The Financial Services Authority (FSA), the U.K. nongovernment finance regulator, recently concluded that several subprime mortgage lenders and intermediaries use weak and irresponsible lending practices, and it questioned the ability of several firms to assess mortgage affordability properly. The FSA has also begun "enforcement action" against five firms, though which firms and what action is being taken have yet to be made public.
Several U.K. investors have praised the FSA review as a good step toward ensuring a solid future for RMBS. "The FSA's statement last week regarding U.K. nonconforming lending provided a strong positive to the sector, in our view," said Societe Generale senior analyst Chris Greener. "We believe that high arrears are in part driven by aggressive sales tactics employed by brokers competing for business and that the FSA's message was that it will not tolerate such behavior.
"We believe that an improved origination process may significantly reduce arrears and, hence, defaults in future vintages," he added. "Given significant spread widening in the sector, we will be watchful for value in the late 2007 vintages."
As part of its work, the FSA reviewed 11 lending firms representing more than 50% of the U.K. subprime market by volume of sales. The FSA also reviewed 34 intermediary firms covering 485 customer files. FSA complaints on lending practices included the failure of intermediaries to explain why they often advised mortgage borrowers to self-certify and the failure of lenders to check the plausibility of these applications, often in violation of the firms' own lending policies.
The FSA announcement comes at a time where a U.S. subprime spillover seems to be threatening the U.K. RMBS market. In fact, more and more investment banks and mortgage lenders are steering clear of commenting on the effects that subprime lending may have on the U.K. RMBS market. Bear Stearns, for example, has initiated crisis management to deal with its subprime woes, but the firm wouldn't discuss its measures with the press.
Bradford & Bingley reasserted that the firm's lending practices (ASR, 5/14/07) are safe and sound, as "we only do prime," according to B&B press officer Nickie Aiken. Lending bank Barclays has also denied reports published in the British newspaper The Telegraph claiming that the bank had decided to jettison subprime lending altogether.
Clive Briault, managing director of retail markets for the FSA, spoke of the importance of reining in subpar subprime practices and remarked that improper lending was bound to have an effect on other markets. "Poor sales practices in this market may lead to serious wider consequences," he said in a statement. "The high level of subprime arrears in a benign market raises some important questions about the consideration given to affordability by lenders and intermediaries when undertaking this business."
One U.K. nonconforming RMBS player gave an example of the widespread improprieties by describing his own personal experience in applying for a buy-to-let mortgage. "The broker said to apply for a residential mortgage instead, because it was cheaper," he said. "When I asked if we could do that, he responded, well, the lender will never know.'"
Multinational lender Oakwood Global Finance, which deals with U.K. nonconforming RMBS with its Alba vehicle, also slammed the seemingly endemic poor advice being dished out by mortgage brokers. "There is a capacity for bad loans to have a great impact and knock-on effect on the U.K. nonconforming RMBS market," said Steve Hogg, a senior associate at Oakwood, "but this impact is likely to be far less than what was seen in the States.
Hogg added that subprime loans in the U.K. tended not to be "as overexposed, as poorly underwritten and as poorly priced" as its U.S. equivalents. He said the FSA demand for more "rational behavior" from brokers would help put an end to the current outpouring of "dangerous advice" from brokers.
Indeed, such practices have also not gone unnoticed by rating agencies. According to Stuart Jennings, a managing director in charge of Europe, Middle East, and Africa RMBS at Fitch Ratings, the agency has "expressed concern with regard to the erosion of underwriting standards through criteria creep' in the U.K. nonconforming mortgage market [over the last two years]. Increased competition from new entrants into the nonconforming space has been a driver, as more players seek a slice of this limited pie."
As part of its ratings for RMBS, Fitch conducts an evaluation process of the originators of the types of mortgages included in the transaction. The agency also reviews the guidelines, underwriting integrity, valuation procedures and securitization practices in order to provide its qualitative risk indication for RMBS transactions, which is factored into credit enhancement levels. Fitch, as well as Moody's Investors Service, has said U.K. RMBS ratings methodology will not change in light of the FSA announcement.
Fitch added that the actions of the FSA should help to serve as a guide to underwriting practices and thereby minimize arrears. Even so, sources at Fitch say arrears will continue to go up this year, but for other reasons, primarily rate rises. If anything, the rating agency believes the FSA announcement doesn't go quite far enough and that future FSA actions should result in even tighter controls and stronger underwriting standards in the nonconforming area.
"[More] improvements in the areas of weakness identified by the FSA can only help in minimizing the risk of borrower default and enhancing the overall performance of UK RMBS," said Alastair Bingley, director of the U.K. non-conforming RMBS team at Fitch. - JG
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