After reassuring the Scottish audience that a north of the border mortgage disease has not broken out, I focused on the fact that a lot of lending institutions in difficulty are those that have increased their asset base significantly by buying in assets from third parties.
Quick synopsis. Many traditional lenders (you know the safe ones who built their business over decades, not weeks) were getting left behind in the pre-credit crunch world.
Ironically, they had all the attributes now considered strengths. No innovation, mainstream products, distribution via clapped-out branch networks, funding mostly by retail deposits, asset growth barely staying a positive number.
So the average chief exec, feeling the hot breath of merger or takeover under his collar, felt compelled to act. Unfortunately, they did not have the in-house ability or funding to leapfrog and up the pace.
However, there was another solution. Over the years, the wholesale-funded lenders had dreamt up an alternative to securitisation – whole loan sales. In the early days, this was mostly driven by two parts. First, the wholesale funded lenders did have all the attributes the traditional lenders did not and therefore were growing their market share ahead of the wholesale market’s ability to fund it.
Second, and more assiduously, in the early days of the growth of the securitisation market, standards actually were pretty high. By this, I mean you had to generate good quality loan asset to put into the pools – the rating agency, the due diligence, the investor and the warehouse line provider (investment banks) were all doing their job.
However, this was slightly inconvenient because it meant a pile of “credit-worthy” loans were getting kicked out. Not necessarily sub-prime, let’s call them niche. Stretched income multiples, high LTVs, large loans, new build BTL, unusual property types. Of course, a rising market disguises all these blemishes. So the wholesale lenders started pitching to the traditional lenders pools of asset – good “credit”, better margins (which at least was truthful) and originated by the “experts”.
This blossomed over the last 10 years to a huge scale with institutions often making it a more attractive alternative than the securitisation route.
Literally billions of pounds worth of mortgage assets were being traded between lending institutions – typically wholesale lender to building society. This reached its peak with the B&B signing up to a multi-billion-pound deal over several years.
What’s this got to do with the Dunfermline? It was yet another building society who had bought in assets from another originator.
In fact, as I was quoted on BBC radio, the first thing I would do if saving or investing, is to check the track record of the institution on this particular point.
The Dunfermline failed because it could not absorb a circa £100m loss. The typical sized trade historically was £250m…and most purchased multiple books.
It appears highly likely that this type of transaction, the whole loan sale, will never reappear. The FSA is certainly aware of its impact on the various institutions it either owns, part-owns or has helped rescue.
Business mantra was always about allowing companies to fail and letting markets decide. Unfortunately, the banking sector has proven to be too important to allow this but lessons will be learnt and despite the buyer beware principle the whole loan sale market for new lending looks unlikely to survive.