Well, a sense of déja vu can help you to form judgements but I don’t believe, either in business trends or in fashion, that the exact same situations come round again.
If you look back to 1974 you learn that if governments try to intervene in the supply side it can end in tears, although it is fair to say the government had little choice but to intervene in 2008.
But one thing that struck me as an 18 year-old was that the consumer wasn’t getting a good deal. The consumer wanted a mortgage now but was told he couldn’t have one. He had to do something he did not want to do which was to save and then he was granted a mortgage as though it was something which was being delivered from on high.
I began to think that much of what I was told about underwriting mortgages was absolute nonsense. I’ll give you an example. Halifax was good at pushing you through to different departments every year so my first department was mortgage applications, where I was told that people could not afford to borrow more than 3 x their income. In fact, when someone came along and said he could afford to borrow 4 x income, I was told to tell him no.
Then I moved to arrears where that same individual – we’d put his interest rate up six times – was now paying the equivalent of 5 x income and we were told to say to him that he had to afford it or we’d take his house away.
In arrears, I also saw people who could not manage 2 x income and those who could manage 5 x income.
So I learnt that the idea of getting confirmation of someone’s income and applying a multiple to it was rubbish. It didn’t take into account their attitude to credit or their ability to pay and even today, 35 years later, we still have the media, some of the balance sheet lenders and some of the regulators saying that is the way to underwrite mortgages.
It was rubbish 35 years ago and it’s rubbish now – it’s treating the customer very badly.
But to come back to your question, I feel I’ve achieved a lot and also that having a 35-year perspective allows me to understand that the things we are experiencing at the moment will pass.
JM: True, but unless someone today has a big deposit and the right income multiple, they won’t get a mortgage. Isn’t that a step backwards?
SK: It would be a step backwards if it was sustainable but it’s not what consumers want and I think a thawing of the liquidity freeze will stop that attitude taking hold.
JM: So was it your frustration with the way mortgages were granted andmanaged that triggered your career in product and market innovation, and saw you launch Private Label?
SK: That’s right. When I moved to Citibank I was tasked with describing to our superiors in New York what the UK mortgage market looked like and what the opportunities were. I thought there was an opportunity to serve what I called the marzipan layer of insurance firms.
The big insurance companies – Sun Alliance, Royal, and Legal & General – were on everybody’s panel back in 1987, and the marzipan layer of insurance companies – about 100 of them – were not being served with the most competitive mortgage products. I had the idea that we could serve them with mortgage products and, to give them an extra angle, they could brand all material as their own.
My boss thought the idea was rubbish so I started to talk to potential funders and they said that they saw guys like me, executives of big US organisations, about new business ideas all the time but when push came to shove we didn’t have the bottle to leave our big jobs and big cars. So I resigned and went back saying: “Now my bottle is off the agenda, can we talk about my business plan?”
It took six or seven months to get the business going and we started offering funding to marzipan layer insurance companies. That took off. I think we had about 20 insurance companies in the end, and then we addressed the broker market at large. And the business, by the time we sold it, was the largest privately owned distributor in the country.
It was the forerunner of the packager industry with about 500 organisations following me into that space but my proudest achievement was the sheer number of products we were able to innovate.
We only sold and marketed products we invented and we only got paid when mortgages completed. So I could say to my team: “If we don’t innovate we don’t eat.” It was as simple as that.
JM: Your first book, The Art of Marketing Mortgages which you published in 1997, reflects an enthusiasm for the business but a year later you sold to GMAC-RFC – why was that?
SK: I felt that by 1998 the model only had a few more years to run. Technology was taking out the need to do the processing and I thought the expansion of the internet would see the beginning of the end of the packager model.
Those who try to sell at the top and buy at the bottom are making a mistake unless they are lucky – you should try to sell near the top and start at the bottom.
JM: So with GMAC-RFC, you became a lender.
SK: Yes that was a surprise to me. When GMAC-RFC bought my business the intention was that we’d run Private Label as the branded mainstream arm and a company called RFC Mortgage Services as the sub-prime arm but suddenly we had several other acquisitions as well and head office said: “We’d like to merge them all into one and we’d like you to be the chairman.”
I didn’t want to become another employee but I decided to do it because it was a fresh challenge. I’d shown I could take a start-up and build it into a medium-sized company – could I now take a medium sized company and grow it into a large company?
