Target Practice

1 September 2008 | By Robert Thickett

Along with equity release and sub-prime, it is one of those mortgage products that the media regularly predicts will bring about a latter-day economic apocalypse. But despite the bad press, self-cert has continued to survive and thrive.

Beyond the hysteria, can self-cert be sold well and should it have a future? The product was subject to two investigations by the BBC’s The Money Programme in 2003 and 2004. Both showed that self-cert sales processes were severely wanting in some cases.

While brokers at Birmingham Midshires branches were caught aiding the falsification of clients’ incomes, others were also shown to be more than happy to get their hands dirty.

Reporter Michael Robinson led the BBC’s original investigation into self-cert and at the time accused major players in the industry of being unwilling to face up to “one of the biggest scandals the British housing market has ever seen”.

Both programmes were heavily debated within the industry. While the brokers found to have falsified client data were universally condemned, the market was split when it came to the ethics of self-cert products.

In February 2004, the Council of Mortgage Lenders published a lengthy repost to the second BBC investigation, in which it defended lenders and insisted that self-cert fraud had been greatly exaggerated.

Although there was still another 10 months to go before the mortgage market was regulated by the Financial Services Authority, it extensively quoted the FSA’s then chief executive John Tiner’s speech at the CML’s annual conference in December 2003.

“It is a criminal offence for an individual to lie about their income or for an institution to encourage their customers to lie,” Tiner said at the time. “Clearly, there is an inherent higher risk with self-cert loans, which means that lenders need to have robust controls in place to ensure that the features of the product are not abused by either borrowers or sellers.

“We are taking a close look at self-cert mortgages to make an assessment of how widespread abuses may be. We will then determine what, if any, further action we need to take.”

Michael Coogan, director-general of the CML, stated his position in the letter too.

“We agree with the sentiment of these comments but do not believe that there are widespread abuses requiring further FSA action,” he said.

But the regulator believed that self-cert required further investigation, a stance it has continued to take, especially in the wake of the credit crunch.

Last year the FSA’s small firms division undertook a thematic review into the quality of self-cert sales.

It visited 89 brokers to scrutinise their practice. Out of these, seven were referred to the FSA’s enforcement division and five were fined.

And on June 5 2008 the regulator fined Andrew Jeffreys, who traded as Chepstow Financial Services, the not inconsiderable sum of 15,000 for failures regarding the sale of self-cert mortgages. Because Jeffreys played ball from an early stage of the investigation, this was reduced to 10,500.

While the FSA said it couldn’t find any evidence that Jeffreys had deliberately strived to mislead lenders, there was a serious lack of evidence to support the suitability of the self-cert products he recommended.

You could argue that this is hardly in the same league as the criteria-lite lending seen in the US and the now infamous ninja (no income, no job, no assets) mortgages that allowed pretty much anyone to get on the housing ladder. But it’s a sign that the world of self-cert in the UK hasn’t been quite as rosy as the industry likes to paint.

A former head of one lender admitted to Mortgage Strategy that in the run-up to the credit crunch’s beginnings in August 2007, it had a product that was effectively a ninja mortgage in all but name. They said that every borrower who took out the product had subsequently been repossessed.

Nick Baxter, managing director of Mortgage Promotions and partner at Baxters Business Consultants, works as an expert witness in legal disputes involving mortgages.

He says he’s starting to see a notable rise in the number of mortgage-related disputes working their way through the courts. Many of them involve self-cert deals.

Baxter has seen all this before - he was an expert witness in the mid-1990s when the UK was in the grip of its last housing crash and he makes a simple comparison between then and now.

Back then lenders were dogged by lousy record-keeping, which meant it was difficult for them to prove their lending was prudent.

Nowadays thanks to advancements in software, producing robust lending documents is easy. The key question is whether those who underwrite cases comply with lending policies. Both lenders and brokers have been guilty of not doing so.

“It’s as though the messages from the FSA surrounding plausibility and affordability have gone unnoticed by both parties,” he says. “I suspect brokers have ignored them because len-ders continue to accept applications that are flimsy to say the least. Of the cases I’ve seen, often there’s weak ass-essments and the belief that whatever clients have said is correct.”

Baxter in part blames self-cert problems on the industry’s unwillingness to tackle the practices exposed by the BBC four years ago.

“At the time of the programmes the industry threw its hands up in horror and said it can’t possibly be the case, we know you’ve got secret recordings but of course that wouldn’t have happened,” he says. “But now you see what the FSA has done over the past year and clearly it did happen. The big question is to what extent.

“The BBC alleged that these practices would have a damaging effect on the housing market. Maybe it was right.”

One man who didn’t bury his head in the sand was Matthew Wyles, non-retail director at Nationwide. When the first show aired, Wyles was group development director at Portman. He was interviewed for the second programme and was the only lender to speak on the record about self-cert.

“I remember being regarded as a renegade when I spoke on the programme,” he says. “Every other lender approached refused to comment.”

