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Is the number up for non-conform?

Guy Anker gauges market reaction to a Standard & Poor’s report which says cracks are starting to appear in the non-conforming market

The non-conforming mortgage market is in serious trouble, if you believe Standard & Poor’s. Its recent study claims that the first chinks are starting to appear in the market after three different portfolios of homeloans sold by lenders had to make reserve draws since the start of the year to protect them from losses because too many of the borrowers in the various books are in arrears.

Two Rooftop transactions, called Farringdon 1 and 2, were picked out by S&P as suffering from particular stress, with Farringdon 1 being downgraded by ratings agency Fitch earlier this year after twice drawing from its reserves to shore up losses.

One of Kensington’s portfolios also had to draw on its reserves due to a number of serious arrears cases. S&P expects further draws to be necessary in the market and is predicting further losses in the sub-prime sector.

One analyst last week raised fears that Rooftop may struggle to sell future portfolios of loans, which is the basis of its business model, because of past underperformance from Farringdon 1 and 2 although Rooftop refutes the claim.

The general consensus in the market is that any problems that lenders are experiencing are of their own making and do not represent a wider problem for the market as a whole. But experts warn there are issues that the industry needs to keep an eye on to prevent future problems.

Pink Home Loans managing director Tony Jones says: “I think the market is healthy. There will always be issues in any sector and if they get worse and lenders have problems with their books, then there could be an issue with confidence.

“There are some high-profile problems out there and if there is a tightening of criteria, it could dampen activity in the market.”

Bradford & Bingley head of strategy and planning and economic expert Peter Charles says: “The economic environment is pretty stable. There is no huge rise in unemployment so there should not be particular pressure on borrowers on the whole. What it means for non-conforming lenders is that they must be careful with the borrowers they take on.”

Nevertheless, arrears and repossessions are on the rise although they are still at historically low levels while interest rates increased from 4.5 per cent to 4.75 per cent in August, with a further 0.25 per cent rise expected before the end of the year.

That will inevitably bring more pressure on borrowers which are teetering on the edge of their financial capabilities and subsequently on lenders which have to pour further resources into their arrears management, as Rooftop has done this year.

The Council of Mortgage Lenders has put the blame for the rise in arrears at the feet of the sub-prime market because such lenders are more liable to take a sterner line with arrears and because of the high-risk nature of such borrowers, which supports the assertions that the problems in the market are nothing to do with the economic climate.

Premier Mortgage Services managing director John Malone says lenders are to blame for the rise in arrears and slams some firms for irresponsible lending.

He says: “If the strategy is to lend money on the understanding that properties are appreciating so in 18 months they can be repossessed, that is irresponsible and the FSA will frown upon that.

“Some people end up committing suicide so you could call it suicide mortgages being sold. Brokers must also realise that they are part of the process and make sure they assess the client’s capacity to repay.”

S&P has a chilling outlook for the remainder of the year for the non-conforming sector. It says: “The arrears and repossession levels in the non-conforming market continue to rise and we expect to see an increase in the losses in the second half of the year, with the possibility of more reserve draws.”

S&P says the emergence of automated valuation models could lead to further issues because they involve greater uncertainty than physical inspections. Only time will tell whether the instant offers that benefit from AVMs such as those unveiled by GMAC and Edeus recently will make it harder for firms to securitise books of business.

An analyst at a major investment bank, who wishes to remain anonymous, says Rooftop, in particular, may struggle to securitise in future. The source says: “There is no doubt that specialist companies are designed to sell mortgages so you could argue that the viability of Rooftop’s policy in its current circumstances needs some thought. It will become more difficult when the next sale comes along.”

Rooftop managing director Jonathan Naylor says: “We are not of the view that this investment performance will adversely affect future securitisations.”

GMAC has yet to experience any such worries. Marketing director Jeff Knight believes smaller lenders will always fare worse than their bigger counterparts if their underwriting criteria is not robust enough because they have less financial clout behind them to make up for any losses.

He says: “There are no serious chinks in the market. It is competitive so there will always be winners and losers. The issues that the smaller lenders have do not make as much difference to the market as if GMAC or another big lender got into trouble.”

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