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Rating downgrade was warning shot

This week my column carries a health warning – it contains scenes of mild peril and references to securitisation.

You may be thinking securitisation is about as exciting as watching wood warp and from an intermediary’s point of view that may be true. The problem with securitisation is its lack of visibility. By nature it is a process that is one for the back room boys.

But hang on, securitisation is an essential element of not only the UK mortgage market but mortgage markets across the world. The heartbeat of product choice in this country’s mortgage market is lenders’ ability to securitise.

Consider how the market looked before the mid-1980s. Lending was controlled by a tight band of lenders that looked like a cartel and lent off balance sheet. Then came securitisation and the market transformed itself overnight. There was a ready flow of funding for consumers’ mortgage requirements. The old barriers to entry had been swept away.

Fast forward to 2006. Things look just as rosy, with plenty of funds to supply customers’ needs. From the financial market’s viewpoint performance has been good. But more importantly the rating agencies have been happy – until recently that is. The fact is that the rating agencies have not needed to downgrade any residential securities until the past few weeks.

Then, two weeks ago, one unfortunate lender’s security became the first to be downgraded since the late 1990s – a pretty nasty fate to befall any security. All lenders take note.

In the heat of doing business and competing – which all serious lenders have to do – it’s all too easy for lenders to overlook credit quality and underwriting standards.

For those lenders that relax underwriting standards there will be a sting in the tail. Lenders that take a relaxed view of the twin essentials of credit quality and underwriting standards will need to review their policies – and quickly. The capital markets will act without mercy when it comes to such lenders’ securities, and rightly so.

But there is a need for some perspective here. I’m sure the downgraded lender is just an isolated case. But there will be ripples with the potential to cause problems in securitisation markets in the short term.

Should we be concerned? Not overly. But we must be clear that a threat to securitisation will be a threat to the lending market as a whole.

The rating agencies are watching, as they are supposed to. Any action they take is likely to have a knock-on effect. Lenders looking to aggressively build business by volume without paying due regard to underwriting standards have just heard a loud warning shot.

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