The UK non-conforming mortgage market – colloquially known as sub-prime – was the only fully fledged non-prime mortgage market in Europe. It was one of the first sectors to suffer contagion from the US sub-prime crisis. Indeed, spreads on non-conforming RMBS began to widen in March 2007 – well before the generally acknowledged beginning of the credit crisis in August of that year. What has now become of that market? Can it ever be revived?
The short answer is that much of the UK sub-prime market has either stopped lending or simply disappeared. Deutsche Banks DB Mortgages operation was one of the first to cease lending to new sub-prime customers, in August 2007. Investec-owned Kensington Mortgages followed suit in November 2007. Paragon, a leading buy-to-let lender a market that partly overlaps with non-conforming lending ceased lending to new customers in February. In mid-September, it rejected a £373 million ($687.7 million) takeover proposal from a private equity group and abandoned talks with other potential bidders.
London Scottish Bank stopped writing new second-charge mortgage lending in January and first-charge lending in June. It is rather appropriately now principally focused on debt collection. Morgan Stanley pulled the plug on its Advantage Home Loans operation in February this year and Bear Stearns-owned Rooftop Mortgages ceased operating in April after its owner was taken over by JPMorgan. Merrill Lynch-owned Mortgages PLC was shuttered in April, as was Skipton Building Society-owned Amber. Merrills other sub-prime lender Wave, ceased lending the following month.
A late entrant to the sub-prime world, Alliance & Leicester, is now owned by Santander and no longer operates in the market. Northern Rock, of course, is government-owned, no longer lends to sub-prime customers and is trying to persuade as many as 60% of its less-creditworthy customers to go to other providers when they need to remortgage.
Lehman Brothers was in negotiations with private equity firm BlackRock to sell its Southern Pacific Mortgages, London Mortgage Company and Preferred Mortgages operations before it collapsed in September. Even if the BlackRock deal goes ahead under the auspices of Lehmans administrator, the mortgage lenders are likely to be bought for their outstanding book rather than their potential for new lending no buyer will want to resume lending to the UKs most risky borrowers at a time when house prices are falling at an annualized rate of 12.7%, according to HBOS. Similarly, any broader consolidation of UK sub-prime assets is unlikely to herald a recovery in lending.
Of the remaining UK sub-prime lenders, BM Solutions is perhaps the most prominent. However, it is owned by HBOS, which was bought by Lloyds TSB in September, and is widely expected to be closed following the takeover. Other names still in the market include operations run by building societies such as Chelsea, Britannia and Yorkshire and GE Money-owned First National. Unsurprisingly, all are reliant on balance sheet funding rather than securitization which, according to research from Deutsche Bank, funded as much as 70% of all outstanding UK non-conforming mortgages.
Ray Boulger, John Charcol: funding resumption years away
"The sub-prime market is concentrated solely on balance sheet lenders and has contracted sharply as a result," says Ray Boulger, senior technical manager at UK mortgage broker John Charcol in London. Charcol estimates that sub-prime lending constituted up to 9% of UK mortgages before the credit crisis and is now less than 2% of a much smaller market. Figures from the Council of Mortgage Lenders showed that in August 2008 overall mortgage lending was 36% lower than a year earlier.
The UK RMBS market, which totalled the equivalent of 132.5 billion in 2007 and accounted for 51% of the overall European RMBS market, according to the European Securitization Forum, has effectively been closed to UK issuers this year even for prime collateral. Only two public deals have come to market: a Bank of Scotland £500 million Permanent master trust deal in May and a £400 million equivalent issue from Alliance & Leicesters Fosse master trust in August. Other private retained deals, used as collateral with the European Central Bank and the Bank of England, amount to 99% of issuance in the first half of 2008, according to Royal Bank of Scotland.
"The MBS market is simply not open to sub-prime lenders and even if it were the cost of funds would be prohibitive," says Boulger. "When the market does reopen most likely in a different form sub-prime will be the last in the queue. Prime will lead the way, followed by buy-to-let, eventually followed by sub-prime. No-one can tell when that will be the resumption of market funding for sub-prime lending could be many years away."
Certainly, the performance of outstanding non-conforming RMBS is likely to give investors little cause for celebration. Standard & Poors UK non-conforming RMBS delinquency index hit a record 23.31% in the second quarter. "The rise is being driven by affordability pressure, especially for borrowers whose loans are resetting to higher floating interest rates," explains Kate Livesey, credit analyst at the rating agency. "With no sign of credit conditions easing and house prices continuing to fall, we expect delinquencies to continue rising and losses to increase over the coming quarters."