Jitters continue after US mortgage crisis growth

Jul 4 2007 by Tony McDonough, Liverpool Daily Post

IT WAS always a risky premise, lending large amounts of money to those with either a poor credit history or no borrowing track record to speak of.

So it is hardly a surprise that lenders targeting this so-called “sub-prime” market are finding themselves in hot water as borrowers start failing to meet repayments.

In the US, where the sub-prime market has mushroomed in recent years, the issue has become so acute that it is now being referred to as a full-blown default crisis.Earlier this month, the Mortgage Bankers’ Association in America revealed that the number of sub-prime borrowers who got into arrears or had their homes repossessed spiked to a record level in the first three months of the year. Three out of every 20 US mortgages are now more than a month in arrears.

So far, the UK appears to have escaped a similar fate – or at least, on the same scale. The bank reporting season earlier this year showed that UK lenders have enjoyed their fair share of rising default rates.

Lloyds Bank and HBOS both reported substantial increases in their bad debt provisions, although nowhere near the scale seen with US giant HSBC, which was one of the first American lenders to raise the alarm. HSBC upped cash set aside to cover bad debt at its US mortgage operation by 35% to $US10.6bn (£5.3bn). In the UK, the issue has predominantly centred on defaults of credit cards and unsecured personal loans and banks have been keen to distance themselves from the troubles seen in the emban increaseattled US sub-prime mortgage market.

But recent news would suggest lenders are perhaps not as shielded from the fall-out as they would have us believe. Barclays hit the headlines last week when it emerged the banking giant’s investment arm, Barclays Capital, had lent money to US Bear Stearns hedge funds that are now facing collapse after investing in the non-standard and higher-risk home loan market.

The ripple of fear spread as it dawned that the US sub-prime mortgage meltdown could have far-reaching implications for the UK. London-based hedge funds are also said to have been buying bonds whose value is linked to US sub-prime loans.

Worryingly, these investments have been re-packaged and sold on to a range of European investment groups, including insurance companies and pension funds.

This week, London fund manager Cambridge Place was forced to close one of its listed funds as the US sub-prime sickness spread yet further on UK soil. The group’s Caliber fund, which had the majority of its investments in US sub-prime mortgage debts, suffered a net loss of $US8.8m (£4.4m) in the first quarter of the year alone.

Meanwhile, for all the assurances that UK lenders caught the trend in the nick of time and began tightening their lending criteria, there is a steady trickle of data implying that not all were so fortunate.

Kensington Mortgages, which was recently sold amid warnings over falling profits, revealed in March that the arrears record for borrowers behind with payments for 90 days or more had further increased this year, as borrowers continued to struggle with their debts. Northern Rock also said this week its arrears levels were rising, with borrowers feeling the squeeze from four interest rate rises since last August.

Rising interest rates have been cited as a key reason for the US sub-prime problems, so surely the UK, with its recent spate of rises, will simply follow suit into default despair. Apparently not, according to Alex Potter, banking analyst at Collins Stewart, who believes it is the unfortunate combination of hefty rate increases and sharply-falling house prices that has amplified the issue in the US.

While rates have risen from 3.5% to 5.5% in four years, America has faced around a dozen hikes in just a couple of years, from as low as 1% to 5.25%.

Mr Potter added that the sheer size and scale of the US market leaves American lenders far more susceptible to default rates, with 30% to 35% of all mortgages in America now sub-prime, versus just 5% in the UK.

There are also vast differences in selling tactics and the products themselves. The US sub-prime market has been notoriously aggressive in marketing to borrowers, offering seemingly attractive loans with no need for income verification or even any deposit. In the UK, borrowers must stump up at least 10% of the cash, with the average deposit required being 20%, and the sales process is thought to be more rigorous.

Despite its own rising arrears levels, Kensington Mortgages is convinced by the facts. A spokesman said: “There is no reason to worry about this particular US trend making its way across the Atlantic.”

Each time the concerns over the sub-prime market bubble up in the US, the UK stock market feels the pinch.

Only this week, the FTSE 100 Index took a hit as investor sentiment was hit by fresh sub-prime mortgage fears. The effects have not been long lasting yet, but it serves to remind how sensitive UK stocks are to US troubles.