A return to common sense lending?

Do you remember when your kids could play in the street without you worrying if they were going to be shot or stabbed? When Winters had a certain predictability, Summers actually seemed sunny and when going on holiday was an adventure, not an endurance test?

I have reflected on this recently in light of the now infamous ‘credit crunch’ caused by the suicidal lending policies of the US non-conforming sector, to a time when things seemed altogether more structured in the mortgage industry, where lenders could price for risk, and everyone made money.

Those heady days have seemed so far away lately, but could they be making a comeback? I would say very possibly, as far as mortgages are concerned anyway. Sadly the weather just seems to get worse.

Crisis and opportunity?

The Chinese have the same symbol for crisis as they do for opportunity, and thus it is so with the current situation in the non-conforming markets – we have seen some non-conforming lenders pulling out of the market altogether, others temporarily, others have increased prices, scaled back loan-to-values or tightened their lending criteria, and at the time of writing, Victoria was on its way into administration – and I am sure it won’t be the last.

The majority of lenders in the sector predictably are saying – at least publicly – that these changes are temporary and short term as they try and reduce volume until the credit markets regain some confidence so that securitisation values once again increase. I believe it’s fair to say that lenders with strong balance sheet facilities or with wealthy parents are quietly pleased that the market is going through this forced correction, which has been long overdue.

Hard to extract margin

In recent years non-conforming lenders have found it increasingly hard to extract margin from lending. The countless new entrants – backed by third party funders – have driven pricing down and loosened criteria far beyond any level that the traditional lenders would have been comfortable with, many of whom have said so publicly. In terms of volumes, from a broker and packager perspective, this has been good news, as some clients have been able to achieve ludicrously competitive rates considering their credit history, and in some cases these rates have been as good as, if not better than prime high-street rates; a situation that could not continue.

Clients that had previously qualified for middle or heavy adverse products were suddenly able to get ‘near-prime’ or ‘super light’ type products. Those brokers and packagers regularly dealing in the adverse market have seen a massive shift in their business mixes over the past few years, with ‘heavy adverse’ volumes down as near-prime rates become more accommodating. As a result, average retained margins have fallen. We all may have been writing more business, but with all the costs attached, in terms of staff, regulatory requirements and time, it’s all been for a much lower return.

Firming up the blurred edges

With the correction – for that is what we believe it is –that is taking place, it is almost certain that less non-conforming business will be written, although I don’t advocate the 40-50 per cent drops predicted by some. However, the business that will be written will be priced for risk and the blurred lines between super light, light, medium, heavy and unlimited will once again firm up, and so they should.

I believe that debt management and Individual Voluntary Arrangement (IVA) counselling will play a bigger part as will secured second charge lending as a viable alternative to often expensive non-conforming remortgaging.

These changes mean that although less non-conforming mortgage business will be written, there will be increased margins generated to offset against the drop in volumes. This means operating costs can stop spiralling and service levels can be enhanced. With no fall in demand for non-conforming solutions, it also means other opportunities now exist, particularly in the loans and debt management sectors, which will both now see a boost in enquiry levels.

Let’s also not lose sight of the ‘Treating Customers Fairly’ (TCF) element. TCF has an increasingly important part to play going forward as more options are explored for many clients who are priced out of the market.

Correcting advice cycles

Now that the market is correcting, broker’s should be correcting their own advice cycles too. If clients will now no longer qualify for a first charge mortgage, they should then be directed towards a second charge alternative. If that is also not an option, only then should debt management or an IVA solution be considered. This ‘safe non-conforming advice cycle’ should be adopted by all brokers in this sector. To ensure that the right solution is recommended to the right client at the right time, brokers and networks will need to seek out providers who can help them efficiently achieve this ‘cycle’ for these clients.

It is a shrinking market and the winners will be those that exploit the opportunities to add value to their clients and distributors in this new era of common sense lending.

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