As negative headlines splash across financial journals, with threats of litigation in the U.S. subprime market, sources in U.K. RMBS wonder if this shakedown will ripple across the pond to the non-conforming market. While the U.K. appears to have been shielded from any direct negative consequences thus far, some maintain that the market is no longer safe.

At a meeting on non-conforming U.K. RMBS sponsored by Societe Generale in London last Wednesday, senior credit research analyst Christopher Greener argued that while U.S. lenders are scaling back the LTV available to customers, particularly in lower FICO credit score bands, competition in the U.K. market is encouraging lenders to advance higher LTVs to these lower quality borrowers. According to Deutsche Bank research, U.K. mortgage lenders, like Northern Rock and the Royal Bank of Scotland, are now lending up to six times' borrower gross salary. Also, interest rates are up 75 basis points over the past year and at least one further hike is expected next month, mortgage payment behavior is very likely to weaken, Deutsche analysts said.

Greener added that the current state of U.K. mortgage borrowing brings with it another concern, one where borrowers find themselves adrift in a sea of overspending and such a situation no longer warrants a must pay the mortgage' mentality that was so prevalent among U.K. borrowers of past. "The attitude towards debt has changed," Greener said. "The old adage that you have to pay the bank first has dropped away."

SocGen has urged caution in the nonconforming RMBS arena. Interest rate hikes and a heavy debt burden have created an environment with more downside risk than seen in previous years. This, combined with jitters created by recent U.K. headlines declaring "repossessions up 65%," is diminishing the potential for lower risk non-conforming RMBS growth.

While repossession rates in the U.K. are rising, SocGen said that the 65% value is more reflective of the number of repossession orders, which are currently more than five times the rate of actual repossessions in 2006, only 36 % below the 1991 recession peak. The 2006 gap is being filled by some 74,195 borrowers. According to Greener, customers have gotten savvier and less intimidated by repossession orders. Instead of allowing the court to decide the fate of the property, more and more sell-up right away or finance with a new lender.

Greener added that the inception of concepts, such as self-assessments, meant that more and more "people are putting frothing income into their calculations" and many non-conforming RMBS are with people who spend upwards of 75% of their after-tax income on the mortgage.

"[Lenders] are assuming people don't want to spend money on new cars and holidays," he said, adding that the Financial Services Authority (FSA) is currently looking further into the affordability issue. In fact, the FSA has moved into the second stage of its review of the effectiveness of its mortgage regime for U.K. non-conforming mortgages and is expected to publish its findings of this report at the end of June.

"In October 2004, U.K. mortgage lenders and financial intermediaries came under the regulatory supervision of the FSA," explained Deutsche analysts. "By contrast, the U.S. mortgage market is not as broadly regulated as the U.K. market with many companies falling outside of the jurisdiction of federal banking regulators."

Barney Frank, head of the House of Financial Services, is looking to change this nature of U.S. mortgage regulations and told the Financial Times this month that he is pressing for a bill that would assign some liability for future misselling of mortgages, which could essentially penalize secondary market investors (securitization investors) and make them liable for any future claims.

Whether or not the FSA will implement more regulation, in a move to incorporate Frank's proposals, remains to be seen. The U.K. regulator has gone on the record and said that the focus of its current report will investigate whether customers are taking out suitable mortgages and whether they are treated fairly by their lenders, should they go into arrears. Some sources are not mincing their words, saying that the issue is not one of opinion but one of inevitability. "The class-action system is coming to the U.K.," an RMBS analyst said. "Companies that negotiate IVAs are now saying to people no win-no fee,' and even that they can claim back money they've paid in. And to the banks, these people are scum."

Nonetheless, signs still point to steady growth in nonconforming RMBS, even with the potential for more litigation. Sarah Barton, lead analyst at Morgan Stanley, makes the case that strong house price inflation [in the U.K.] gives borrowers a refinancing option, which helps avoid repossession. "Smaller interest rate movements in the U.K. mean that U.K. borrowers are relatively shielded from affordability shock," she wrote in a report titled Oceans Apart last month.

Barton added that the primary driver of defaults in the U.S. is loan to value (LTV) based, and the ratio is typically higher in U.S. mortgages versus U.K. mortgages.

(c) 2007 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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