Alex Broad: Regarding pricing for risk ‘ are lenders becoming more sophisticated or are they taking more risks as the market becomes more competitive?
Peter Beaumont: Some of the newer entrants to the market are possibly not pricing for risk at this point through lack of experience. I think the danger of the hyper competitive market we are in at the moment could lead to lenders throwing the risk/ reward principal out the window or certainly not considering it as they should.
Brian Pitt: I think pricing for risk is a philosophy that ought to be adopted across the whole market place, pricing for risk in other industries is well established and has been for a number of years. With buildings and contents insurance and car insurance, risk pricing has always been inherent and I think the quicker the mainstream lenders start applying the principle across every borrower, the better.
Jeremy Duncombe: In the last few years there have not been any real losses to speak of. When times change is when you will find that pricing for risk and risk/rewards will be given the right of way.
Peter Beaumont: As and when it changes, it may well be that the risk/ reward principle has remained sound all the way through. And I think just to do it to try to gain market share means in the short term you will have some gains, but in the long term there is going to be a price to pay and it should be remembered by all.
Jeremy Duncombe: In the long term, it has to be sustainable. All of us want
to be here several years down the line so we have to make sure we are making sensible decisions now.
Ray Boulger: Long term in the sub-prime market is different to long term in the mainstream market. My understanding is that the average length of a sub-prime mortgage is between two and three years, and therefore while you could argue that with most clients you can take a shorter term view rather than long term. From a broker’s perspective I am happy to let lenders fight it out and we’ll help our clients find the best deal.
David Connolly: At Mortgage Express we have only just recently entered the
sub-prime market and we are looking to retain customers certainly over two or three years.
Brian Pitt: We have been operating in a very positive economic cycle, and none of us have had the experience, with our current hats on that is, of seeing a down turn in the market. And I think that there is a real danger of being over-exposed in a market that is going to come back and bite some of us. So getting more sophisticated about measuring the activity of existing customers is going to come increasingly to the fore.
Peter Beaumont: Without doubt our potential investors are drilling down to a level where they have never been before in terms of looking at loss ratio, performance profiles, redemption profiles and there is obvious concern. There is now such a comprehensive bank of data out there that we can get some really meaningful statistics.
Jeremy Duncombe: We do capture a lot more information these days as lenders have a history of five years plus and history of their own statistics. If the lenders were to go and show information to each other’ which is happening ‘ it can speed up the credit scoring. As a starting point you can find out what is a quick path as long as you are using individual underwriters behind that. It is not there yet but the credit scoring can be developed at some point to enable you to do sit on top of individual underwriting.
Michael Bolton: Probably the combination of credit scores ‘ which is undoubtedly around the corner ‘ together with electronic online application process will give a competitive advantage to those lenders that get it first. It will completely change the structure of the market. Frankly the amount of mouths to feed in this market will diminish very quickly on the back of credit scoring and the electronic route. Our view is whoever gets there sooner will grab a huge competitive advantage in this market.
Chris Fleetwood: Do you really think that the electronic route is ready?
Michael Bolton: We have got lenders around this table who are already doing a great proportion of our business. We launch our own over the next month or so.
Brian Pitt: In the business to business environment it is an absolute market winning position. We are currently generating in the region of 38% of all of our intermediary business over the web and I don’t know anybody else that is doing that. It is not business to consumer but as a tool for the intermediary it is proving invaluable.
Alex Broad: What are your thoughts on how the market will shape up in terms of growth, and where will that growth come from?
Ian Balfour: We are keen to see long- term stability in the market place and I think you have to be profitable to do that. The key to the sub-prime market is many lenders are now run by larger organisations who are coming into this market because of profitability, because they are not making the money on the other stuff.
Ray Boulger: One of the key things is that there are a number of less experienced brokers and brokers who specialise in the sub-prime market who will place business into this market, but it could actually have been placed in the mainstream market. So what you define as non-standard depends to some extent on your expertise and your contacts.
Brian Pitt: It is important, and we have probably all had this discussion privately as well as publicly. The non-standard market is not a new market, it has been around since the early 80s. The Bank of America was probably one of the first that came into this market and The Bank of Scotland has
been lending in my definition of sub-prime over the last 20 years, and neither are defined as a sub-prime lender. We all know they do sub-prime lending. So whether the profile of the customer is going to change or not, I believe it is how the lenders interpret the profile of the company. Profile acceptance from lenders has got to change. And a 95% first timer with no credit history has got to be loaded. In my opinion that is where pricing for risk will really start to kick in.
Alex Broad: Do you agree that the boundaries in the sub-prime sector are
blurring and will technology exacerbate this?
Jeremy Duncombe: The boundaries are already blurred. Lenders who have
previously seemed to be non-con- forming no longer are. Some people might move up and down the spectrum as the boundaries are not really there anymore.
Peter Beaumont: I think we are saying we are using technology to identify the quick lend but I do not foresee a situation especially in the next few years where we move away from having underwriters to take accounts of those personal situations. And I don’t see technology helping us out in the short term.
Keith Street: At Kensington we appreciate that most of our customers are around for typically three years and then they move on to other lenders once we feel they have been prepared. We like to talk to the customer, and what is important to us, is not the level of judgement but the circumstances surrounding them. A machine cannot do that for you and I am not sure that will ever be fully utilised.
David Copland: It can help but what we are finding with a lot of lenders is that they are using credit score for the cases that fit easily. They are using underwriters to actually underwrite now. It’s a smart move.
Peter Beaumont: It is actually understanding what mix provides the real risk and somebody that could look a little unattractive a first glance and actually statistically could still be a good risk. You only get that with a lot of experience and a lot of data analysis from years of lending. If you do not have this then you are going to fall foul.
