It is a rather well-worn phrase that when the US sneezes Europe catches a cold but recent developments in the US sub-prime market could give some in the UK cause for concern, particularly given the similarities that exist between the two markets.
A recent article in The Times newspaper called the collapse in the US sub-prime market a “deepening scandal” that looked “more and more like a cautionary tale of financial excess that sits unhappily alongside Enron and the dot-com bubble, both in terms of scale and consequences.”
The factors that contributed to the collapse of the sub-prime market in the US are familiar to anyone working in the mortgage industry in the UK. Lending criteria were relaxed in part at the start of the decade because of a booming housing market. But vulnerable borrowers were given 100% loan to value mortgages or higher income multiples were applied to allow them to borrow more, which in turn helped to continue to push house prices up.
The majority of sub-prime loans in America were adjustable rate mortgages, or “Arms”, says The Times. These started out as discounted rates but interest payments soon jumped when the discount period came to an end.
Meanwhile, the historically low interest rate of 1% that held sway over the US economy in 2003 and 2004 has now risen to more than 5%, heaping greater pressure on borrowers. The net result in the US has been a surge in mortgage arrears and defaults on sub-prime loans, while more than 30 mortgage lenders have gone bust since last year.
Moreover, The Times continues, thousands of Americans who were already struggling to service their loans have resorted to refinancing, taking on still more debt at disadvantageous terms. But with falling house prices in some areas now pushing these overstretched people into negative equity, the lenders’ doors are barred. And repossessions and forced sales of homes are rising sharply.
While the problems in the US are somewhat exaggerated they could hint at problems that are only beginning to appear in the UK, with research from ABN Amro suggesting UK house prices are more vulnerable to a crash than in the US. And Standard & Poors have revealed that while only 5% of UK mortgages are sub-prime loans, a quarter of them are 30 days in arrears.
Mortgage arrears have been increasing all the time and there have been three interest rate rises since August last year. Kensington Mortgages also recently reported loan losses of £6.2m for the three months ending February 28. And total personal debt rose to £1,310bn at the end of February with estimates suggesting it is increasing by £1m every four minutes.
Lenders themselves have expressed concerns about lendsing criteria, David Tweedy, managing director of Platform at the Packager Summit earlier this year said: “We have seen margins reducing, we have seen credit being stretched to points which five or seven years ago we never would have imagined.
“And pricing for risk? Sometimes it is clear it’s not being followed or at least not as well as it should be. This is all good for borrowers and intermediaries but there is a danger that we go to far.”
At the same event, Peter Beaumont, deputy chief executive of Mortgages PLC said: “There is evidence that where certain lenders have pushed their credit risk criteria their ” Only the most optimistic believe UK sub-prime market growth over the past few years can continue”arrears performance is way above the average. Investors read this sort of research and there is a danger you get into a vicious cycle where that type of lending can get itself into some difficulty and once the market slows down and those lenders don’t have house price inflation to cover them, they could get themselves into a very tricky situation if they are not careful.”
But Nigel Payne managing director of The Mortgage Business argues the risk appetite of UK mortgage lenders has not been as extensive as in the US sub-prime market.
He adds: “Unemployment is low in this country and interest rates are also still pretty low and if there is anything that will cause problems in the UK they will be driven by higher interest rates and unemployment.
“But the demand for housing is still there as well and as long as it continues to outstrip supply it’s unlikely we will see any problems. Growth may not be as high – it may not be in double figures – but there will still be growth.”
That said, Nick Baxter, director of Mortgage Promotions believes packagers and distributors should be concerned by what has happened in the US.
He says despite the fact the UK appears to be in a different part of the economic cycle to the US the recent arrears figures announced by Kensington – revealing 10% of its borrowers were in arrears – is a source of concern.
“If lenders start having problems, then everyone else in the value chain starts having problems as well and intermediaries and distributors would have to make serious changes to their business plans and strategies if we experienced similar problems to those occurring in the US,” Baxter says.
“If I was a lender in the UK I would be looking at tightening my lending criteria now to be on the safe side.”
Predictions the UK sub-prime market will suffer a catastrophic collapse would be wide of the mark but only the most optimistic believe the growth seen over the past few years can continue.
Maybe the truth lies somewhere between the two extremes but can anyone afford to ignore what has been referred to as merely “a serious correction” in the US sub-prime market?