Northern Rock was the UK's fifth largest mortgage lender and in the first six months of 2007, it made pre-tax profits of just under £300m, barely changed from the previous year. However, Northern Rock had loans and other assets on its balance sheet of £113bn whereas the value of deposits placed with it by retail customers was £24bn. Therefore, Northern Rock relied on funding provided by wholesale channels in order to fund the loans. This business model was the Achilles heel in Northern Rock’s business strategy.

How did the subprime crisis unfold in 2007? (BBC News)

Players in the mortgage industry and the mortgages food chain (PDF)

Following the widespread losses made by investors in loans to US homebuyers with poor credit history, the so-called subprime loans, investors became wary of buying any mortgage debt, including that of Northern Rock, and the bank  struggled to raise money to finance its lending as the money markets seized up over the summer. As a result, the Bank of England agreed to give emergency financial support to Northern Rock.

Shares in Northern Rock fell 32% after it had to ask the Bank of England for emergency funding and some other lenders’ shares also fell sharply. The impact was felt throughout Europe in September. The German lender IKB Industriebank has said it expects to lose almost $1bn (£500m) as a result of its exposure to subprime mortgages in the US.

Then, in November, the impact was felt at the UK high street banks as Barclay’s revealed subprime losses to the value of £800m ($1.64bn) and HSBC raised its subprime bad debt provision by $1.4bn (£670m) to $3.4bn.

What is on the horizon for 2008?
The housing market is poised to become one of the biggest casualties of the global credit crunch with house prices forecast to mark the lowest annual growth in the UK since the mid-1990s and repossessions expected to soar to a 15-year high. The economic projections show the UK housing market suffering over the next two years. Although national house prices have continued to soar against a background of higher interest rates, the current boom has been uneven regionally. The latest figures show an exceptionally buoyant market in Northern Ireland and continued strength in Scotland and London, but elsewhere there are already signs of deceleration, particularly for houses in the south-west and Midlands, which will see the steepest price corrections.*

The slowdown in the property market over the next two years will be driven by tighter lending sparked by rising defaults in the US subprime mortgage market. The tightening in credit follows five interest rate rises since August 2006, which are affecting demand. UK rates are 5.50%, following December’s quarter point drop.

Britain may be facing a fall in house prices similar to that currently being endured in the US, the International Monetary Fund (IMF) has warned. The IMF says there is evidence to suggest that the UK and a number of other European nations are also vulnerable to a price correction.

The IMF also says that the UK and other western European housing markets are in a better state than that in the US, because they have generally avoided the subprime mortgage industry. This sector, which specialises in higher risk loans to people with poor credit histories, or those on low incomes, has all but collapsed in the US. However, the other European nations that the IMF says are at risk of seeing falling housing prices are France, the Republic of Ireland, Netherlands and Spain.

The international markets have closed the door on funding for subprime. In the UK, the Council of Mortgage Lenders predicts there is not enough funding through savings and investments alone to account for the borrowing demand of consumers in 2008. As a result, lenders who require funding, known as wholesale lenders, will suffer and some will withdraw from the market. The traditional balance sheet lenders, such as building societies, will be able to maintain performance and, along with strong customer management strategies, may benefit long-term.

As the predicted levels of bad debt increase in the UK, the demand for subprime mortgages will increase as the availability decreases. Unless a bold balance sheet lender with a healthy book decides to take a leap of faith by investing in subprime during 2008, there is growing concern over what will become of existing subprime consumers and the growing population of subprime who cannot invest for the future.

How can Experian Decision Analytics help?
We understand the uncertainty surrounding the credit market in the UK and Europe, and it is often during such times that it feels safer to close the door on risk entirely rather than manage the risk effectively. Our expert Consultants are here to assist in building a robust risk strategy plan for your business in 2008 and beyond, which can continue to deliver long-term profit and customer loyalty in an unstable environment.

To help mitigate high levels of bad debt and repossessions, Customer Management strategies are key.  These involve customer segmentation and analysis of the behaviours which drive negative outcomes. Delphi for Customer Management allows the ongoing monitoring of customer risks and the Probe solution enables smarter decisioning. In terms of performance reporting, Experian Decision Analytics is currently pulling together a suite of reports which can enable individual lenders to benchmark their performance against a group of other anonymous lenders in the market and drill down on specific indicators of bad debt. These suites of reports are known as Market Portfolio & Insight and are available to demonstrate to lenders now.

Finally, we are fortunate to own one of the leading European debt management systems, Tallyman, which can assist in building strategic collections solutions across a variety of operational areas.

Sam Archer
Head of UK Mortgages
Decision Analytics
Experian

Contact us for further discussions about this article.

Sources

• Datamonitor
• *Experian Business Strategies

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