Wyles says that some in the industry were so incensed by his comments that they called for Portman and its specialist intermediary brand The Mortgage Works to be expelled from the Intermediary Mortgage Lenders Association.

But why did everyone get so heated about an issue that if not properly add-ressed could have posed a major threat to the industry?

“The programmes were embarrassing for the industry because they pumped the oxygen of publicity around the fact that self-cert products were being widely sold as a means of getting around income multiple limits,” says Wyles. “So at TMW we erected a series of defences and spot checks to deal with abuses.”

For example, TMW requires brokers to sign a declaration affirming they are satisfied that applicants have provided genuine information and are able to repay their loans.

Wyles adds that the main benefit of the BBC expos豠was that they woke the FSA up to the problems surrounding self-cert.

“Ironically, until the credit crunch most lenders did little to tighten up,” he says.

“But a lot of brokers realised that they were running legal risks and it is the broker community which now app-roaches self-cert with greater caution. Indeed, many brokers prefer to steer clear of self-cert altogether.”

But Baxter argues that while there have been weaknesses, apportioning blame may not be that easy.

“Was brokers’ behaviour driven by the demand to satisfy clients’ requirements?” he says. “Possibly. But was that drive encouraged by some lenders that wanted to lend as much as they could as quickly as they could, securitise it and flog it to someone else?

“In that regard it’s not that different from what happened in the US. Maybe not quite as bad, but with some of the cases I’ve seen the underwriting has been questionable to say the least.”

Baxter and Wyles do not argue that self-cert should be scrapped - quite the opposite. They say for the right clients the product is ideal.

But self-cert hinges on clients being honest, brokers not stretching salaries to hit required income multiples and lenders asking whether it is plausible for a shelf stacker at Tesco to earn 80,000 a year.

“I continue to believe that self-cert has a place and can meet the needs of certain customers with complex or irr-egular incomes,” says Wyles.

“Many self-cert lenders will learn useful lessons as they study their rising arrears statistics, which is good. There is no point in making mistakes if you don’t learn from them.”

Baxter’s concern is that too much self-cert was done prior to the credit crunch.

Whereas in the mid-1990s the argument was whether the approach was justified, these days this has been squared.

“Even the FSA accepts it is reasonable to have a self-cert lending policy,” he says. “In Tiner’s annual letter issued in 2004, it estimated that self-cert constituted about 6% to 8% of the mortgage market. A hell of a lot more has gone through since then.”

His concerns are shared by others. Kevin Friend, strategic partnerships director at Mortgages.co.uk, envisages the credit crunch will herald a return to old-fashioned standards of good quality self-employed applicants who need to self-certify their incomes.

“Lenders created a market which became tainted by offering criteria that accommodated borrowers, employed applicants in particular, providing loans they shouldn’t have offered,” he says. “This put brokers in the firing line - perhaps we need to look elsewhere for the real problem. But it’s back to basics now.”

Neither the CML nor the FSA list how much self-cert business has been completed annually but the amount has no doubt dropped considerably since August last year.

Mortgage Strategy compared the top 10 fixed rate two-year self-cert products available in August 2007 and 2008 (see tables above). While there isn’t that much separating the headline rates of the number one products - 5.34% in 2007 and 5.99% in 2008 - criteria have altered radically.

In 2007 Heritable Bank’s 5.34% deal had a bargain 399 fee and a generous LTV of 80%, while the top product this year, offered by TMW, has a 2.5% fee and a prudent 50% LTV.

There is nothing in the 2008 top 10 available above 75% LTV and the gap between the products in second and third place is a whopping 1.3%. The 10th cheapest product in the market is provided by Money Partners and weighs in at a hefty 8.05%.

Clearly, with pricing as it is, self-cert nowadays will only appeal to borrowers who have a genuine need for it and hefty deposits to boot.

So will pricing for self-cert return to how it once was? This will depend on the speed with which the securitisation markets reappear. The few super-prime securitisations by the likes of HBOS and Alliance & Leicester have had poor rates of return - for the issuing lenders at least. Unfortunately, investor confidence in any form of mortgage-backed asset is low. Internationally, their fingers have been badly burnt.

For the self-cert market to get back on its feet, it will have to prove that it has addressed the sins of the past. It must prove to jittery investors that its risks have been minimised.

Bob Sturges, director of communications at Goldman Sachs-backed Money Partners, believes the market will eventually return. It has to - for firms like Money Partners, their raison d’鳲e is to originate mortgages and without a market to sell them to, the scope for specialist lenders is limited.

Sturges says investor appetite - and by proxy, funding appetite - for specialist products like self-cert will depend on marketing and subsequent sales must be more transparent and rigorously rated than before. This will take time.

“That appetite will return over time,” he says. “But we are probably talking about a couple of years rather than months. I have no doubt about that.”

Changes to the way self-cert is done will ensure the product’s future

Martin Reynolds is corporate manager at Premier Mortgage Service

Virtually since its inception, self-cert has had to suffer a Daily Mail-style doom mongering campaign. Nevertheless, some 20 years later it is still going strong.

