Bear traps in the newlending landscape

26 July 2010

The Financial Services Authority has released its consultation paper on responsible lending and to all intents and purposes it looks like it has listened to feedback following the publication of the Mortgage Market Review and chosen to largely ignore it, continuing doing what it wanted to do in the first place. Quite why it calls these publications discussion or consultation papers is beyond me as it’s obvious they are anything but.

This latest salvo is prefaced with warm and comforting reassurances such as ’a more interventionist and robust approach’. It takes many of the telegraphed proposals published in the MMR and ratchets them up.

The cacophony of criticism the regulator received at the beginning of the year for effectively lumping self-cert mortgages with the fast-track process clearly fell on deaf ears.

And this is despite its own research highlighting that fast-track mortgages generally perform better than those that are not fast-tracked. There’s also a lack of understanding of how fast-track mortgages worked.

The FSA has chosen to believe that borrowers - or more often brokers - went down the fast-track route because they could not or did not want to provide evidence of income. This is simply not the case.

In most cases, you could not select a fast-track route - it selected you through the decision in principle process, assuming applicants scored highly enough. The flimsy reason the FSA gives for throwing this particular baby out with the bath water is that with smaller lenders fast-track did not work well. I don’t think that revelation comes as much of a surprise to the rest of us.

So with the demise of self-cert and fast-track - which effectively formed half the market at its peak - lenders will be required to obtain more evidence of affordability. Effectively, they will have to assess borrowers’ ability to repay based on factual information and on a capital and repayment basis, as well as building in a margin for potential interest rate increases.

I wonder if the formula also allows for breakdowns in relationships, unemployment, accident or sickness. But the FSA stops short of being prescriptive about the type of evidence that can be used. This ambiguity will make an already nervous lending community even more jumpy and
The FSA has stated that it will hold lenders individually accountable for customers’ ability to repay, so this additional burden will do nothing to foster innovation or flexibility in a lending community already under siege. The regulator cites ease of available credit and inappropriate applicants as the primary reason for the draconian approach put forward in its consultation paper.

The criticism the regulator got for lumping fast-track and self-cert together clearly fell on deaf ears

But much of the mortgage community feels, quite rightly, that the FSA is attacking the problem from the wrong angle.

I don’t think any sensible person would disagree with the proposition that lenders should not lend to borrowers who can’t afford it but in most cases the reasons for default have little to do with clients overstretching themselves.

Research conducted in 2009 highlighted that overcommitment was a factor in only 10% of arrears cases, whereas loss of employment was a feature in more than 40% of cases.

If lenders are to have any clarity or comfort when it comes to lending in the mortgage market the FSA needs to spell out exactly what it expects to see instead of leaving big bear traps around for them to walk into.

Similarly worrying are FSA chairman Lord Adair Turner’s remarks that consumer protection had been inadequate in the past, not only when it comes to lending but also with regard to borrowing decisions. He seems to be encouraging more of a shift towards a nanny state by removing further responsibility from borrowers to be accountable for their actions.

Using phrases such as ’enhanced consumer protection strategy’ and ’intensive day-to-day supervision’ is unlikely to encourage lenders to lend unless they have absolutely watertight cases. And even then, as we have seen in recent times, situations can change, altering the landscape for clients in a heartbeat.

In all this the FSA has missed one important point and that is the cost of implementing these changes. Ultimately, lenders will comply if they want to continue to lend but in most cases they will simply pass on the extra cost to consumers.

Still, as John Charcol’s senior technical manager Ray Boulger so eloquently puts it, borrowers who got used to the nanny state under the previous government will be happy to pay extra to be protected from themselves. Spot on, Ray.

If the past three years have taught us anything it is how quickly circumstances can change so assessing a borrower’s ability to repay a loan in a vacuum is not a solution. Lenders should be looking at customers’ holistic financial situations. They should not simply be assessing the practical issue of repaying the mortgage or future movements in interest rates but also their ability to cope with unforeseen circumstances such as long-term sickness or unemployment.

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