A liquidity crisis such as the one we are experiencing is bound to trickle its way down to all areas of lending eventually.
So it’s no surprise that in recent weeks, commercial self-cert mortgages have fallen into its grip. But lenders in this sector are treading a fine line be-tween mitigating risk in a less forgiving market and trying to stay loyal to the true meaning of self-cert, so how are they doing this?
Perhaps the first thing to note is that there is no definition of self-cert.
“Self-cert has always been a grey area, especially in the commercial mortgage world,” says Sarah Busby, managing director of broker Birchwood Business Finance.
“It’s not just a self-declaration of income because even Commercial First required an accountant’s letter, and other lenders require some sort of documentation too.”
Commercial First, which is a key player in the sector, suspended all new lending on March 24.
Gary Spencer, director at broker Bedrock, agrees that lenders think in shades of grey when it comes to defining self-cert.
But both brokers have noted that more lenders are now asking for supporting documentation that is surplus to their self-cert criteria.
“Random requests for additional proof of loan serviceability such as credit histories or references to income are more frequent than six months ago,” says Spencer.
“This is not surprising because loans are likely to be sold on through securitisation at a later date so they have to be as clean as possible.”
True, but doesn’t this mean that brokers are no longer dealing in truly self-cert applications?
John Phillips, chief executive of broker Kingswood Associates, says the true definition of this type of application is self-certification of the serviceability of loans.
“While this may require additional documents including an accountant’s letter, the important thing is that this letter should only confirm that an app-licant has been trading for a given length of time rather than what they earn,” he says.
In that case, Base Commercial Mortgages, a firm that lends on prime and near-prime businesses, has undeniably stepped outside the self-cert camp. The lender has changed its criteria three times since its launch in August last year.
“We never claimed to offer a traditional self-cert service because in addition to requiring an accountant’s letter to confirm loan serviceability, we have always carried out checks with Experian,” says Paul Marland, sales and marketing director at BCM.
“But this year we have been asking for three months’ bank statements from applicants. This is why we call this kind of lending part-disclosure rather than self-cert.”
Other lenders are choosing to stay put in the self-cert camp but moving their goalposts.
InterBay Commercial arrived from the other side of the Atlantic in May 2006 to target small and medium-sized businesses.
InterBay describes itself as a true self-cert lender but unsurprisingly, protecting this pedigree has come atthe expense of other criteria.
Two weeks ago the lender cut its LTVs across the board from 85% to 70%, while substantially reining in its distribution.
“Whereas before we received business from an array of brokers, we now work through 20 selected partners – the majority of which are packagers,” says Anna Bennett, sales and marketing director at InterBay Commercial. “Brokers who come to us direct are referred to these partners.”
InterBay has also declared that 25 jobs are at risk, but maintains that be-cause of its transparency, this news has met with understanding.
InterBay is not alone in its plight. In the past 18 months Commercial First has made four changes to its LTVs and reduced its margins.
Stephen Johnson, sales and marketing director at Commercial First, says the changes in January shaved 5% to 10% off LTVs especially on leisure-related properties including pubs, bed and breakfast businesses and hotels.
“These changes reflect our experience with a portfolio that exceeds £2bn,” he says. Busby was at the sharp end of this change recently when she discovered one of her clients would only qualify for 75% LTV with Commercial First.
“Things are changing fast,” she says. “Commercial First would not have batted an eyelid at 85% LTV a few months ago.”
BCM has dipped even lower in the LTV stakes and now offers a maximum of 55% LTV across all products.
When it comes to mitigating risk lowering LTVs is seemingly easier than hiking rates, as self-cert lenders are still struggling to offer the most competitive deals.
Bennett says that having switched to the better understood base rate, pricing on variable rates at InterBay has come down in recent months while fixed rate deals are pegged where they were this time last year.
A one-year fixed rate product now starts at 8.25% while a two-year deal costs 9%.
“There’s a small differential in pricing due to the risk of self-cert but this gap has narrowed as competitors have raised their prices,” she says.
