand at risk.
But this provides opportunities for newer entrants in the market to expand their own operations, build recognisable brands and perhaps even enter the mainstream arenas.
One thing is for sure, pricing for risk is here to stay in the sub-prime market. A mortgage is the biggest financial commitment most people ever enter, so pricing for risk is set to continue. The widening of product ranges is also essential if the larger players are genuinely looking not just to gain new customers, but retain more of their existing ones.
Now that some specialist lenders have had five years of trading, meaningful analysis of mortgage portfolios is possible. It could be argued that lending in this sector is riskier. But if the underwriting and collections processes are built correctly and these are balanced with additional margins being charged, a successful business model can be established.
An important factor here is that most lenders in the specialist sector do not credit score, but use individual underwriting processes from the first stage. The same principle of individuality is also applied once the loan completes. Customers generally understand that because sub-prime lenders treat them as individuals, they help them to get the loan facilities that mainstream lenders do not offer. In turn, this can often help build a stronger lender/borrower relationship in the longer term. It seems likely that loyalty programmes in the specialist sector will become more prevalent, an obvious example being a reduction in interest rate charging to reward a period of payment commitment.
The average life of a sub-prime loan appears to be slightly shorter than that of a standard loan, but with such a booming remortgage market in the mainstream market, this statistic will soon become irrelevant as more people change their mortgage provider on a regular basis.
So, what about the intermediary? Some commentators have criticised the level of fees paid to intermediaries and suggest an environment has been created that will cultivate the next mis-selling scandal. No doubt there remain some unscrupulous sellers of mortgages that may place mortgage cases with lenders that pay the highest fees without considering the best deal for the customer, but these remain a small minority and ultimately should be caught by regulation whichever way it pans out.
If the Financial Services Authority (FSA) takes responsibility for the advice part of the mortgage sales process, there will be direct sanctions. If, as looks likely in the shorter term, lenders are to take responsibility for that part of the process, then restrictions in the form of smaller panels of intermediaries may become common and lenders’ compliance procedures should eliminate them.
There is great sympathy for the majority of intermediaries who provide a valuable service in the mortgage sales process, but we cannot escape the fact that regulation may well limit the numbers of people active in the market. A number of smaller intermediaries will decide to opt out of the mortgage market as advice givers ‘ ultimately restricting customer choice.
As for the sub-prime sector as a whole, it looks likely the future will hold a number of developments which will work to create competitive advantage. New products will be developed, with a cross over into mainstream lending by some specialist players. Wider distribution strategies should also emerge. To date the majority of specialists look to the intermediary market as the main distribution point ‘ with limited numbers going forward, it seems likely that some lenders will begin to look for alternatives, such as other lender referrals and direct selling.
An increase in the use of technology will undoubtedly form part of the market’s future ‘ whether as a cost cutting communication platform, such as websites and email or as a genuine attempt to try to speed up the mortgage process, with interactive mortgage application and case tracking features.
Finally, the future of sub-prime will be moulded through consolidation. This will come in the form of mergers between some lenders, take overs by existing high street names or even buy outs by new entrants. As a result, a new breed of specialist lenders may be created, who will build on the growth to date and continue to seek out new opportunities to develop specialist markets which are yet to be discovered.
Industry players give their views on the sub-prime market
Bernard Clarke, communications manager at the Council of Mortgage Lenders
‘We are going to see more high street lenders moving into this area of the mortgage market, and more market players should ensure it stays competitive and also give more choice to consumers. There has been a continued decline in the number of arrears and repossessions since the 1990s. Economic growth is continuing and there are no indications that unemployment will rise this year, so as long as the economic outlook remains favourable it should be good news for both lenders and borrowers.’
Guy Batchelor, sales and marketing director at Platform Home Loans
‘Our sector is now different to what it was, even last year, as more high street lenders are entering through already established brands. The sub-prime market is growing quickly because more people, more advisers and more specialist mortgage brokers are aware of the lenders operating in this field. The outlook for sub-prime is good, because it is now more accepted. I think that it is now the fastest growing sector of the mortgage market behind buy-to-let, and we are going to see some more big changes in this sector over the next 12 months.’
Colin Sanders, chief operating officer at i-group
‘We believe that as more acquisitions take place in this market and non-conforming mortgage lenders are being bought by major corporate institutions, the smaller players will find it more difficult to compete. This is likely to produce more competitive products in the marketplace, resulting in a better deal for borrowers.
We have anticipated a number of changes that mortgage regulation is likely to bring about in the medium term. We also believe that mortgage regulation will guarantee that the borrower receives transparency of products and the highest of standards.
Jim Gillespie, director of Independent Financial Services,
‘I have noticed over the past year or two that there are more players comng into the sub-prime market. Whereas before most lenders might have only dealt with squeaky clean cases they are now more flexible in their outlook, which means we do not always have to refer clients to a specialist. It makes sense for larger lenders to acquire sub-prime subsidiaries because they still have the borrowers on their books.
The continued growth of sub-prime is a symptom of the way we live now. It is easier to take on more credit and this means that some people will get into difficulties and there will be more defaults and CCJs.