In the end, when I resigned from GMAC-RFC in April 2007, we had 950 employees and were the 10th largest lender in the UK. I felt I had done what I set out to achieve.
JM: As a member of the worldwide board of GMAC-RFC you had first-hand exposure to the US sub-prime market so do you disagree with the media pundits who argue the market collapse over there was driven by insatiable greed?
SK: Many of the problems were driven by greed. In the US business was originally properly securitised but the conduits were wanting more business, so they started lending to people who could not afford it. The problem then became one of processing, so issuers agreed to buy others’ production. There was a greed for getting in an increasing amount of business.
In 2005, this quest for more and more business hit the UK when investment banks started to grow substantially, saying that they wanted to get closer to the collateral. At the time I was quoted in Mortgage Strategy as saying this didn’t make commercial sense and was “big swinging dickmanship”.
I got my knuckles rapped by head office for that non-PC phrase but it was a pretty good description of what was happening. Everyone was piling in and you had a situation whereby the top five products in every category were below the cost of funds. It was unsustainable.
But getting back to the US comparison, what needs to be understood is that lending to people who have no income is not allowed in the UK. The Financial Services Authority does not allow it and if a lender did it, it would be picked up in an arrow visit and those responsible would be drummed out of the Brownies.
Also, buying someone else’s production blind wouldn’t be allowed here. High LTV sub-prime would not be allowed. Huge discounts followed by leaps in payments – similar to the deferred interest mortgages we once saw in the UK – would not be allowed. So several of the main contributors to the US problem would never have been allowed to arise in the UK. In this context we should be praising the regulator.
When you look at Council of Mortgage Lenders’ figures, 90-day arrears are something like 2%. And if you look at the figures for 30-day arrears they are something like 4%. That’s a huge contrast with the situation in the US, where some issues have 50% arrears.
I was chairing a conference recently at which the media, consumer groups and some MPs kept repeating the phrases ‘irresponsible lending’ and ‘irresponsible borrowing’. I had to remind them that there are a lot of lessons to be learned from the credit crunch but 2% arrears on 90-days down does not look like a crisis situation.
JM: But for all that, the UK securitisation model, if not dead, will need major surgery to resurrect it. Dr Crosby’s diagnosis and prescription has been a long time coming. Are you optimistic about what it offers?
SK: I don’t know about the Crosby report but the securitisation model was misused. Getting a set of assets together in a transparent way, having them checked by a ratings agency and using that to obtain collateral-based financing is a perfectly good model. It hasn’t disappeared forever. In fact, there are still some private placements going through.
What happened in the UK was that companies were buying the riskiest BBB-rated pieces and restructuring them into new securities with AAA pieces at the top. This led to the nonsensical situation whereby there were more AAA bond issues in the market than there was AAA collateral backing them. You can see why it all went wrong. The ratings agencies should have seen it too.
But when you start to see the securitisation model return in the next few years it will be back to where it started about 20 years ago. You’ll see lower LTVs, proper transparency and a checkable line be-tween collateral and investment.
JM: That’s for the future. The immediate problem is the 50% funding shortfall.
SK: Worse. I think if you look at the last three months of 2008, were they to be annualised you’d be talking about £180bn gross lending.
JM: And that’s going to have serious consequences for the economy.
SK: It’s taking away from absolute spending power, confidence and labour mobility. The reduction in lending caused by the liquidity freeze is having the greatest negative effect on house prices. Affordability is a secondary issue and would not have triggered the current price adjustments of itself.
When historians look back on the events of 2008 they will say the biggest mistake we made was to let Lehmans swing. There was already widespread concern about exposure to US sub-prime but once we let Lehmans go and people realised a 150-year-old bank had been allowed to disappear they were doubly worried about their peers’ exposure to Lehmans as a counterparty in certain transactions. This multiplied concern and pushed us to the brink of a worldwide banking collapse.
JM: So this is an inauspicious time to launch Checkmate onto the market?
SK: You started by asking me about lessons from the 1970s. One of the lessons that came out of that period was that those who keep their heads realise these things pass.
I’m lucky to have been in a position to have accumulated some capital and I’m also lucky to have attracted the interest of investors – RIT Capital Partners and Lord Rothschild’s family interest are long-term players – and that’s why we are building a business ready to take advantage when the market permits.
