Mutuals could reclassify sub-prime back book as prime

26 March 2010 | By Natalie Thomas

The regulator has published additional guidance for building societies today to ensure that mutuals wanting to diversify away from the traditional building society model can continue to trade.

The guidance includes published feedback to CP09/17, an earlier consultation paper for building societies that would curtail mutuals’ lending activities according to their size and business model.

In its latest guidance the FSA says that recent experience has shown some building societies diversified without having the necessary skills and systems to manage the risks they were undertaking.

Building societies will still have freedom to diversify, the FSA says, but this further guidance sets out what the systems and controls a building society needs to have in place to manage more complex business models.

Due to the attention the FSA is paying to risk, the regulator has examined how building societies class high LTV lending they have done in the past.

The FSA says: “We do not believe that seasoned high LTV lending becomes less risky for a society as the borrower proves they can afford the mortgage, since the risk is primarily associated with ‘loss given default’ rather than ‘probability of default’.

“We do, however, agree that it would be reasonable for seasoned sub-prime lending to be recategorised as prime after a number of years (if affordability has been demonstrated) since in the case of such lending it is affordability rather than loss given default which is the main risk factor.”

The FSA suggests that five years would be an appropriate benchmark to gauge whether past sub-prime lending could be recategorised as prime.

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