The reality behind the headlines

It’s a tough time for adverse lending at the moment, as economic conditions beyond our shores and general market sentiment conspire to put the squeeze on funding lines, which has a knock-on effect on UK lending and the perception of the industry.

Yet, although recent headlines may have painted a rather gloomy outlook for the market and the so-called ‘credit-crunch’, if you look behind the stories and speculation it is clear that the sector is growing steadily, based on the same strong drivers that have helped develop it over the past 10 years.

Cream rising to the top

The measure of a well-managed and sustainable industry, and the businesses that populate it, is the ability to deal with issues such as the current credit concerns and move on. There is no doubt that the cream of the industry is again rising to the top.

According to Datamonitor, the adverse credit market experienced another strong year of growth in 2006, with gross advances increasing by 28 per cent on 2005 to reach £24.6 billion. Datamonitor estimates that around 4.2 million people of working age in the UK would have been classed as adverse credit mortgage individuals in 2006, which again represents an increase on 2005. The firm’s research also shows that 11.6 per cent of the working population can now be classified as having adverse credit requirements.

Within this overall growth, the near-prime sector is currently the fastest growing segment of the adverse market, with Datamonitor estimating that the segment currently accounts for 70 per cent of new business in the adverse credit market – whereas around five years ago the majority of the market was for medium and heavily credit impaired individuals. If you compare those figures with the picture of woe some commentators have painted about ‘non-conforming’, then the reality of the market’s future is a lot healthier.

In the future Datamonitor expects the adverse credit market to grow at a yearly compounded rate of 4.7 per cent – nearly twice the rate of the mainstream. According to the company, this growth will mean that by 2011, the adverse credit mortgage market will reach £31.5 billion and account for 8 per cent of the total market – up from 7.3 per cent today.

Datamonitor’s estimate of 4.2 million credit adverse borrowers in the UK – 2.3 million households – means that an additional 132,000 people were deemed an ‘adverse credit risk’ in the last 12 months. But the reasons for this growth are more diverse than simply financial or credit problems, and show why the growth of specialist lending is vital.

Here are some of the headline figures in the breakdown of those 4.2 million people:

  • The number of unemployed people in the UK increased by 120,000 between the end Q1 2006 and end Q1 2007, and there are currently 1.65 million people registered unemployed in the UK, many of whom need common-sense lending advice to help them through a difficult period.
  • The number of people struggling with financial problems is also on the up, as seen by the increase in CCJs, with 445,000 CCJs issued in the first half of 2006. In addition, more than 11,000 individuals entered in to Individual Voluntary Agreements (IVAs) in Q2 2006.
  • The cost of modern life is also taking its toll, as it is estimated that 40 per cent of all marriages end in divorce, with around 150,000 divorces each year in the UK alone according to the Office of National Statistics. Research by the BBC Money Programme put the average cost of ending a marriage through the courts at around £13,000. So divorcees are likely to be people with financial issues, and possibly even borrowers with no credit history.
  • At the other end of the spectrum, people are getting into debt earlier and earlier – compounded by the fact that many people have to wait longer to be able to afford a property. According to NatWest, the average student debt was £13,252 in 2006. Students currently in their first year of university can expect to leave with average debts of nearly £15,000. Despite this, more people are applying for university than ever.
  • Meanwhile, buy-to-let and self-certification sectors are also growing as borrowers seek more specialist mortgages unavailable on the high street. People with non-traditional employment patterns, whether it is the self-employed or people working contracts or multiple jobs, are also finding it harder to get mortgages on the high street and are consequently turning to specialist lenders. Soon the specialist market will account for a third of all UK mortgage applications.
  • According to our own research, the average ‘adverse’ customer is aged 42, owns a house valued at £133,000 with a mortgage of £88,000. This is not the profile of a high-risk borrower set to bring down the industry, but rather an ordinary person that does not fit the tight constraints of ‘mainstream’ funding found on the high street.
Reshaping the market

It is these drivers for growth that are also changing the shape of the adverse credit market, with a shift towards near-prime. Lenders are responding to this change by developing quicker and more efficient processing systems. The specialist mortgage market, including adverse credit, self-certification and buy-to-let, is more criteria sensitive than the mainstream, so technology now plays a more important role in the specialist mortgage market than it does in the mainstream as it provides a tool for brokers to source products on criteria as well as rate.

Major distributors are developing their own systems to help brokers source specialist products and automated decisioning is becoming increasingly prevalent in the adverse credit market, where the majority of applications are now simpler near-prime cases.

However, we must ensure that we use technology sensibly. Experienced lenders have pragmatic underwriters who can make a decision where a computer cannot, and this must continue. Otherwise the evolution of the market could risk it arriving at a point were some borrowers are excluded because of the rigid criteria of automated systems – and this was why the industry was established in the first place.

Adverse mainstream

So the reality behind the headlines is that the adverse market is becoming more mainstream. It is touching more borrowers and becoming more accessible to more brokers. It has also attracted more lenders, with 54 lenders offering specialist mortgage products in 2007.

Here again there is a different reality under the perception of a growing and potentially over-supplied market. Many new lenders have battled aggressively for market share, using criteria and price, but there have always been doubts over the sustainability of this tactic, and it is likely that several of these late entrants will be forced out of the sector by the market correction now taking place. What this does do, however, is highlight the longevity and the experience of those lenders that have been around for a long time, bringing stability to the industry.

The specific problems faced by non-conforming lenders in the US will not find their way over to the UK, but as global credit market sentiment has changed, LIBOR has increased as banks have become more cautious and the cost of funding for adverse credit lending has increased. As the market has tightened, some lenders that had set criteria and were pricing for volume instead of risk, have reassessed their positions. Others have proven that they are experts in assessing risk and have maintained robust, sustainable models, built to provide consistent lending at competitive prices throughout a series of economic cycles.

There will be an inevitable flight to quality by investors worried by global credit issues and this will mean a move to invest in portfolios that were constructed by experienced lenders, who priced for risk and whose portfolio management is high performance. This flight to quality will encourage continued high standards within the UK to meet the demands of a growing specialist mortgage sector and that means those lenders who are committed to the market for the long term will rise to the top.

For brokers, this reinforces the long-term viability of both the adverse credit market and the majority of lenders who supply it. So introducers should not fear for the health of the industry. They need to be proactive in marketing to specialist customers by making it clear that they can find solutions for people with CCJs, arrears, IVA or bankruptcy. They can make their marketing go further by widening the scope of advertising, making use of the web and lead generators and raising their profile with the local media.

Importantly they should be looking to build strong working relationships with specialist lenders and stay abreast of industry issues.

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