The Financial Service Authority recently launched an investigation into U.K. self-certified mortgages, following a British Broadcasting Corp. program that highlighted an increase in fraudulent claims.
According to the BBC findings, a large percentage of borrowers applying for these non-conforming mortgages were encouraged by brokers to exaggerate yearly salaries in order to boost their borrowing potential. According to one broker, at least 30% of his business was accounted for from these types of mortgages.
One of the key rules under the FSAs new mortgage regime - which they plan to implement in October - requires mortgage lenders to take account of the ability of a borrower to repay any loan advanced.
"It is a criminal offense for an individual to lie about their income or for an institution to encourage their customers to lie," explained the FSA. "Clearly, there is an inherent higher risk with self-certified loans, which means that lenders need to have robust controls in place to ensure that the features of the product are not abused by either the borrower or the seller. We are taking a close look at self-certified mortgages to make an assessment of how widespread abuses may be. We will then determine what, if any, further action we need to take."
FSA estimates that 6% of the U.K. mortgage balance and 8% of new lending fall under this category, but the BBC program suggested that it is an even greater percentage, if fast-track mortgages are to be included.
Although lenders reserve the right to require adequate documentation to prove salary claims under fast-tracked mortgages, in order to expedite the process, these mortgages often remain largely unchecked, said the report. The program cited a major U.K. lender, Northern Rock, as not always requiring documentation for loans with loan-to-values of 75% or below.
The FSA concluded that lenders often employed various methods of credit scoring outside of income verification that included stress testing against a rise in mortgage rates and fraud detection systems. Also, based on arrear trends, self-certified lending performed better than mainstream lending.
"Trading in mortgage-backed bonds with exposure to self-certified loans reflected little concern over the BBC report," said analysts at the Royal Bank of Scotland.
Because of weakening consumer fundamentals, the market is placing a greater emphasis on performance levels for non-conforming mortgage pools, especially as it becomes a place investors look for value. With prime mortgage spreads at tight levels, a bid in this sector should continue into the year.
Analysts remain confident that, in the event of further deterioration - such as a rise in arrears - these structures incorporate enough credit enhancement to adequately cushion losses. Fitch Ratings last week upgraded 18 U.K. non-conforming RMBS transactions, affirmed 50 subprime RMBS deals and said that, despite the recent rate rise, the economic condition remains benign.