Marland says the positioning of BCM in the marketplace means that it can’t use rates as a vehicle with which to claw back security.
“We stick to the prime end of the market notwithstanding justified County Court judgements and small blips on credit reports,” he says.
“This means that our rivals are the likes of Abbey and CHL Mortgages. That’s why we have to be particularly conscious of rates that start at 2.35% above the base rate and 2.15% above LIBOR.”
Marland says rates can also be kept down as the lender started trading when the liquidity crisis broke, so it has no borrowing back book.
But Busby says that where lenders take a more open approach to applications, higher rates will follow.
“I recently refinanced a deal away from Commercial First to Abbey for a lady who had a bed and breakfast,” she says.
“Her accounts were weak so Abbey spent some time focussing on the business projections and granted the loan. But Abbey has also increased its rates by around 0.5%.”
Busby points out that rates on adverse self-cert deals such as those offered by the likes of London & Scottish and Lancaster Mortgage Corporation, have become higher still.
“Lancaster can charge flat rates of 10%, 11% and 12% but interest is calculated on day one and lumped onto the loan, which can result in an expensive APR of 30%,” she says.
Going a stage further and looking at non-status lending – where no checks are undertaken – applicants will have to be pretty desperate to borrow as rates are now around 8% above the base rate and that’s with a minimum 30% deposit.
In addition to the changes made to self-cert lending to take account of the liquidity crisis, existing measures that lenders put in place to mitigate risk must be considered.
InterBay’s risk position in the self-cert market is already arguably well contained.
It offers a maximum loan size of £600,000 and restricts lending to applicants with a minimum of two years’ sector experience.
And while applicants’ income is not verified, InterBay assesses credit histories and the marketability of properties and their location.
Add this to the recent scaling back of LTVs and distribution and you have a model fit to weather the storm.
“Criteria are now robust enough that we shouldn’t have to change anything for a year,” says Bennett.
But InterBay is also in the process of expanding its product range, which could change the benchmark for self-cert applications.
Similarly, while Commercial First does not require borrowers to have sector experience, it shies away from being branded an adverse lender de-spite being named by several brokers as one of the first ports of call for this market.
“Sub-prime is a small part of our activity,” says Johnson. “Around 80% of our applicants have full credit status including histories of good mortgage conduct.”
Johnson says applicants with histories of adverse credit are restricted in terms of LTV or declined loans.
So while the lending landscape is changing, the definition of self-cert seems to be staying the same.
“The liquidity crisis has not had an effect on the nature of self-cert,” says Johnson.
“The biggest effect is that the limited number of lenders that have al-ways allowed employed applicants to use self-cert products are gradually tightening up on this.”
But stricter criteria across the self-cert board are plain to see. And according to some brokers, this is starting to inhibit individuals at the margins of commercial borrowing.
“Customers whose dream has al-ways been to start a business are still borrowing but those who are not so driven or were thinking of entering buy-to-let are opting out,” says Busby.
“Business is quieter than it was last spring and this is the time of year it usually starts to pick up.”
So while small businesses had little to cheer about in the recent Budget, chancellor Alistair Darling’s decision to increase funding for the Small Firms Loan Guarantee Scheme, which aims to provide funding for smaller companies that are not eligible for conventional business loans, could be welcome news indeed.
Old-style self-cert is dead, long live self-declaration plus common sense
Kevin Cooke is sales and marketing director at Business Lending Only when the tide goes out can you see who has been swimming naked. I’d love those words to be mine but instead am indebted to US financier Warren Buffet for them.
We have never aspired to be a truly self-cert lender. Our main proposition is a near-prime offering, but we are willing to consider cases where verifiable income is deficient but the fundamentals of lending proposals are sound.
The starting point for near-prime lenders is that we prefer income-verified transactions. Why? Because businesses should keep proper financial records. This is required by Revenue & Customs for annual tax returns and for VAT if turnover exceeds £67,000 per year.
