Semper Capital co-founder Andrew Way explains why brokers must be ambassadors for change as near prime becomes the new normal
The so-called near prime lending sector appears to have grown in the last year. It’s important for commercial loan brokers and borrowers to better understand this sector and its implications in order to better serve its corresponding customer base.
Near prime customers are one or two deviations away from prime customers – they may have previous credit defaults (usually to non-financial institutions), or properties in a secondary location, or be self-employed with insufficient personal or business income to secure a prime rate. They are usually borrowing at a low enough LVR to provide strong asset coverage to make up for these factors.
Truthfully, near prime credit specifications are more a subjective consideration lender by lender than an algorithm of historic experience. They are made up of many contributing factors, which are not typically consistent between lenders.
At present in Australia it isn’t the case that an evolutionary adoption of clever forward-looking credit predictabilities is driving an expansion of the near prime market, but rather a systemic reduction of credit appetite in the bank-funded prime space. In effect, regardless of how good your credit history is, the banks don’t want to lend to you unless you are an absolutely prime candidate.
Notwithstanding current efforts to attract absolute prime borrowers to bolster Treasury value, ultimately banks will raise interest margins, causing an increase in so-called out-of-cycle rate rises. So, regardless of your credit standing, all borrowers will pay more, and many won’t be able to borrow from the banks at all. At the same time, the cost of funds that banks borrow from the market will increase, and institutions will raise the rates they expect to be paid for on- or off-balance-sheet mortgage assets from banks now overexposed to these assets.
The credit-weary vacuum created by gun-shy banks has enabled near prime lenders to creep in on the margins that were once deemed prime
The credit-weary vacuum created by gun-shy banks has made way for near prime lenders to creep in on the margins that were once considered prime. Some of the players exploiting this space have recently been bought out by large institutional overseas financial entities that are able to provide them with cheaper sources of capital to bring their interest rates down, making them increasingly competitive at the fringe of the prime lending space.
This combination of out-of-cycle margin and capital adequacy increases is going to expose the soft underbelly of the banks and create the scenario for major disruption in the mortgage lending space, which will further exacerbate bank woes.
For brokers and borrowers alike, these events will cause significant change. Rates will rise, LVRs reduce and T&Cs tighten, and some borrowers will be locked out of the lending market unless Capitalthey are willing to pay more to play.
So what does this mean for mortgage brokers?
First and foremost, there is going to have to be a realisation of true appetite because, despite the fact that banks are advertising products, particularly in the SME space, the truth is they have moved out of those areas. Borrowers don’t know this and will need some convincing, and since banks won’t admit it there is going to be a lot of time wasted on applications. In many ways brokers are going to have to be the voice of reason and ambassadors of change.
There is a new reality, which is that rates are going to climb for anyone who doesn’t fit an absolutely prime mortgage that enables banks to enjoy a risk-weighted premium by lending. For all others who present as a greater-than-100% risk-weighted average, there is no bank appetite. Further, bank rates are going to climb, breaking further and further away from the RBA rate.
Brokers who take stock and diversify will secure clients. But they will often need to perform dual applications – one to a bank for those applicants who still believe they are prime candidates, and another to a near prime lender more likely to have an appetite for the risk. In short, use pragmatic judgment, be smart, and work harder with multiple applications. This experience will prove where the risk appetite truly sits.
What’s next? Overall, we believe the domestic investment market is ready to enjoy rate-for-risk returns it hasn’t seen since before the GFC. We urge the market to keep an eye on players that do not hold long exposures to high-LVR loan portfolios and by default are positioned to benefit from the dislocation that will occur in property and property lending (while maintaining a strong credit position where the banks are at an increasing disadvantage). We’re in the early stages of witnessing an emerging marketplace that will be transformed by a new era in mortgage-backed lending, in which customer profiles are broad, risk is visible and tangible, and returns are transparently justifiable.