Unforeseen dangers of weak criteria

I recently attended the Global ABS conference in Barcelona. This year, 4,000 people from all over the world descended on the city to discuss the European securitisation market.

As in previous years, the conference provid-ed an opportunity for lenders that rely on securitisations to meet investors, answer questions and brief them on future developments.

Why does this matter to brokers? The reason is that shifting trends and opinions in the securitisation market affect the products lenders can offer. Some of the largest providers of specialist loans in the UK rely on the Barcelona crowd to fund their production.

If investors take a vehement dislike to a product or a particular element of lending policy, the affected products will disappear from lenders’ ranges.

Predictably, a lot of the concerns this year relate to the problems seen in the US market. The fallout from the sub-prime correction is becoming increasingly political, with US regulators asking fundamental questions about the viability of certain products.

Basic elements of product design are under scrutiny. Regulators are questioning whether or not lenders should originate interest-only loans, whether teaser periods should be permitted and if they are, what level of payment shock should be allowed. The outcome of these discussions could alter the shape of lending in the US, with the worst case scenario ultimately leading to smaller sub-prime volumes in the country.

The UK is a different market to the US and the macroeconomic fundamentals are sufficient-ly different to make US-style problems unlikely here. But a few investors in Barcelona highlighted UK trends that are worrying them.

The most common issue raised was that competition in the UK has increased significantly. More lenders are fighting for a slice of a market pie that hasn’t grown much since last year. And if lenders find their volumes being squeezed, some will succumb to the temptation to weaken their criteria.

The US problems were triggered substantially by macroeconomic changes. But the scale of the impact those changes eventually had was driven by weak lending criteria across the sub-prime market. It is not sensible to lend 100% LTV first mortgages and 25% ‘piggy back’ second mortgages to borrowers who state their income and properties’ value over the phone.

I’m not suggesting that anyone in the UK is that cavalier. But lenders would do well to remember that the views of investors will drive product design, so any decision to relax lending criteria will have consequences beyond the intended growth in volume.