Specialist Lending - Non-conforming back in the game

Not only did it force many of Australia’s largest lending institutions to tighten their credit criteria, but it also changed the face of the non-conforming market.

Traditionally, non-conforming borrowers were perceived by brokers as being heavily credit impaired. They would have multiple defaults on their credit report or recent arrears on their loan statements.

However, this is no longer the case.

As lenders and mortgage insurers tighten their credit requirements, a borrower can have as little as one default on their record – a late payment fee on a telephone or utility bill, for example – and still be considered non conforming.

Self-employed borrowers in particular can find the lending environment tough, unable to meet standard lending requirements for a range of reasons such as employment, cash-out requirements and security type.

And according to Genworth’s latest mortgage trends report, 12.8 per cent of all Australians are self-employed – making the non-conforming segment a very lucrative market for brokers.

But, the non-conforming borrower segment reaches far wider than Australia’s self-employed market, Pepper’s chief operating officer David Holmes says.

“Almost 35 per cent of all borrowers fit comfortably into the non-conforming space,” he says.

“In today’s environment, a non conforming applicant is really a good borrower in a tricky circumstance. That is to say, a non-conforming borrower is really any person, company or trust with a genuine requirement beyond the scope of traditional lenders. This can include unconventional income types, urgent settlements and low-doc lending. It is certainly not limited to applicants with severe credit impairment.”

In fact, Mr Holmes says he expects the market to grow over the coming months.

“We have BDMs out there talking to people and engaging the market. And from their feedback I can safely say that demand for non conforming products is growing day after day.”

Better Mortgage Management’s managing director Murray Cowan agrees.

Mr Cowan says the abolition of exit fees will help stimulate demand for specialist products.

“With the abolition of exit fees, slightly credit impaired borrowers can start in a specialist product and then refinance into a standard rate product once they get their affairs in order,” he says.

“Once brokers see the potential to help clients get finance now with a plan to refinance to standard products in 12 -24 months, demand for specialist products will inevitably grow.”

DEMAND STEPS UP

But it is not just lenders that are seeing greater demand for non-conforming products.

Brokers are also witnessing growing demand thanks to tighter lending criteria by mainstream lenders brought on by the GFC and NCCP.

According to a recent The Adviser straw poll, 41.6 per cent of brokers have seen demand for specialist lending products increase, while 27 per cent said demand was roughly the same as 12 months ago.

But while the vast majority of brokers are positive about the future of non-conforming products, the third party channel is still largely hesitant to write these types of loans, MKM Capital’s operations and marketing manager Michael Watson says.

Mr Watson says there is a commonly held belief amongst brokers that non-conforming loans are far more complex than prime loans, and this acts as a deterrent.

However, in reality this is not necessarily the case.

“There is no question that being a non-conforming broker requires a different skill set. By definition this kind of lending is complex, so I can understand how it would be intimidating for newcomers,” he says.

“But, at the end of the day, providing reasonable enquiries are made as to the borrower’s financial history, writing a non conforming [loan] need not be daunting.”

NCCP CREATES CAUTION

According to Mr Watson, the NCCP’s responsible lending guidelines could also be stopping brokers from diving into the very lucrative non-conforming space.

“We feel that once more brokers realise that non-conforming lending is an opportunity under NCCP, business volumes will reflect this,” he says.

“After all, NCCP was not designed to penalise the good borrower in a difficult situation. It was designed to foster responsible lending and hold lenders accountable.”

RESIMAC’s national sales manager David Coleman echoes Mr Watson’s comments.

Mr Coleman says NCCP had not and would not stop non-conforming loans from being written.

In fact, he believes there is more scope to write non-conforming business under the new regulations than ever before.

He says while brokers are undeniably cautious in the face of changing regulation, they needn’t be.

“RESIMAC believes that there is definitely scope for such loans in this post-NCCP environment as long as the broker and the lender follows a process to ensure the loan is not unsuitable: that is, a loan contract will be unsuitable where either it does not meet the consumer’s requirements and objectives, or the consumer will be unable to meet the repayments,” he says.

“This means that once the lender and the broker make their reasonable enquiries to verify the information provided by the borrower, non-conforming and low-doc loans can be presented to applicants as a viable home loan option. [This] still meets the definition of responsible lending.”

NCCP and the complexity of non conforming loans aside, Mr Coleman says there is one more issue that may stop brokers from writing these types of products – price.

With much focus on interest rates, many consumers expect a mainstream loan interest rate despite not meeting prime credit requirements.

What they don’t understand is that the interest rate on a non-conforming loan is generally higher than the standard variable rates advertised by Australia’s lenders.

And, as a result, it can be difficult for brokers to sell these types of loans.

But, as the old adage goes: through adversity, opportunity is born – a fact brokers that target the non-conforming sector know all too well.

OPPORTUNITY THROUGH ADVERSITY

While selling non-conforming products definitely comes with its own set of hurdles, it also comes with an array of benefits, namely solid returns and increased customer loyalty.

Non-conforming lending is a lower volume, higher-margin market.

Brokers who target this space and become good writers can make solid returns from fewer loans.

Other brokers who do not target non-conforming borrowers but are aware of the options are able to diversify from their “prime” activities with non conforming business.

And, in today’s market, diversification is more essential than ever.

According to the Australian Bureau of Statistics, monthly housing finance commitments slumped to a 10-year low in May 2011.

So, with opportunities fewer and further between, it is important for brokers to capitalise on every opportunity, including non-conforming loans.

Brokers that diversify their core prime residential offering to include non-conforming borrowers have the opportunity to genuinely help clients access finance now, while at the same time highlight the goal of accessing cheaper finance down the track once their defaults are cleaned off their credit report, BMM’s Murray Cowan says.

“This provides the broker with revenue from the newly settled loan plus the strong possibility that the client will return to refinance the loan again in 12 to 24 months.”

And even if the client doesn’t refinance within two years, Pepper’s David Holmes believes these borrowers are still likely to stay loyal to their broker because they helped them “out of a difficult situation”.

“Everyone remembers the person that helped them overcome adversity to achieve their goals,” he says.

“A borrower knows when their loan situation is complex. So they will respect any broker that can help them get finance.”

Mr Holmes says these types of customers are also more likely to pass their broker’s information on to their friends and family – thus helping the broker to write more business.

WHERE DO I LOOK?

But once a broker has decided to diversify their core offering and target the non-conforming sector, where should they look to find potential customers?

“Brokers would do well to target their own backyard,” EZY Capital director Matthew Watts says.

And, with 70 per cent of his business made up of non-conforming borrowers, it is fair to say Mr Watts knows a thing or two about the borrower segment.

According to Mr Watts, brokers can send emails to their existing client database letting them know that they now specialise in this area.

“We send newsletters on a weekly basis updating them on our non conforming lenders’ products, any new products we may have available and the type of loans we cover,” he says.

But, if the emails render no response, referral partnerships with accountants, real estate agents and financial planners can also illicit a number of non conforming business opportunities.

And, by Mr Watts’ own admission, there is a number of non-conforming business opportunities to be had.

“We know that the majority of brokers stick to mum and dad clean credit type loans and that is fine. This however means there are fewer brokers in the non conforming space. So, if you can become a specialist in the area of non-conforming and keep up with all the various loan products available, then you can very much carve out a niche business for yourself.”