It is easy to forget that, prior to Kensington’s entrance into the market in 1995 as the first UK-based provider to get into sub-prime, consumers failing credit scores had few options. Now, as the number of non-conforming lenders has increased, the market has gone from strength to strength.
Figures from Datamonitor show the non-standard market has almost doubled in value over the past five years, from £7.8bn in 1998 to £15bn at the beginning of this year. And Platform says it expects the market to grow by at least 25% this year as a result of the continued growth in consumer credit.
Guy Batchelor, sales and marketing director at Platform, says: ‘There are more and more consumers failing credit scores because consumer credit is so high, but back in the early 1990s they would have had to go to a loan shark and pay huge rates.’
The development of big participants such as BM Solutions, the specialist lender of the Halifax, Platform, the intermediary lending arm of Britannia, and GMAC RFC has driven the market on and helped narrow the difference between prime and sub-prime rates. And now even some mainstream lenders are offering more innovative sub-prime loans through specialist-lending arms or by forging reciprocal arrangements with existing players. The most recent example is Bristol & West and Mortgages plc who have just agreed a deal that takes sub-prime further into the mainstream, with Bristol & West to sell sub-prime mortgages under its own brand as part of a through-lending arrangement.
Although these new products are sold under the Bristol & West brand, very little of the lending appears on Bristol & West’s balance sheet. Peter Beaumont, sales and marketing director at Mortgages plc, says the specialist underwriting and funding nature of sub-prime means the big mainstream lenders are still likely to prefer to work with specialists such as Mortgages plc rather than establish their own operations. ‘We are going to see more deals like this between lenders. There is a definite benefit of forming this type of alliance to leverage each lender’s particular skills and strengths,’ says Beaumont.
The sub-prime market has been characterised by continued innovation over the past year. Sub-prime products are starting to look more like their mainstream prime counterparts as the big players compete to offer discount and short-term fixed mortgages, with loans to value of 95%-100%.
Although sub-prime mortgages are still more expensive than high street mortgages, the differential between average prime and sub-prime rates is now about 1.5%-2% compared with around 2%-3% just a couple of years ago.
Indeed one recent announcement saw packager Pink Home Loans, in partnership with BM Solutions, launch a new sub-prime range with rates starting at just 2.74%. The menu style product tracks the Bank of England base rate with a discount of 1.76% for three months and a maximum loan to value of 95%.
And David Hollingworth, mortgage specialist at London & Country, predicts competition will get even fiercer in sub-prime. ‘In higher margin areas such as sub-prime the market is bound to get more competitive. When there is a bit more margin to play with there will undoubtedly be more pressure on interest rates,’ says Hollingworth.
In particular competition has increased in the credit repair or mid-prime area, with more lenders offering rates as a stepping stone between full adverse and prime deals. Michael Clapper, managing director of Enterprise Homeloans, says: ‘There has been a broadening of product ranges into the lighter adverse sector of the sub-prime market. A move to pricing for risk by some lenders has removed some of the market’s anomalies.’
Platform, which also serves the prime market under the same brand, says its pricing now reflects the whole spectrum of adversity, from someone with just one county court judgement against them to someone at the further end of the spectrum who has previously been declared bankrupt. In practice it means that the more adverse credit, the higher the interest rate charged and the lower the loan to value offered. But the rapid development of the market means that pricing is no longer the key.
‘In general, pricing has become much more uniform and lenders have differentiated themselves by the quality of service offered, including sales information and staff, accurate and consistent underwriting, and responsiveness in helping intermediaries develop their business,’ says Clapper.
As margins have been squeezed in the mainstream market, the higher procuration fees in sub-prime have attracted more mortgage brokers and IFAs ‘ these range from 0.5% to 1% compared with just 0.35% for high street loans ‘ but these are now falling too due to basic supply and demand economics.