But whispers about its future seem to be growing louder as lenders rein in their credit policies. So will self-cert finally pass into history? The simple answer is no.

With current economic conditions and predictions highlighting the need for a flexible workforce, demand for self-cert could grow.

MCOB 11.3.2R states that “in taking account of a customer’s ability to repay, a firm may rely upon self-cert of income by the customer in circumstances where the firm considers it to be appropriate, having regard to the interests of the customer and where the firm has no reasonable grounds for doubting the information provided”.

But will self-cert remain in its current format? The answer is probably not. During the past year it has been compared with liar loans, which were prevalent in the US. But such a comparison shows no understanding of the different underwriting processes involved.

Self-cert has also been linked to fraudulent applications and while this may be true, fraud is not an issue exclusive to these products. Fraud will be attempted across not only all mortgage products but the wider financial services industry too - this is a fact of life. What’s important are the controls we use to detect and prevent it.

As an industry we need to be more open, understand what lenders’ processes are and work in partnership with them. It should not be a game of cat and mouse.

There will be changes to how self-cert is sold and the eligibility criteria involved over the next few years. Some of the modifications could be as follows:

• We may see the end of self-cert deals for first-time buyers.
• The definition of clients will be clarified. We could see restrictions with self-cert only allowed via brokers who have held relationships with clients for a specific time period, maybe two or three years, and where they have already arranged at least one previous mortgage for them and sold them additional services. This could lead to the creation of a bespoke advice process different to that seen with mainstream products.
• We will have to consider whether self-cert is appropriate for employed clients. I think it is but only in certain circumstances, such as when clients have multiple jobs, varying bonus structures or where mainstream lenders struggle to offer the full amount.
• LTVs will remain low. I would expect them to creep back above the current norm of 75% but not much higher than 85%.
• There will be more checks on the validity of the information given by employers. Applicants self-certify their incomes, not their place of work or job role.

While lenders will modify their systems to include greater use of audits and reasonability checks, they will still want to lend in this arena. On one sourcing system there are 21 lenders still offering self-cert mortgages and just over 3,000 products are available. While this is down on previous numbers it still shows a healthy appetite for the product.

Due to the nature of self-cert, we will see more products offering flexible benefits to allow for the varying nature of clients’ income streams while also complying with Treating Customers Fairly principles. While the market is challenging at the moment, we should not be too quick to write off self-cert. It is a viable option when used responsibly and should not be marginalised.

The industry has upped its self-cert game

Andy McQueen is managing director of The Mortgage Works

Scrutiny of the self-cert market is nothing new. Whether it’s television documentaries or the spate of regulatory action earlier this year involving brokers accused of self-cert failings, the sector is used to such attention.

Despite negative press coverage, self-cert continues to occupy a significant place in the residential mortgage market because it offers a viable solution to millions of would-be borrowers’ needs.

Self-cert mortgages allow those who struggle to provide proof of income to buy homes. The most obvious group this applies to is the self-employed, whose income may fluctuate from month to month and who do not have employers who can testify they are paid fixed amounts at regular intervals. For these borrowers, self-cert mortgages can represent their only chance of home ownership.

Another reason for self-cert is the growing buy-to-let sector. Landlords may want rental income to be included in affordability calculations but the figures may fluctuate and can be transient in nature. Self-cert can offer the flexibility buy-to-let borrowers need.

The latest criticism levelled at self-cert has focussed on arrears figures for the sector and how these compare with those of the prime residential market. But such comparisons miss the point because as a specialist product, self-cert mortgages are priced higher because they take into account the higher risk profile of applicants.

So it is to be expected that self-cert arrears will run at higher levels than in prime business. That is not to say there won’t be examples where unscrupulous brokers or lenders have been involved in poor lending practices that ultimately result in borrowers defaulting, but the fact self-cert arrears are higher than those seen in the prime market should not be taken as a sign it is failing.

Lenders and brokers have an obligation to act responsibly and prudently, and the responsible lending practices that have been put in place, especially regarding plausibility and affordability, should alleviate some of the concerns surrounding self-cert.

Public criticism of isolated cases, or of a particular part of the mortgage market, always has the unfortunate effect of casting the sector as a whole in an unfavourable light and self-cert mortgages are unlikely to have seen the last of the bad press they attract.

But professional brokers who understand why and how specialist products should be recommended and applied for are unlikely to let this attention put them off advising clients about self-cert if they feel it’s the most appropriate product for them.

These brokers do not encourage unsuitable clients to opt for self-cert or to inflate their incomes, but rather work through their financial circumstances and make suitable recommendations based on the information available.

Lenders too have a responsibility to monitor self-cert business, and with lenders and brokers working together to carefully scrutinise applicants, there is no reason why self-cert cannot continue to be a viable product offering a much-needed solution for borrowers.

If you enjoyed this article, sign up here to receive daily email updates from Mortgage Strategy and Follow @mortgagestrat