As margins on mainstream mortgages are squeezed tighter and tighter, it is no surprise that all eyes are now on the sub-prime market. With some new loans having to be held for six years before they become profitable for the lender, lenders are being forced to consider higher risk lending where margins are bigger.
‘All the high street lenders are suffering from the negative margins on new lending and this is hurting them. They need to look at new sectors where they can make some money,’ says Paul Howard, sales and marketing director of Mortgages plc.
Two years ago, Bristol & West became one of the first high street lenders to test the sub-prime waters and now Halifax, via its subsidiary Birmingham Midshires Solutions, is gearing itself up for a full-scale entrance into the market.
Cheltenham & Gloucester has announced that while it has ‘no immediate plans’ to enter the sub-prime market it is entering the non-conforming market, with the launch of a 100% and self-cert loan under its own brand. An unusual move, when you bear in mind that most mainstream lenders usually enter these markets under the guise of a subsidiary.
Other lenders are entering the market through acquisition, for example, the acquisition of Platform Home Loans by the Britannia Building Society.
But it is not just lenders that have their eyes on the sub-prime market. Some of the world’s largest financial institutions are identifying sub-prime as a big opportunity. Only last month, Citigroup acquired Future Mortgages, following the acquisition of i-group by GE Capital only a few months before.
So, what will all this change mean for the broker operating in the sub-prime market?
One of the first benefits is sure to be the raising of awareness that will result from the high street’s entrance. ‘There is no doubt that the high street has a role in the sub-prime market. It will help broaden the market and add credibility,’ says Alastair Pate, head of marketing at Kensington Mortgage Company.
Sub-prime lenders do not have the developed consumer brands of their high street counterparts and as a result the general public has little, if any, awareness of this sector. But the advertising and promotional activities of newer high street entrants could change all this and individuals that did not think they were eligible for a loan, will start investigating their options.
The backing of a strong brand, that is not associated with adverse credit will be an attractive proposition for many borrowers, according to Debbie Staveley, PR officer at Bristol & West, because when they remortgage they will leave their sub-prime past behind them. She says: ‘We aim to get these borrowers back on the straight and narrow and when they remortgage, no-one will know that they were sub-prime because they will still be remortgaging away from a high street bank. If they come from a specialist sub-prime lender the new lender will know they had credit problems.’
But while the high street may have brand awareness on its side, the sub-prime specialists do not appear to be threatened by these new entrants.
Brian Pitt, sales and marketing director at Future Mortgages explains: ‘Sub-prime falls into the specialist market because it requires specialist underwriting and it takes a long time to convert a prime underwriter into a sub-prime underwriter. In the prime market assessments are based on a credit scoring model. But credit scoring does not work in sub-prime ‘ there is an awful lot of ‘gut’ underwriting involved with each case assessed individually and it takes a long time to acquire these skills.’
As a result, there is a concern that declinature rates from these new players could be high. ‘They are going to be more cautious about where they lend,’ says Pate.
This is one criticism that has already been levelled at Bristol & West, according to Pitt. ‘Our intermediaries report that their decline rate is too high and so the range is not popular,’ he says. But Bristol & West attests that this is mainly due to the fact that brokers have misunderstood its lending criteria, that is, that it will not lend to any individual whose debt has worsened in the last six months. ‘The prime reason for rejecting business is the broker submitting cases where the debt is deteriorating. We do not want to add to these people’s problems,’ says Staveley.
There is also concern that these new inexperienced lenders will find it difficult to maintain a consistent approach in a changing economic landscape.
According to Pitt, mainstream lenders have already attempted to enter the market, only to withdraw when the market turns. ‘In the early 1990s, some of the high street building societies relaxed their criteria to beat off competition from the specialist, centralised lenders. They may have taken some of this business, but retracted when the market took a downturn.
However, Stephen Sandiford, head of borrowing products at Birmingham Midshires, says it has overcome these hurdles by ensuring it is equipped with staff already expert in this market. ‘We recognised this could be an issue early on and bought in specialist expertise. We have also introduced specialist systems and a programme of training.’
Likewise, Bristol & West has taken steps to ensure its underwriters are up to scratch. ‘We do have specialist underwriters that were recruited and trained for this. They work away from the rest of the under- writers and assess each case individually,’ says Staveley.