Non-compliance with these requirements is a serious business and you shouldn’t mess with the taxman. Tax investigations take time, cost an arm and a leg in accountancy fees and penalty fines and in the worst cases, lead to imprisonment. In short, they can be devastating to small businesses.
So with that in mind, why do we entertain self-cert applications? Well, we live in the real world where the cash and barter economy exists. We realise that deals for cash are commonplace in some trades. So a sensible underwriting policy has to take into account that certain trades deal in cash and that some transactions will not be recorded.
But while self-cert loans work for cash and barter businesses, they don’t work for non-cash businesses. And even with cash businesses there are limits.
If you are pocketing more than a few grand per month, the odds are that if you lie about your income you’ll get caught. The taxman is not stupid and we’re back in the world of penalties, fines and potential porridge.
So self-declaration of income has a place in the mortgage market, but only within the boundaries of common sense in terms of business type and the amount of earnings being self-certified.
We prefer to assess and price credit according to risk, and only with honest disclosure can we properly assess that risk and price loans competitively.
Near-prime lenders are more likely to decline unrealistic self-certified income cases than those where there is evidence of income but business profits are limited. So we price risk on the possibility that businesses are not generating high levels of income, but that price premium is less than the premium applying to the familiar ‘I earn £60,000 a year, honest’ letter.
Limited self-cert is a useful tool where applicants can show patterns of income generation and established payment records. It should be used to augment files that otherwise present good credit cases and supportable lending propositions.
All too often in the past few years, self-cert has been used as a crutch for failing businesses or ill-conceived ventures. Self-cert has rightly been in the spotlight and has been found wanting. The old style self-cert is dead, long live self-declaration plus common sense.
What is a commercial self-cert mortgage?
Gary Spencer is director at Bedrock A true self-cert product is when a loan is made against the value of a property alone.
Stephen Johnson is sales and marketing director at Commercial First Self-cert is a term applied to a declaration of income made either by an individual or company applicant. This is now a mainstream product in the mortgage industry.
John Phillips is director at Kingswood Associates The term implies the self-certification of the serviceability of loans. This requires an accountant’s letter to confirm how long applicants have been trading rather than what they earn.
Sarah Busby is managing director of Birchwood Business Finance Self-cert has always been a grey area but broadly, it is where an applicant has no accounts but has the support of an accountant who can sign off their projected income and verify they are good for a loan.
Anna Bennett is sales and marketing director at InterBay Commercial Self-cert is where an applicant’s income is not verified by audited or filed accounts or a letter from their accountant. Instead, their mortgage is underwritten and their case assessed on factors other than income such as credit history, their previous mortgage repayment conduct and experience in the relevant business sector.
Lenders are stretching the traditional definition of self-cert
Nick Reeves is head of commercial lending at The Business Mortgage Company The self-cert commercial mortgage market has changed significantly since the beginning of this year.
This has come about mainly because of the ongoing credit crunch in the world’s financial markets and the effect this is having on the confidence of lenders and investors.
Many of the big self-cert commercial lenders in the UK rely solely on the wholesale and securitisation markets to obtain the funding lines that allow them to originate new loans and remain trading.
But the knock-on effect of the sub-prime mortgage collapse in the US is that the securitisation markets are now effectively closed. Indeed, the last successful securitisation by a commercial lender in the UK was in November 2007.
Commercial lenders have had limited supplies of funds since the beginning of the year. Fresh funding lines are unavailable to many, meaning several big names in the self-cert commercial mortgage market have had to temporarily stop lending to new clients. Despite being profitable businesses, these lenders have no alternative solutions until the securitisation market reopens.
There is considerable pressure on financial institutions and the government to address the securitisation problem and the Treasury has proposed developing a gold standard for mortgage-backed securities. But of course this won’t help lenders looking to securitise their books now.
The liquidity crisis has also affected LIBOR, which has risen considerably. Interbank lending has slowed due to concerns about the unknown level of bad debt circulating in the sub-prime mortgage market.
