Will heavy sub-prime lending make a comeback to the mortgage market?

One of our experts believes heavy sub-prime is dead while the other thinks a more risk-averse version of it will rise from the ashes eventually

You should never say never but I believe the answer is no and for many reasons.

Kevin Friend:As one victim of the market turmoil says, “Exit stage right for the end of an era.” That’s how I see the sub-prime sector.

Anyone who suggests that heavy sub-prime lending will return as we knew it in the past doesn’t understand the mortgage market and why it is in turmoil.

In March 2007 there were 32 lenders offering sub-prime loans but how many are there now? Heavy sub-prime lending was arguably the most irresponsible approach our industry has ever taken. Some lenders have been slammed by the Financial Services Authority for failing in their duty to protect vulnerable debtors and rightly so.

The criteria and rate war waged by lenders competing in heavy adverse led to loans being offered to home owners who were compulsive non-payers. We now see delinquencies running at over 20% in the sub-prime sector and the provision for bad debt is rising.

Why would lenders in the future offer loans in such a risky area and will they even be allowed to? Home owners who require loans that meet medium or heavy sub-prime criteria need financial advice – debt counsellors and even IVA guidance, not more debt.

The cost of heavy sub-prime loans to borrowers is high, as is the price being paid by firms that built their businesses on the back of the high proc and packaging fees associated with them.

Around 3% plus was the norm in fees and this has been paid by borrowers and the firms that purchased the loan books where the debt now sits.

There’s no business or moral reason why the answer should be yes. The market has had to learn hard lessons and there’s no place for heavy sub-prime.

Danny Lovey:I believe the mortgage market will find a way to meet the needs of heavy sub-prime borrowers as there’s still demand for such products.

While I wouldn’t suggest that UK sub-prime underwriting was ever as lax as it became in the US, there’s no doubt that our adverse sector effectively stopped pricing for risk in the first half of last year, such was the market’s competitiveness. After all, there were too many players and supply outweighed demand.

When a market stops pricing for risk you know it will end in tears. But nobody could have forecast the depth of the damage done by US sub-prime mortgages and their ramifications for global liquidity.

One could argue that investor confidence in securitised bonds of any currency has been terminally damaged by the debacle.

Certainly this is the case in the short term and as a result only balance sheet lenders can compete successfully for funds at the moment, with wholesale financing having dried up.

In the medium term, off-balance sheet adverse lenders will look for regular warehousing streams when liquidity returns and allows them to sell on their mortgage books again. But until this happens it’s difficult to see the green shoots of recovery in heavy sub-prime.

In the long term some form of securitisation will return and an updated model will rise from the ashes. But regardless of when this happens, I doubt heavy adverse mortgages will ever be as readily available as they were in the pre-credit crunch market.

This is no bad thing as pricing should reflect risk. If it doesn’t it sends the wrong signals to consumers, i.e. it’s no big deal to have a poor credit record.