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Sub-prime loans could mean trouble at home
Jon Ihle



TWO US investment banks that recently entered the Irish home loan market are at the centre of the "sub-prime" mortgage lending and property market crisis that sent global stock markets tumbling again last week and threatens to tip the US economy into recession.

Merrill Lynch and Lehman Brothers were critical in nurturing the US sub-prime market. In recent months they have partnered with Irish lenders to provide subprime loans here to customers whose mortgage applications have been rejected by mainstream lenders.

Sub-prime loans are so-called "affordability products" that allow borrowers with blemished credit histories to take out loans at less favourable rates in order to get on or stay on the property ladder and repair their credit profiles.

Merrill linked with Irish Life & Permanent in January while Lehman hooked up with IIB Homeloans earlier this month. They joined incumbents Start, which is owned by UK sub-prime player Kensington, and GE Money Mortgages, a venture between GE Money and IFG.

Finance Ireland has also partnered with South Africa's Investec under the Nua Homeloans brand.

The development of a new niche in the Irish mortgage market to serve riskier borrowers comes as the US mortgage and property markets are spiralling into chaos over a rise in defaults and bankruptcies. The problems have spilled over into the global equity markets, which have twice in the last month shed tens of billions in value over worries that poor lending practices and soft house prices this spring could cause an economic downturn in the US. Foreclosures reached historic highs in America in the fourth-quarter of 2006.

Analysts estimate the size of the Irish sub-prime market to be around Euro1bn this year, or just over 2% of the total mortgage market of Euro41bn. IL&P believes this could grow fourfold within a few years, though, bringing it closer to the UK market where 10-15% of mortgages are at the subprime end. In the US it's closer to 20%, with sub-prime accounting for up to 35% of new business last year.

Lenders here - as in the US - are attracted to the fat margins and strong growth available through sub-prime loans. Although the credit risks are higher when lending to less-eligible borrowers, higher interest rates compensate. Start achieved a spread of 360bps over Euribor in 2006 compared to the 100bps earned by a typical Irish mortgage book, according a note by Davy. But the typical Irish mortgage book also has an arrears rate below 1%, while Start is saddled with 3.4% of its loans in arrears.

That figure is a fraction of the 14% default rate across the US sub-prime market.

The default rate among all US mortgages is around 4.65%.

David Odlum, an analyst with NCB, said that although lenders in Ireland had the same motivation as their counterparts in the US, Irish mortgage providers use more appropriate risk criteria for assessing borrowers.

"People are looking for higher margins and new segments [in Ireland], but American lending has fallen off a cliff, " he said. "It can always happen that people overstretch at the end of a bull run, but Irish banks are generally pretty cautious."

He also said personal credit in Ireland was less under pressure than in America because "we are richer than we think we are".

Mortgage brokers Irish Mortgage Corporation has said the sub-prime market is driven by short-term credit repair, while the author of the Davy note, Marc McGovern, believes the main targets of the market are self-employed tradesmen and professionals, rather than credit delinquents.

Still, the US market unravelled as rapidly in the last few months as it grew in the last few years, driven by upbeat analysts at the very investment banks - Merrill and Lehman, among others - that were buying mortgages from issuers, pooling them and then packaging them as securities for sale, reaping huge revenue from the trade. The Irish market is structured in exactly the same way, even if the criteria are tighter. Start, for instance, completed a Euro525m securitisation of its book only in January.




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