In the past month, the Bank of England has injected more liquidity into the market by making £5bn worth of short-term loans available via an auction. Unsurprisingly, the auction was oversubscribed.
Lenders that remain active in the self-cert commercial market are less dependent on securitisation and are likely to be underwritten by banks, which is one reason the market is taking a stricter line on underwriting.
In recent months, these lenders have been steadily adjusting their lending criteria in response to changing financial conditions. They are increasingly diligent in their approach to underwriting and are being more selective about the deals they offer – most notably by reducing their LTVs.
In fact, for some time now it has been virtually impossible for borrowers with adverse credit issues to obtain commercial self-cert mortgages of more than 75% LTV, and the market is still constricting.
The reasons self-cert underwriting has been tightened up of late include the fact that lenders want high quality loan books when the securitisation markets reopen, that they want to minimise their exposure to risk and that they wish to control the amount of business they receive either because of restricted funds or limited processing capacity.
In the present challenging financial environment, few commercial lenders are willing to consider mortgage business from applicants who are unable to provide meaningful trading accounts or who have substantial credit misdemeanours against their names.
The situation now is that most lenders want to see either a minimum of 12 months’ trading figures endorsed by an accountant or between three and six months’ worth of bank statements to substantiate affordability. This is stretching the traditional definition of self-cert.
It remains to be seen how long the credit crisis will affect the financial markets but the commercial self-cert mortgage sector is bound to take some time to recover from it, and its future will be shaped by the risk and funding-related lessons it has learnt.
The number of individuals seeking advice has grown fivefold in a year
Simon Baker is commercial manager at Leadbay The demand for self-cert mortgages has grown dramatically this year and while lenders may be unwilling or unable to continue to lend on a self-cert basis due to the liquidity crisis, this does not yet appear to have filtered down to the borrowers who require such deals.
The number of individuals looking for brokers’ advice on self-cert mortgages has increased fivefold in the past year, with most growth since the liquidity crisis started. These are usually borrowers looking to remortgage onto self-cert products, showing that it’s not only prime borrowers who are worried about rising rates.
The number of borrowers looking to purchase using self-cert has increased more moderately than demand for remortgages, although growth has still been dramatic.
The number of self-cert purchases dropped off between March and September last year but has increased threefold since then.
This increase in demand should be seen against a backdrop whereby the number of borrowers in general has doubled since the beginning of the year and there has been a dramatic rise in remortgaging activity. Despite this, the demand for self-cert mortgages has significantly outstripped demand in all other sectors.
The consumers looking for self-cert mortgage advice via our system appear to present a good risk. They have a different profile to the average borrower. They are older than average, are borrowing against bigger than average property sizes and have much larger deposits available. This indicates that these borrowers are mature, using self-cert mortgages to help them budget for their businesses or more complex than average lifestyles.
The average LTV requested by self-cert borrowers is significantly lower than on most residential mortgages. In the past year, the average self-cert LTV has remained just below 60% despite rising property prices.
As lenders restrict their criteria in a difficult market, big deposits are good news for brokers buying self-cert leads as it should be possible to place the business.
Not only is the average value of property being bought by self-cert borrowers higher than the norm, the value of the type of properties these borrowers are buying has also risen more than average, having gone up 15% in the past year.
Given the rise in property values, it would be reasonable to think that deposit sizes have shrunk in the past year but in fact, average deposits have increased by 13.3% in the period. At the same time, the average self-cert mortgage requested has increased from £133,000 to more than £155,000. This means that although self-cert borrowers are having to borrow slightly more, they don’t appear to be overwhelmed by the challenging market conditions. They are keeping a firm grip on their investments and borrowing – hence the stable LTV ratio.
The profile of the average self-cert borrower in the past year shows they are mature and in a relatively good financial situation. But the growth in demand for advice shows that a self-cert mortgage is still a product most borrowers prefer to take advice on.
So the strength of self-cert is good news for all players in the mortgage market because these borrowers are relatively good risks for lenders and will provide a consistent source of income for advisers.