Self-cert mortgages: a warning from the last crash

Prior to 1992, National Home Loans who started business somewhere in the mid- 1980s, was one of the first British lenders to make "non-status mortgage loans". In their early days they were fairly strict about other financial information such as County Court Judgments and the like, but near the peak of the housing market, prior to 1992, they and many others would do almost anything for anyone and certainly there was plenty of bad lending similar to that which occurred in this most recent debacle.

The reason for saying the above is because of a news item in the Financial Times last weekend, headlined "A fifth of new mortgages subprime or self-certified". The article quoted Peter Williams, Executive Director at Intermediary Mortgage Lenders' Association (IMLA), as saying "We didn't really have a mortgage market for the credit-damaged in the 1980s because people with County Court Judgments against them or who had declared bankruptcy could not obtain mortgages."

Anybody who was in financial services in the late 1980s early 1990s will know that the equivalent of what we now call subprime mortgages were prevalent and as said above, at the peak lenders would make loans available for almost any reason to almost anyone, irrespective of financial information.

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Worse still, this was coupled with extravagant valuations. When the bubble burst, repossessions went through the roof to about 80,000 a year, causing huge losses for lenders. There had never been anything like it before. Sorry to disagree with you Mr Williams.

Instead of learning from previous mistakes, the financial industry seems to relish in repeating them! One thing we try to do at fullCircle and the basis for much of our work, is to learn from history, especially where similar activity took place. That's why we are very confident that the third insane credit expansion of our experience will be followed by a credit contraction set to be worse than the other two because this 21st century credit event was so much more absurd.

We have contended all along that the destructive credit defaults that are still to take place remain invisible. Imagine yourself as a banker who has made a loan and the terms of that loan have been complied with for an extended period, why would you be concerned that this borrower might default. However, if you knew the truth - that same borrower with a good credit history might well be on the verge of financial collapse.

In about 1992, we knew of such a borrower this is his story. He owned a commercial property on a beautiful plot in one of the best parts of Southern England. He had bought the property from a building developer who had gone bust in the 1970s credit crunch, it produced just enough income to keep it going.

In 1986 everything changed. He got planning permission to develop the site which increased its value considerably. He decided that, although the planning was not for residential development, that he should be able to sell the property for residential development for £3million. He called it The Big Three. The house market was very buoyant and a stream of developers viewed the property. They offered him less than £3million as it was, or £3million conditional upon the improved planning for residential development being first obtained. He refused all of these offers and said he wanted an unconditional £3million.

As this was going on and just after the 1987 stock market crash, he came across a beautiful house standing in several acres which in today's market would be a multiple of millions of pounds to buy. He agreed to pay £750,000 except that he didn't have any money. He went to the bank and borrowed £750,000 on a short-term basis, secured on his commercial building, expecting to repay the short-term loan from the sale of the commercial property. After about a year, the commercial property remained unsold meaning that his short-term loan arrangement with his bank needed to be refinanced. He negotiated a self-certified mortgage on the house for £900,000, so that he could hold back some of the cash to fund the unaffordable mortgage payments whilst continuing to unsuccessfully sell the commercial property for £3million.

Time went by and eventually his slush fund to finance the mortgage payments was almost exhausted and he was on the verge of defaulting. With only funds left to pay one instalment, he needed to borrow enough to repay the mortgage plus a further slush fund to meet future payments. A new mortgage was arranged and he self-certified his income. The mortgage was for £1.7million, secured on the house which he said was now worth £2.5million.

The loan application was made to a major international bank whose surveyor incredibly valued the property at £2.5million. But now he had passed the point of no return. The credit expansion had ended and the 1990s credit contraction had started. This was his last bite at the cherry unless he sold something, the house or the commercial property, his eventual default was inevitable.

Stupidly, he never changed his game plan, the market overtook him, he could not sell either property and he went gloriously bankrupt. The lending bank lost huge amounts of money. That's the sort of stuff that's out there again at all levels and like our story, the problems remain invisible to the lending banks until the money runs out and then the losses become monumental.

By John Robson & Andrew Selsby at fullCircle Asset Management, as published in the threesixty Newsletter, a fortnightly newsletter that gives insight into the investment markets.