Back from the dead: Is sub-prime about to make a comeback?

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Mortgage experts believe the UK could be heading for a return to the kind of mortgage lending that triggered the financial crisis.

Some argue we could see the comeback of sub-prime mortgages on such a scale that these loans could be packaged up and sold in the same way as we saw in the run-up to 2007 and 2008.

Ratings agencies Fitch and DBRS recently rated the first US securitisation backed by sub-prime mortgages since the crash.

The $161.7m (£110m) bond launched two weeks ago is backed by mortgages from US lender Caliber Home Loans and was bought by the hedge fund Lone Star.

Fitch says the deal will be a “trailblazer” and that similar offers are likely to follow in the third quarter.

Brokers say there is demand for mortgages for borrowers with less than perfect credit histories, and a return to securitisation in the sub-prime sector in the UK would fuel appetite for this kind of lending.

Those in the mortgage funding business say the packaging up of loans in this way, were it to see a resurgence in the UK, would look very different to the layered, misrepresented tranches of loans seen in the past.

But has sub-prime lending done enough to overcome its bad reputation? How does this sit with the tougher affordability requirements of today? And can we really get to a place where the return of sub-prime mortgages is a good thing for consumers?

The Savile Row solution

Clayton Euro Risk carries out due diligence on mortgage finance deals and also offers risk management for lenders, institutional investors and third party servicers.

Chief executive Tony Ward says future UK sub-prime securitisations are likely, but will be more tailored than previous mass-market offerings.

He says is partly due to tougher regulation, such as capital requirements for buyers and rules which require sellers to retain 5 per cent of the risk on their own balance sheets when selling on mortgages and loans.

He says: “Investors want a Savile Row solution rather than something off the peg.

“It is more likely that originators will identify buyers– such as pension or investment funds – and construct portfolios specifically for them. They are securitisations, but designed to meet an investor’s bespoke requirements. If the investor has a minimum yield requirement then this might require near-prime and sub-prime loans to form part of that package. But there will be much more oversight than there used to be.”

Investors want a Savile Row solution rather than something off the peg

GPS Economics director Gary Styles says: “You have to be very clear about what you mean by sub-prime. In this marketplace there’s a lot of difference in how it’s described, from one lender to the next.”

John Charcol senior technical manager Ray Boulger says lender appetite for sub-prime lending has clearly waned following the crisis, but says this could change if investors begin demanding it.

He says: “I rather doubt any of the lenders that are currently in that market are doing enough business [for a securitisation].

“But the fact that the first such securitisation since the credit crunch has been done in the US clearly does set the tone, and I would think there is a strong possibility that we could see something similar happening in the UK. Not this year, maybe not even next year, but it’s setting the direction of travel.

“Certainly the more appetite there is from investors to offer this sort of mortgage, the easier it becomes for lenders to offer it.”

Specialist buy-to-let lender Fleet Mortgages chief executive Bob Young says there is demand from consumers for more sub-prime lending.

He says: “There is appetite from borrowers for it, and brokers too would like to have more sub-prime back in the market. Is there investor appetite, from a bond perspective? The answer is, if the yield is big enough, there will be interest. The final kicker is, will the FCA allow it?”

But Paragon Mortgages managing director John Heron doubts whether the packaging up of sub-prime loans can return to the UK.

He says: “Although all sorts of things are possible, with financial engineering, I don’t see any prospect of material levels of sub-prime loans being generated in the UK market.

“Regardless of investor sentiment, lender behaviour is underpinned by a whole number of things, not least their own approach to prudent lending. But underpinning that is a very tough conduct of business regime which lenders cannot breach. I cannot see any basis on which you could see a return to so-called sub-prime lending in the UK.”

Financial Inclusion Centre co-founder Mick McAteer argues regulation has gone a long way to keeping the mortgage market in check, in terms of curbing the excessive borrowing levels of the past.

He says: “The post-crisis clampdown has been a good thing. It’s [now] a much more regulated and sustainable retail mortgage market.

“Yet while it’s not the same level of risk as there was before, there is a concern we are getting there. If you look at the Office for Budget Responsibility’s projection for overall consumer household credit, in a few year’s time it looks like it will rise to pre-crisis levels. I hope we don’t get back to that. While a lot of that has been driven by the buy-to-let market, there will be sub-prime in there as well.”

McAteer is also concerned about the knock-on effect of any return to sub-prime lending.

He says: “Borrowers on interest-only mortgages will find it hard to remortgage and they could get pushed into the sub-prime market because they have no other options. That’s the real consumer protection angle we are concerned about, the availability of mortgages for people who are coming towards the end of their term and may have to remortgage.”

A different beast

Chadney Bulgin mortgage partner Jonathan Clark says a new wave of sub-prime securitisation would be good for the market, particularly as the controversial practice of self-certifying income is no longer permitted in the UK.

He says: “The return of securitisation among sub-prime lenders will understandably be viewed with some concern by our industry but as long as these lenders continue to grant their new loans responsibly, it should be good news as it will free up funding and help stimulate competition.  Today’s sub-prime market is a very different beast to the pre credit-crunch one as of course, self-certification no longer exists and looks set to remain extinct.”

Your Mortgage Decisions director Dominik Lipnicki says the market needs more lending to those with imperfect credit histories.

He says: “We have lenders that play in that market, and hopefully we will see more of those. The industry has got to represent the people that it lends to. There aren’t enough lenders to deal with any niche side of the market. All the big players want the same people. If a borrower falls outside of that, they start having issues.

“Do I see a return to how it was, such as lending money to absolutely anyone? No, but I do see a return to the more sensible end of it, and that’s right.”

Could packaging up sub-prime mortgages make a comeback in the UK?

YES
RAY BOULGER

The fact that the first such securitisation since the credit crunch has been done in the UK clearly does set the tone, and I would think there is a strong possibility that we could see something similar happening in the UK. Not this year, maybe not even next year, but it is setting the direction of travel.

If lenders can securitise certain types of lending, it should have the effect of increasing appetite. At the moment, the relatively few lenders still in the adverse credit market are not accepting that much, and that could be another consequence of this [latest deal]. It might be that lenders are prepared to go up the risk curve a bit.

If lenders have to charge significantly more, because there is a degree of risk, there comes a time when borrowers say “its too expensive” and decide to keep renting. Certainly the more appetite there is from investors to offer this sort of mortgage, the easier it becomes for lenders to offer it.

NO
JOHN HERON

It is all about the underlying asset. Could you securitise such mortgages? With the right structuring, yes. But what you do not see in the UK is any flow of such mortgages. Mortgage market regulation is such that we have very robust rules around lending.

All loans have to meet minimum standards, including affordability assessment. So sub-prime is generally associated with a combination of self-certification of income, adverse credit and so forth. Those loans are simply not being generated in the UK market.

Although all sorts of things are possible, with financial engineering, I don’t see any prospect of material levels of sub-prime loans being generated in the UK market. Regardless of investor sentiment, lender behaviour is underpinned by a whole number of things, not least their own approach to prudent lending.

But underpinning that is a very tough conduct of business regime which lenders cannot breach. I cannot see any basis on which you could see a return to so-called sub-prime lending in the UK.