The fortunes of the sub-prime mortgage market have tracked those of the prime mortgage market in recent years and both have grown substantially. Market analyst, Datamonitor, estimates the non-standard mortgage market was worth more than £15bn in 2002, up from £7.4m in 1998. Its report, Non-Standard and Sub-Prime Lending 2003, found the non-standard population decreased in size from 7.9 million to 7.8 million between the end of 2001 and the end of 2002, and since 1998 this number has decreased in size from 8.2 million. Yet, despite this decline more than 21% of the UK adult population can now be classified as non-standard.
However, one slight problem with accurately defining the size of the sub-prime market is in the definitions themselves. Datamonitor defines a non-standard borrower as ‘someone who is systematically refused credit from mainstream lenders (banks, building societies and large finance houses), whatever the size or nature of their application.’
Therefore, Datamonitor’s definition of non-standard includes borrowers classified as sub-prime but also includes self-certification, which makes it hard to define the actual size of the sub-prime market, as it is debatable whether self-certification mortgages would still be considered sub-prime.
Richard Hurst, communications manager of Future Mortgages, says; ‘Self-certification is a niche or non-conforming sector in its own right. People can have a perfect credit history and still need a self-cert mortgage. But you can muddy the water with a self-certification sub-prime mortgage. The same goes for buy to let.’
Nick Baxter, director of network Mortgage Promotions, is in complete agreement. ‘With a higher proportion of people self-employed or working on a contract basis these days, without any adverse elements self-cert could not be considered sub-prime, just a niche,’ he says.
Nevertheless, Datamonitor defends its decision to include self-certification mortgages within the sub-prime definition. ‘Despite the growth of financial services products aimed at the self-employed, most evidently self-certification mortgages, self-employment remains a barrier hindering access to credit offered by mainstream providers. The Chancellor Gordon Brown…has recently introduced tax concessions that should increase the attractiveness of self-employment,’ says Alex Boorman, financial services analyst at Datamonitor and the author of the report.
As it stands it is difficult to estimate the exact size of the sub-prime market, but some industry experts put it at between £10-12bn.
Recent years have been characterised by the entry of the high-street brands into the sub-prime market, mainly through acquisition. However, the greatest movement in the market in the past year was probably the merging of Verso and Platform Home Loans to form Platform, however, both were already experienced in the sub-prime market. And in 2002, if anything the sub-prime market has moved towards the prime as lenders stretch their product ranges upwards into standard territory. Hurst says: ‘It is much easier for a sub-prime lender to shift its product base upwards, rather than a prime lender moving into sub-prime. Hence prime lenders buying sub-prime lenders. Those that attempted to create them organically have problems. Over the next twelve months you are going to see the sub-prime lenders offering nearer and nearer prime products. We [in the sub-prime market] are expanding into their market because they have not been terribly successful in expanding into ours.’
However, the boundaries between the markets are definitely beginning to blur. A good example is Chelsea Building Society, which has successfully moved into sub-prime territory. Its range of impaired credit includes ‘Scheme 4,’ which allows up to eight county court judgments (CCJs), provided they were not made in the last six months and up to six missed payments in the last 12 months, but again not the last six. Until recently, this would be seen as a sub-prime product in many intermediaries’ eyes, but not Chelsea’s.
Jeremy Hicks, corporate affairs controller at Chelsea Building Society, says: ‘Sub-prime lending is a skill, but the lending we do is nearer to standard lending in outlook.’
He explains the sort of people the Society lends to are no longer in the problematic situation that caused the adverse credit. ‘We look at it as a standard lending situation, with similar credit scoring and income multiples. The main issue is what type of problem the customer has had in the past and how well they have got over it. As for the real sub-prime market, our view would be to leave it to the specialists,’ he says.
It is perhaps logical to consider the boundaries as blurring when you look at the rates under offer. The difference between sub-prime rates of interest and a standard prime rate has converged in the last year. For example, Chelsea’s Scheme 4 only has a penalty of 1.75% over the standard variable rate (SVR).
However, few expect the differences to disappear altogether. Hurst admits: ‘This expansion is as close as it will ever get; you have to keep some element of margin. When base rates were higher there was historically a bigger margin between prime and sub-prime, but sub-prime lenders have got much better at pricing for risk. They are breaking sub-prime down into lots of different categories, so the lighter adverse can nearly take a prime rate.’
Underwriting in the sub-prime market is based on experience. Five years ago, rates were higher because lenders were not experienced, but today they are making more informed decisions on the likelihood of what a borrower is going to do.
Baxter says: ‘This is probably as near as the two types of rates will come, lenders still need to price for risk. They have been forced too near parity by the hunt for market share and competition. I have noticed sub-prime lenders moving more into areas of prime lending, but I am not sure the margins are there to satisfy their appetites.’
However, the innovations keep happening and this problem between the two sides of the divide may eventually be overcome. Mortgages plc is to set up a ‘Mutual Co-operative,’ allowing regional building societies to originate margin business in the credit-impaired sector. The lender hopes the move will allow it to compete with those large mainstream lenders looking to move into the light-adverse sector, and widen the lending criteria of the regional building societies.
Peter Beaumont, sales and marketing director of Mortgages plc, says: ‘The Mutual Co-Operative is a classic example of true partnership. We have the distribution base and expertise to originate margin-positive business, and the building societies have an opportunity to collectively design and control the exact profile and volume of business they want on their books.’
Bending the rules
There are a growing number of lenders willing to stretch their criteria; not to the extent they are pure sub-prime, but they are willing to lever people into products.
Hicks says: ‘If it is a good enough case, then we should consider anyone, provided we have gone through correct underwriting and the case stacks up in its own regard. But we do put limits on the amount of flexibility we can use in a quarter.’ There is no doubt sub-prime underwriting is still a specialist skill involving a different mentality to prime. Those prime lenders who have entered the market thinking it is not have, in general, been given a fairly severe wake-up call.
‘We have individuals looking at cases and put a lot of emphasis on our duty of care towards affordability, it is possible to be technically within criteria for a product but the affordability just does not add up,’ says Hurst.
CCJs are perhaps the attribute most commonly associated with sub-prime borrowers. Because a CCJ remains on file for six years, both the number of CCJs registered and recorded annually impact upon the size of the sub-prime population. The most recent year for which data is available is 2001, when 700,000 CCJs were registered and five million were on record. Both figures are much lower than previous years. In 1995, 1.2 million consumer CCJs were registered and 8.5 million were on record.
Boorman says: ‘While attributing importance to favourable economic conditions as a driver of the fall in CCJs registered and recorded, other factors are also at work, mainly a change in the way that creditors pursue debtors. In recent years more emphasis has been placed on conciliation and negotiation than pursuing debtors through the courts. As a result more consumers are able to avoid acquiring CCJs by negotiating with their creditors.’
Drivers of the non-standard population in 2002 included the wider economic situation, mainly the historically low point of interest rates and unemployment, which is around 1.5 million, and dropping. Subsequently arrears and repossessions have fallen. Datamonitor figures show repossessions after the first six months of 2002 at 6,860 compared with 16,980 after the first six months of 1997. However, penetration of mortgages within the non-standard population remains considerably lower than within the population as a whole. Datamonitor estimates at the end of 2002 19.8% of non-standard households owned their property with a mortgage relative to 43.3% of the population as a whole, which gives plenty of room for growth even if the margins are becoming less distinct..