Tinkering and tweaking
The fallout from the US sub-prime crisis continues in the form of tighter credit markets. We take a look at the different ways non-bank lenders have attempted to adapt by slashing how many loans they write, tweaking their range of products and cancelling riskier loans
An eye on volume
"As far as I am aware, all specialist lenders including Pepper adjusted products in response to the credit crunch," Pepper Homeloans' head of marketing and product Ed Thian said.
Pepper adjusted its product range in October last year, suspending its Xpress and Mega Express loans which were low margin high volume mortgages targeted at prime and near prime credits. It also revised its maximum LVR downwards from 90% to 85%.
"The supply side of mortgage lending has changed dramatically since August last year," Thian explained.
"The high volume low margin non-bank model targeting prime borrowers that worked well for Rams et al over the last decade is now under considerable stress."
Rams, which had been struggling to refinance, was recently forced into a fire sale of its assets, offloading mortgages worth $1bn to NAB as part of a plan which helped it secure refinancing of its short-term lending obligations.
Bluestone is another lender which has looked to curb loan volume.
"We haven't changed eligibility criteria," CEO Peter McGuinness said. "About three to four months ago we took a decision to scale back our origination from $120m a month to $60m-70m a month.
"By throttling back applications, Bluestone has been able to preserve its warehouse funding capacity despite the uncertainty in credit markets," McGuinness noted.
However, this reduction in loan volumes has not been sufficient to secure the continuation of Bluestone's commercial arm, and the firm suspended all commercial loans in January. McGuinness has acknowledged it could be several months before it is reinstated.
Bluestone has also moved to tweak its existing loans, building a 25 basis point buffer for the product into its fixed loan offering as well as reassessing LVR ratios.
"We have capped our high LVR lending," McGuinness said.
"So we don't write any business over 90% LVR now, and the reason for that is really to ensure that we maintain a book which is well within the governance that our funders proscribe."
McGuinness says that at the moment the warehouse funders are fairly key partners for the business, "so we've worked with them and agreed that that's slightly riskier funding, we've just parked [it] on ice for the foreseeable future".
Bluestone's decision to pass on some of its increased funding costs has taken its toll, with McGuinness admitting the lender had lost some business as a result.
Liberty's loyalty program is another example of an attempt to slash loan volumes.
The program, which was introduced in November 2007, permitted only those brokers who had already written five deals with Liberty over the previous 10 months to continue to submit loans.
Earlier this year, Liberty's head of mortgages James Boyle told AB the move was necessary in light of the 'uncertain funding environment', but indicated the program would soon be shelved.
Fewer low-docs, lower LVRs
Lauren Newlands, a financial analyst with Cannex, which releases the 'low-doc home loan star ratings' report, acknowledged the credit crunch had seen lenders reassess their low-doc loan products, noting there had been a slight drop-off in the number of low-docs being offered.
"It hasn't been huge, but it has been noticeable, I suppose," she said. "It is all pretty much for the same reason. The credit crunch in the US has hurt a lot of people or made a lot of people rethink their loan book, particularly since a lot of the sub-prime loans in the US were also low-doc loans."
She said whereas Cannex assessed approximately 201 different low-doc loans in 2007 this time round there were 180 eligible products.
This was the result of lenders pulling certain products, or lowering LVR on existing products to below Cannex's benchmark of 80%, she explained.
Mobius is one lender moving to scrap its riskier loans, recently dumping a "no-doc" loan which offered borrowers loans with no limit on their arrears within the past six months and a loan-to-value ratio of up to 80%.
Recent S&P statistics on Australia's sub-prime mortgages revealed Mobius Financial was the nation's worst performing sub-prime lender, with over 15% of its $680m loan book in technical default.
However, in 2005 Mobius was one of the more aggressive non-conforming lenders offering low-doc loans with loan-to-value ratios as high as
95%. According to the Cannex report, there are currently no lenders now offering such lofty LVRs, with the highest ratio offered by any lender being 90%.
But fewer low-docs does not mean brokers have been left in the lurch without sufficient products to meet demand, according to Mortgage Choice's national corporate affairs manager Warren O'Rourke.
O'Rourke says Mortgage Choice is not actively looking for customers in need of non-conforming loans, but when they came along they have little trouble finding appropriate products.
"As and when there is a demand, we generally find it can be satisfied but it's not a major part of our business," he says.
Finding a niche
According to Ed Thian, the challenge for non-bank lenders is to find ways to avoid competing with the major banks by exploring gaps in the market.
"Pepper is a specialist non-bank lender focused on niche segments and does not compete directly with the major banks," he explains.
"Non-conforming lending is essentially defined by the gaps that traditional lenders do not service competitively."
By aiming to provide products which do not already exist, non-bank lenders are able to pass on their higher credit costs as price is less important to the consumer.
This type of lending is 'more solutions than price focused', Thian explains.
Comparison with the US
In the US, the impact of the sub-prime crisis on the non-bank sector has been far more dramatic. According to the mortgage lender implode-o-meter website (http://ml-implode.com/), the crisis has seen 226 US companies implode. Included in these is the nation's largest mortgage lender Countrywide Financial. Once responsible for issuing loans worth US$500bn annually and with assets of US$200bn, Countrywide is now set to be purchased by the Bank of America for US$4bn after seeing its share price nosedive as it struggled to secure sufficient credit supplies. By 30 June last year, almost 25% of the firm's sub-prime loans were in arrears, according to a report in The New York Times.
Last year alone, over 50 lenders including high profile sub-prime lenders New Century Financial and NovaStar Financial; and companies that were focused almost exclusively on prime loans, such as American Home Mortgages, filed for bankruptcy in the US. Unlike in Australia, the plummeting fortunes of lenders have been exacerbated by a collapse in housing value in the US, with homes in some suburbs now being valued at 30% below their original purchase price.
Kenneth Lewis, the chief executive of Bank of America, told The New York Times this collapse in value was fuelling a "change in social attitudes toward default" with more borrowers now willing to give up on their homes. In response, many lenders, with little chance of recouping the full value of loans, have moved to offer struggling prime and sub-prime borrowers a chance to halt foreclosure proceedings for 30 days and work out new loan terms.
Although not grappling with defaults or plummeting home values on the same scale, there is no doubt the Australian non-bank sector has been forced to make significant changes to their operations in an attempt to ride out the crisis. But despite this, Pepper for one remains optimistic about an improvement in the credit markets.
"The view is that credit markets will improve," Thian said. "Exactly when, I don't think anyone knows."
Until then, adjustment and reduction seem to be the order of the day.