JM: But given your record of achievements, why did you feel the need to create Checkmate?
SK: I resigned from GMAC-RFC in April 2007, and the CML asked me to give a speech in December – it books early. I said OK and my speech will be called Blood in the water: who will survive?
The CML thought that sounded aggressive and I said there was going to be a big supply side adjustment in the mortgage market which is partly why I resigned from GMAC-RFC. And so it proved, al-though I did not predict the liquidity freeze as we have seen it.
I spent the summer thinking about it. A few of my friends argued that I should retire and take non-executive director positions, a couple of which were offered. But I came to the conclusion that building businesses is what I do, and decided in the late summer to come back to the market.
JM: Do you have a unique selling proposition this time round?
SK: I’ve a number of them. We have no pre-2009 assets to worry about so we don’t have legacy problems.
We are also launching a brand new credit scoring and underwriting process that embraces the best of post-credit crunch learning.
A lot of the things that have gone wrong in the UK mortgage market are simple. We lost the credit perspective. And the biggest problem of all was risk layering. What normally happens in mortgage underwriting is that when you’ve got someone with one or two credit problems they require a lower LTV. If you’ve got someone who is squeaky clean and has proved himself on existing credit you might let him have a slightly higher LTV. What we were doing, forced by competition, was to lend on high LTVs to people with covenant issues. That’s risk layering and it was a mistake.
That’s why we’ve been working with Experian to replicate 100,000 mortgage accounts and all of the factors associated with good and bad mortgages. We’re spending a lot of money writing a credit score that is fit for a 2009 launch.
We’ll offer funders who can see the opportunity to build a mortgage pool with 2009 assets underwritten with post-2008 learning and marketed to intermediaries by a team unrivalled in experience and innovation.
So far, I’ve taken 20 people with me – all the top spots are accounted for. They’ve all worked for me between 10 and 20 years and they’re all people I regard as the best in their spots.
JM: I’m not sure if this is tactful but don’t you have a legacy issue with the portfolios GMAC-RFC sold to the likes of Bradford & Bingley and the Derbyshire Building Society?
SK: It’s a few months short of two years since I resigned from GMAC-RFC so it’s not easy to comment on what went wrong with the B&B relationship. It was working perfectly well while I was there. B&B was raving about the quality of the assets it was buying and wanted to buy more. It would credit score `every loan, which means it would only buy loans it would accept directly.
If you look at the latest Fitch arrears analysis of non-conforming residential mortgage-backed securities you’ll find that GMAC-RFC’s sub-prime arrears are running at two-thirds of the level of all other lenders’. I’m in contact with asset buyers who confirm the GMAC-RFC assets they bought are good quality. This whole thing is a mystery to me.
JM: So you think a scapegoat factor has been at work?
SK: It’s easy for a story like this to gain momentum, even if it isn’t true.
JM: Some would say your timing with Checkmate has been unfortunate. Are you still planning to press the launch button in Q1 2009?
SK: We won’t launch in the first quarter but I have invested a substantial amount in Checkmate as have my investors, who are widely acknowledged as clever people. We have faith in the project so we’ll continue our funding discussions and launch when the thaw begins.
When you can see the bottom of the market in your rear view mirror it’s too late – when you can see it through the windscreen, that’s the time to act.
Your question was prefaced with the phrase ‘some say’. When I started Private Label some said it was ridiculous – how can a new organisation impose itself on relationships between lenders and brokers that have been established for 100 years? I said – because we’re going to innovate on product and service, and look what happened.
Stephen Knight – personal profile
Position: Executive chairman and founder of Checkmate Mortgages, and the largest individual shareholder.
Always wanted to be a lender?: I joined Halifax in 1973 with the view that everyone needs a home, so it was a secure place to pursue a career.
Likes: Friendly, straightforward and reliable people. My family are important to me.
Hates: A wasted emotion. Anyone who hates anything ends up harming themselves.
Relaxation: I’ve never made a distinction between my business and my private life but when I’m not working I’m with my family at home, on holiday or at Spurs. And I like to read.
Favourite food/restaurant: I like all kinds of food – I think that’s obvious! My favourite restaurant is the Louis XV at the Hotel de Paris, Monte Carlo.
Current bedside book: A biography of Tommy Cooper I picked up on holiday.