She adds that the lender is also unlikely to make a dramatic exit from the market, should the economy take a turn for the worst. ‘This is because we are already using responsible lending criteria. We have been relatively cautious, but that does not mean we are not committed,’ she says.
In a market where speed is essential, the service standards offered by the high street lenders will also have to match those of the specialists if they are to be popular with brokers, says Pate. ‘If the high street make the broker jump through hoops that the specialists do not, they will not use them. Specialists should give certainty straight away ‘ a same day answer is very important.’
Indeed new players will have to work if they are to crack the broking community. According to recent research from Mortgages plc, only 35% of intermediaries regularly deal with three or more sub-prime lenders, suggesting that many brokers only deal with lenders they are confident with.
However, according to Rob Clifford, managing director of mortgageforce, high street lenders have the potential to shake-up a market that has until now, been dominated by specialists.
‘The sub-prime market has always been depressed by price and credibility and it is this that the high street can deliver easily. The major lenders could sweep up in this market, with massive retail deposits they will be able to price more keenly. Specialist lenders, without a retail deposit base have to buy funds on the money markets to lend and the margins on this are going to be slimmer,’ he says.
As a result, Clifford believes the high street is in a position to undercut the competition in a traditionally expensive sector of the mortgage market.
‘They can afford to be cheaper than the specialists and still make a bigger margin than they can on mainstream lending,’ he says.
Of course in a market such as sub-prime, price is very much a second consideration, with the actual lending criteria of the lender needing to be looked at first. The mortgage rate is irrelevant if the lender will not even consider the application.
What’s on offer?
So, what is actually available on the high street? Lenders such as Bristol & West and Birmingham Midshires will never claim to go as far as specialists such as i-group or Kensington, however, there will always be a demand from applicants with less severe credit problems.
Sandiford says: ‘We believe there are a lot of people falling into the sub-prime market that are not a bad risk. They are not necessarily at the lower end of the income scale and are often professionals that have fallen on hard times or divorcees.’
Birmingham Midshires starts with a loan to value (LTV) of 90% at 2% over bank base rate, accepting two months’ arrears (as long as they are not increasing) and county court judgements (CCJs) up to £5,000 as long as none are from the last six months. This stretches to bank base rate plus 3% with a maximum loan to value of 75%, accepting unlimited CCJs and unlimited arrears. Rates decrease over four years and so by the fourth year the most anyone will be paying is bank base rate plus 1%.
Bristol & West, meanwhile, will accept up to £10,000 in CCJs , unlimited arrears as well as discharged bankrupts. Loans reach 85% LTV and rates start at 5.25% on its discount product and rise to 7.50% and 8% on its two and three-year fixed rate loans. All rates revert to base rate plus 1.75% after two or three years.
Staveley says prices are so low because the lender will not take on any applicants who’s situation is not stable. ‘We price according to risk and we do use tight criteria ‘ so we have very low arrears.’
Only time will tell the impact the high street has on the sub-prime market. But the additional choice and consumer awareness that the high street will bring can only be good news for the market. Yet it is unlikely that either the high street or the specialists will lose their place in the market.
The high street may have their brand and price advantage, but with companies such as GE and Citigroup taking position in the market, the financial strength of the specialists is growing.
Colin Sanders, chief operating officer at i-group, says its acquisition will strengthen its proposition considerably. ‘GE means stability, long-term planning and more financial strength. For example, we no longer need to securitise to get funds,’he says.
Platform has also found that acquisition is helping it price more competitively. ‘The acquisition gave us a parent that is a committed and long term player in the market ‘ this reduces our cost of funds dramatically,’ says Guy Batchelor, sales and marketing director for the lender.
The chances are the market will follow the lead of the buy-to let market. A few years ago that market was dominated by specialists, but now the majority of high street lenders will consider buy-to-let applications ‘ yet the specialists do not seem to have suffered as a result.
Those with only slight credit problems who have been back on track for some time may be better accommodated by the high street. Yet those with more complex requirements or those whose finances have only recently improved may be better served by a specialist, whose years of experience in the sub-prime market enable them to take a less cautious approach. With the number of sub-prime borrowers growing and each with their own set of needs, there will always be room for both.
High street lenders are able to raise awareness of the sub-prime market and improve its credibility.
Declianature rates in the high street may be high as they have less underwriting experience.
High street lenders with retails deposits may be able to price more competitively than specialist lenders.