Peter Stimson, head of product development at GMAC RFC, says: ‘It is less profitable than it was but profitable nonetheless ‘ unlike the mainstream market where there is hardly any money to be made nowadays. Much of the perceived stigma of dealing in the sub-prime market has disappeared. I feel sub-prime is going in a similar direction to self-certification, in that when it first emerged it was often viewed as a specialist niche. Sub-prime is now a category that most brokers are comfortable operating in.’
A big change over the past year has been a jump in the number of IFAs getting into sub-prime. Batchelor says: ‘Life and pensions’ IFAs are doing business through us that previously would not have happened. Pressures on IFAs such as the poor state of investment business means they are looking for an alternative investment stream.’
The 2003 Sub-Prime Mortgage Report, commissioned by Preferred Mortgages and carried out by the Survey Shop, suggests that the level of sub-prime business carried out by intermediaries over the past year had more than doubled. The survey of 512 mortgage brokers and IFAs found that 57% had significantly increased their activities in the sub-prime market while 68% expected to be more active over the next 12 months.
These findings are bourne out by Towry Law Mortgages, the mortgage arm of IFA group Towry Law, which launched a new service earlier this year called Credit Assist aimed at finding the best deals for those with credit problems. The service aims to place business with a mainstream lender for those who would normally have to approach a sub-prime lender.
While the overall level of mortgage lending has slowed down compared with last year consumer credit, including credit card borrowing is at historically high levels. Bank of England (BoE) figures show that consumer credit grew by £1.7bn in May, which was 14% higher than in May 2002. This increase has been accompanied by a rise in the number of individual insolvencies which indicates that there is still plenty of development left in the market. BoE figures show there were 8,103 insolvencies in England and Wales in the first quarter of 2003, an increase of 11.9% on the same period in 2002.
Platform says the majority of its sub-prime borrowers have suffered life-changing events such as divorce, illness, insolvency and redundancy. Many did not have adequate mortgage payment protection insurance in place on a previous loan.
But given the increased enthusiasm from intermediaries for sub-prime and its wider acceptance, mainstream lenders have showed more willingness to promote sub-prime through their own brands. The soon to be rebranded specialist lender Britannic Money, for example, now offers a flexible mortgage for credit-impaired clients. And HSBC, which has recently acquired US sub-prime lender Household International, says the acquisition has given it new insights that could prove useful should it decide to get into the UK sub-prime market.
‘Prime lenders have tended to use subsidiary brands to promote sub-prime products but now I do not think that there is really too much risk for a lender’s brand to enter this area,’ says Hollingworth and new regulatory pressures are also expected to favour the bigger players, who can cope better with the demands of greater transparency and capital adequacy. In CP186 the Financial Services Authority (FSA) indicated that it wanted more transparent, lower sub-prime fees. The FSA has also warned that packagers involved in correspondent lending arrangements face increased regulation, a factor which is also likely to shake out the smaller players who are less able to meet capital adequacy and transparency requirements.
This has already caused changes and earlier this year GMAC RFC purchased High Street Home Loans, which had previously been selling GMAC RFC funded sub-prime products.
The CML has also cited European regulation arising from the Basel II Capital Accord as another factor that could push smaller players out of the sub-prime market with lenders compelled to price products more transparently in relation to risk.
Scale helps the bigger players to price sub-prime products according to individual risk adversity.’The survivors will be the low cost providers who utilise the best in technology to deliver competitively priced products,’ says Matthew Grayson public relations manager at BM Solutions.
But as long as sub-prime remains more profitable than prime, more intermediaries will be attracted to the market. And while regulation is predicted to eradicate ‘excessive’ fees from the market, fees on sub-prime cases are always likely to remain higher than prime cases due to the increased complexity of the issues involved and correspondingly higher workload.
Credit-impaired loans are looking increasingly like prime deals with many rates just 1.5%-2% higher than the high-street.
Future developments in the credit impaired sector are expected to focus on credit repair and mid-prime.
High levels of consumer credit are leading to more insolvencies and a growing credit-impaired market.