Is there a bubble in high-risk lending?

Despite record levels of bankruptcies, the doorstep lending business is booming along with the market for sub-prime mortgages. Why?

Despite record levels of bankruptcies, UK lenders seem to be making sales at a healthy clip.

Particularly lenders who lend money to the sub-prime' or poor credit risk - market that everyone else avoids.

In June, doorstep lender Provident Financial saw an annual increase in the number of UK customers for the first time in three years. The number of people taking out its Vanquis credit card (which charges a typical interest rate of 39.9%, more than twice the average of around 16%) is also set to hit the quarter of a million mark by the end of the year.

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Fellow lender Cattles also said earlier this week that it has seen strong demand for doorstep loans.

So why the boom in lending particularly when we're already in so much debt?

Doorstep lender Provident Financial saw a year-on-year increase in customer numbers in June after three years of reducing customer numbers'.

The amount of credit issued by the company also rose, up 1% for the five months to May 2006 compared to the same period the year before.

But bad debt costs have continued to rise too. The group said this reflected a 7% rise in the amount of money it is owed, "together with continued pressure in customers' disposable incomes."

Provident's sub-prime credit card provider Vanquis now has more than 200,000 customers and the rate of growth is accelerating. It expects to have 250,000 customers by the year-end. The group has kept control of bad debts in this division by tightening its lending criteria.

Provident isn't the only doorstep collector enjoying the good times. Fellow lender Cattles also spoke of strong demand for doorstep loans earlier this week, saying that customers' arrears levels and bad debts had remained stable.

It's unsurprising that demand for credit cards and loans is increasing at the lower end of the scale. Mainstream lenders have been tightening up their criteria, leaving people with little choice but to turn to sub-prime lenders.

The other alternative, widely pushed on daytime TV, is of course to secure a loan against your house. For non-homeowners this isn't an option but plenty of homeowners have been going for it.

This drive to push sub-prime (or 'junk', as we like to call them) mortgages has helped keep the housing market propped up despite the sharp slowdown in growth seen in mid-2004. We wrote about this last week you can read the piece here: How hedge funds affect house prices.

But the sub-prime boom is not the only factor behind the recent mini-revival. During 2005, the average interest rate on a UK home loan fell by more than 0.2 percentage points. The average fixed rate fell by even more, about a quarter point on average.

As David Miles and Melanie Baker at Morgan Stanley put it, this "may help to explain some of the housing market pick-up".

But "many of these factors may now be going into reverse." The average short-term fixed-rate loan has risen by 0.25 to 0.3 percentage points already this year most of that within the past couple of months.

According to Miles and Baker, "the implications of even a small rise in the effective... rate are somewhat ominous". Possession orders in England and Wales (court orders allowing lenders to repossess a house) are up "significantly".

Courts granted 21,997 orders in the first quarter of this year, compared to 14,041 in the first quarter of 2006 - a rise of nearly 60% in just one year, and the highest number since the early 1990s.

Now just because an order is granted, that doesn't mean that a house will be automatically repossessed. But the fact that the lender has gone to the effort of taking someone to court shows that the homeowner is in serious trouble, to say the least.

It's not just housing debt that's getting more expensive to service. The Morgan Stanley team point out that "quoted credit card lending rates have risen some 65 basis points [that's 0.65 percentage points] since January 2005."

Having to keep up payments on all that debt leaves the UK consumer much more vulnerable to interest rate shocks now than before the crash of the late 1980s.

"Household debt service as a proportion of disposable incomeis at levels last seen in 1992, when the economy was in recession and base rates were significantly higher than they are today. All this has happened when rates set by the Bank of England are at a relatively low level and have not changed in almost a year."

With global interest rates on the rise, and continued expectations that UK rates will rise sooner or later, it looks like the cost of borrowing will only get higher from here on in. That doesn't bode well for property prices up ahead.

Turning to the wider markets...

The FTSE 100 was flat, closing unchanged at 5,883 on Tuesday. Property stocks were among the main risers, with Hammerson gaining 3% to £12.41, as the Bank of England's Kate Barker called for a more flexible planning system in the UK. For a full market report, see: London market close.

Over in continental Europe, the Paris Cac 40 gained 3 points to 4,983, while the German Dax gained 16 to close at 5,729. US markets were closed for the Independence Day holiday.

In Asia, the launch of six test missiles by North Korea hurt sentiment, sending markets lower. The Nikkei 225 fell 114 points to 15,523, though military equipment maker Mitsubishi Heavy Industries made gains on speculation of increased defence spending.

This morning, oil slipped back in New York, trading at around $73.60 a barrel. But Brent crude was higher, trading at around $72.65.

Meanwhile, spot gold was higher, trading at $624 an ounce, boosted by the uncertainty over North Korea. Silver made small gains, trading at around $11.22 an ounce.

And in the UK this morning, shares in high street bank Alliance & Leicester have plunged on news that French bank Credit Agricole has decided to abandon plans for a potential bid.

And our two recommended articles for today...

Is gold's bull market back on track?

- The oil price has risen close to record highs, while gold has rallied strongly from its recent low of $544 an ounce. Does this mean the gold bull is back on its feet? Andrew Selsby and John Robson of RH Asset Management think so - to find out how high they believe gold will go now, click here: Is gold's bull market back on track?

How US mortgage debt could cause a global financial crisis

- In the US, Fannie Mae (FNMA) and Freddie Mac are Government Sponsored Enterprises (GSEs) which buy residential mortgages and repackage them to sell on as mortgage-backed bonds. Although these bonds are not backed by the US government, most believe the GSEs would never be allowed to fail. But Dan Denning reports in Whiskey & Gunpowder on how a US Treasury report has acknowledged that this mistaken belief and the illiquid nature of property means that an interest rate shock' could topple the US mortgage market and infect the entire financial system. To find out more, see: How US mortgage debt could cause a global financial crisis

John Stepek

John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.