Lenders warned to heed the US lesson

Declining house prices and rising sub-prime mortgage defaults in the US are early warning signs that UK lenders would do well to heed now or else risk facing similar problems with credit risk in the near future, a new report has warned.

The report from Towergroup, says the UK and US mortgage markets are at opposite ends of the lending market cycle.

In the UK, it says, the Bank of England has kept interest rates at a fairly stable level, while house price inflation has increased at a healthy rate in most regional markets as mortgage lending volume has grown year on year.

In the US, the Federal Reserve raised interest rates over 17 consecutive months beginning in June 2004, causing short-term US mortgage rates to climb, lending volume to decline and regional house price falls.

What this all means, according to Craig Forcadi, research area director at Towergroup, is that US lenders will need to rely more on new product innovation, technology and marketing to gain competitive advantage and increase market share rather than on lending volume.

Meanwhile, UK lenders will need to better evaluate their credit and risk profiles, and adjust their underwriting rules and loan pricing because of an uncertain future, despite the belief in some quarters that house prices will continue to rise indefinitely.

The report warns lenders will need “to replace today’s irrational exuberance with rational exuberance and then sober reality as UK home prices decline and non-conforming and sub-prime loan default rates increase. Those who say it is different this time and that home prices won’t ever decline will be sorely disappointed. Lenders need to polish their crystal balls to identify early signs in the market to determine when to make policy changes and when to tighten their guidelines.”

And the report states lenders reliant on one distribution channel or product line, such as sub-prime remortgages through the intermediary channel, should begin diversifying. Towergroup also warns lenders need to expand into the retail channel, prime credit and purchase loan businesses as well as referral or partnership programmes with home builders and estate agents.

Focardi says: “As more sub-prime lenders fail and equity capital is lost, the mortgage market will continue to be a drag on the US economy and stock market, but will not severely threaten it financially.

“TowerGroup believes the US mortgage market is resilient and will find market-based solutions to resolve its problems.”

He adds: “The UK has an advantage in seeing the effects of overheated housing and mortgage markets in the US, and should heed the US experience instead of claiming that ‘we’re different, and it can’t happen here.”