Sub-prime is an established market in the US, so stock markets were hit hard following news that US market regulator the Securities & Exchange Commission is investigating troubled sub-prime mortgage lender New Century.
New Century is not alone – several other US sub-prime lenders are suffering too. Problems have been instigated by a rise in defaults and bad loans. These are partly down to the rise in interest rates. The worry is that this situation could be recreated in the UK. In the past few years, more big lenders have started offering sub-prime mortgages, directly or through subsidiaries. And a lot of US firms have also invested in the UK sub-prime market.
In the UK, Lehman Brothers has Southern Pacific Mortgage Limited, Preferred and London Mortgage Company, Morgan Stanley bought Advantage and Merrill Lynch owns Mortgages PLC and Freedom Lending. If they withdraw from sub-prime, we could have a repeat of US situation, especially given rising interest rates, spiralling debt and more loan defaulting in the UK.
But this has to be put in context. Commentators have pointed out how small the sub-prime market is in the US, arguing it can’t be responsible for the current market turmoil. Alan Steel, chairman of Alan Steel Asset Management, has done some market analysis. He says around 114 million households in the US own their home, of which 50% don’t have mortgages. At most, a third of this 50% may be sub-prime.
Statistics say less than 5% of sub-prime borrowers risk defaulting. Even if this were 10%, less than two million borrowers would face defaulting – and Steel describes this as a worse case scenario. And as Melanie Bien, associate director at Savills Private Finance, says, the sub-prime market in the UK is less mature than in the US.
US lenders fell into the trap of offering high LTV, but with restrictions. Also, house prices are still rising, so equity can be refinanced. As US house prices have been falling, this has not been possible. The UK market has been watching the US and will continue to. This isn’t the time for complacency.