Chris Fleetwood: Surely the risk is in the eye of the beholder. We talk about risk and prices of risk but no ones actually told me what that risk seems to be. If you have a customer who is a bad payer, is he a bad payer because of circumstances or is he a bad payer because he is just congenital bad payer? The idea of credit score works fine in practice until you try to take the individual’s circumstances in account. And if we go down the line which says everything is going to be slightly more mechanical you are in danger of tarring everybody with the same brush. Therefore you have got a self perpetuating problem with the non-standard individual.
Brian Pitt: We do not want habitual non- payers but to say that nobody is doing it, is not true. What is the non-status product, if that is not what it is?
Alex Broad: Will there be specialist lenders in the future or will more mainstream players just widen their product offerings?
David Copland: I cannot see them taking over. The only way they are going to be able get into that market is if they bought out or merged with another organisation.
Jeremy Duncombe: Where the changes are happening is where lenders are moving into the niche markets which includes self-cert, buy to let and non-conforming lending. Not eveyone will choose to go down this route but
this is where you will see a difference because there will be stockpiled lenders and specialist lenders working side by side.
Brian Pitt: You have to remember where are all our roots are. It was because the mainstream lenders were ignoring 25% of the populace by saying we will not deal with contract. If you are self-employed, we will need to take three years of audited accounts. If you have multiple jobs we will only take one into account. This was the market that allowed us to begin.
Ray Boulger: But now contract workers are a classic case in point. There are
several mainstream lenders who are happy to take contract workers that they probably would not have looked at three or four years ago.
Brian Pitt: So if you take this to its logical conclusion, in a growing market place they will always use mainstream criteria. When the market turns, which undoubtedly it will, the first people in my opinion who are going to start retracting will be us. We are going to start pulling things back, before the mainstreamers do. But where will we be able to pull back to? All that will happen is another opportunity for a new entrant who can cherry pick another part of the market and away the cycle goes again. Lenders have to be very conscious of getting borrowers in the right bucket in terms of margin, where they fit in terms of risk profile and this has not been happening.
Alex Broad: When is it likely to start?
Chris Fleetwood: The lead has to come from the lenders. A lot has been said about the responsibility placed on brokers and packagers but you only have to look at the marketing literature of some of the lenders to see that a lot
of it is aimed at the lowest common denominator. Frankly there has got to be some amount of responsibility taken by everyone around this table.
Ray Boulger: I agree, it could be very interesting when the Financial Services Authority starts regulating mortgages. I am particularly interested to see what lenders put on the negative side of the equation in terms of what they think their down sides are.
Brian Pitt: We are a 100% intermediary lender and it would be bizarre of me to not support that intermediary channel, whether regulated or not. Regarding customer retention, if pricing for risk started at libor flat or bank base flat and went up from there then there is no reason why any of us should not be able to start with a high risk borrower and manage him down that spectrum. However, it is the broker’s duty to get the best deal for his customer. The challenge for us all is how will you manage those relationships sufficiently to try and hold the customer for as long as possible, give him the best possible rate, affecting the profit and loss for us and supporting the intermediary? I don’t know what the answer is to that, but it is a difficult one.
George Dodds: Could ongoing credit scoring help? If you actually got a database of clients reviewing them on a regular basis, you could pass them on to a prime lender or vice versa ‘ would this help?
Ray Boulger: It depends on what assumptions you make. If you make the assumption that they will be in a position to walk in two years time, then if you build that into your model, you should be able to put out a product.
However, if you keep the customer for two years and do not pay another procuration fee and offer them an arrangement this will give you a profit but is it good enough to keep their business?
Ian Balfour: You have got to educate the market to understand what the product is about and again if you have a problem, you know it has to be known that it has to be paid whatever that margin is.
Ray Boulger: A lot depends on the individual. Because they have a perceived problem it will be more difficult for them to move on. Providing they make all the payments on time for two years or three years depending on what the deal is, they will then move onto a better deal but you would probably have quite a few borrowers who would not realise that they actually could move on.
Brian Pitt: There are various ways you can ‘tease’ the client and it is a fact that more products propositions they have bought from you, the better the chance you have of keeping them. However, there are not many of us around this table who have borrowers we know that have links to a credit card, current account, savings account and investment bonds. We are specifically in this market for one reason only and if you take it to this logical conclusion, yes we would all like our customers to stay for a certain amount of years but they are not going to. While we have got intermediary markets that are supposed to be looking after the clients which is absolutely appropriate, the broker should rebroke the deal. And I have got no problem with that.
Peter Beaumont: If we go back to redemption penalties, we have two year redemption penalty prod- uct at the moment which consequently is priced a
little higher and it is flown out of the door. Part of the reason is, we are quick to point the finger of blame at the broker, but actually the clients have some say in this and what they are saying on that product is they accept the higher rate. We do not need to change our distribution strategy at the moment. The online risk and credit score ‘ this is the only route where we will move a wide range of volume.
Alex Broad: What do you think will be the driving forces in the next 12-24
months -‘ the threats or opportunities?
Peter Beaumont: You will see continued rapid growth in this market. I think at some point the debt bubble will come home to roost which will further expand the size of the market. We have to make sure we do not do anything for short term gain that we will pay the price for in the longterm.
Michael Bolton: The old sub-prime approach is virtually dead in terms of margin and acquisition cost. Over the next 12 to 18 months I think you will see a twin track approach to the market continuing to widen.
Chris Fleetwood: Thank God for free trade. As long as there is a choice then I think most borrowers will benefit, sub-prime or not.
