Pepper aims to add zest to specialist lending

Near prime and non-conforming mortgage lenders are sparse on the ground despite the obvious demand from potential borrowers with a less than perfect credit history.

This is where Pepper Home Loans fits in. The new lender launched last month and will cater for both residential and buy-to-let borrowers who have had a past ‘credit event’ whether that is CCJs or defaults or arrears.

Now is the right time to get into the market, says Pepper’s CEO Richard Klemmer, who knows a thing or two about specialist lending having been a director at Preferred Mortgages and Future Mortgages in the sub-prime heyday. He explains why Pepper has moved into lending from its mortgage servicing roots.

Four key indicators

There are four key indicators that Pepper looks for when moving into new lending – demand, supply, understanding the business and funding.
Klemmer explains: “We think there is a substantial demand in the UK for specialist lending. So if there is demand, is there a good supply? If supply is weak or underdeveloped we think that’s a great opportunity for us.

“We also want to make sure we have a good, solid understanding of that market, both from an asset performance and operationally. In the UK with our servicing business we have a fantastic insight into specialist mortgages because we service 80,000 of them and have done so for years; so we have the benefit of real, deep, rich data to mine and the ability to understand performance metrics and credit risk. We can really analyse what drives performance and demand for these types of products.

“And lastly, funding. All of our business is funded through the wholesale market – except South Korea. We have a very well-developed securitisation programme in the group called Pepper Residential Securities. We have issued 17 securities dating back to 2003 and issuance continued right through the global financial crisis (GFC). In addition, we have historically sold bonds out of our securitisation programme in North America as well as Europe and developed a deep stable of investors. That gives us a lot of confidence that we can raise capital to fund our lending activity. “

Klemmer says that those four indicators in the UK are all positive. The GFC has resulted in many people now having some form of adverse credit and
Klemmer refers to research by the Debt Advisory Centre, which shows that 1.7 million potential borrowers do not qualify for a mortgage because of their credit history and the criteria set by the traditional lenders.

“What we see on the supply side is a traditional banking sector becoming more automated and quite rigid in the way they are analysing credit,”says Klemmer. “The advent of the Mortgage Market Review has taken away the flexibility of how you evaluate affordability and become much more restrictive, which is not necessarily a bad thing but it has changed the way products are being designed.

“And then we look at the specialist sector of the market which tries to help borrowers who have had some adverse events in the past and the number of providers is thin on the ground. Pre-GFC there were 25 or 30 specialist lenders doing business of over £30 billion a year. Today there are just a small number in that space and we think it is worth somewhere between £3 billion and £5 billion.

“The trauma of people going through a big recession has led to a perfect storm from a lender’s standpoint – a difficult economic downturn and limited supplies means now is the right time to launch a specialist lender. There is a huge latent demand from customers who have had adverse credit in the past, but not now, and that’s the space we want to fill.”

Products

Pepper Home Loans has a suite of near prime residential mortgage products up to 85 per cent loan-to-value that are also available on buy-to-let loans up to 80 per cent LTV. Klemmer says that adverse buy-to-let is quite unusual in the UK market but Pepper Home Loans will underwrite buy-to-let investors who have had the same type of adverse credit events in the past as consumers looking to buy their own homes. Pepper’s Buy-to-let lending is focused on individuals looking to invest in one or two properties.

The product range is a mix of trackers over Libor and fixed rates, interest-only and part and part, ie. 60 per cent interest-only and 40 per cent repayment.

At launch, residential near prime tracker rates start from 3.35 per cent and non-conforming tracker rates from 4.27 per cent. Buy-to-let tracker rates for near prime start at 3.90 per cent and non-conforming buy-to-let tracker start from 4.55 per cent.

Borrowers

Through its third party mortgage servicing activity Pepper has the benefit of understanding how customers perform and behave in a difficult economic cycle. A good predictor of future behaviour is focusing on the proximity of adverse credit events as opposed to the more traditional ‘how many adverse events have they had for how much’.

Most lenders look at metrics such as the number of CCJs and defaults to evaluate credit risk but Pepper’s view is that is too rigid.

Klemmer says: “We are more focused on how long has it been since the customer had that credit event. Default is usually tied to some event in your life such as interruption of income, loss of a job, illness, divorce. The event is less important to us than trying to find a cause and effect. You often see that when the disruption stopped the customer’s payment behaviour becomes the same as it was leading up to the event. If the event is behind them, it’s no longer affecting their ability to repay a mortgage.

“It is the distance between the event and now that is most important so the product range is designed around the proximity of the event. We will get more robust with the product along the distance between the event or events.”

The pricing starts at six months since the event ahs passed, then 12, 18, 24 and 36.

Where people’s debt has been over £2,000 a senior underwriter will look at the case in more detail. and all declines will be reviewed.

Pepper will also consider past bankruptcy, IVAs and those who have been repossessed but there must be a gap of six years since the event. From a capital markets funding perspective, it becomes uneconomical to fund this type of lending but it is possible depending on the individual case. Debt Management Plans and payday loans must be at least 12 month ago.

Distribution

Pepper’s lending will be carried out through intermediaries – directly authorised, packagers and networks. The lender held focus groups with intermediaries and one issue that kept cropping up was the difficulty in getting through to actual decision makers within the lender firms.

Klemmer explains that all intermediary partners will be able to speak directly to the underwriter who will own the loan throughout the process.
“This encourages openness and we think it is more efficient and will bring better outcomes for the intermediary and ultimately the customer.

“In the first half of this year we piloted our technology platform, the application portal and the underwriting procedures. We started with Brightstar, who were very helpful, and have been slowly bringing in new intermediary firms. By the end of the year we expect to have a broad base of distribution partners bringing them on in a methodical way over the summer so we don’t swamp the back room.”

Targets

The Pepper Group wants to be a significant participant in each of the sectors that it operates in and aims to be in the top quartile. So in the UK Pepper is the second largest mortgage servicer and growing rapidly. Kleemer says the aspiration for specialty lending is exactly the same, and Pepper Home Loans wants to be in the top three of specilaist lenders.

But it doesn’t just stop at mortgage lending as Kleemer explains: “Our objective is to broaden the offer so over time we will introduce other lending such as auto loans, secured and unsecured loans. We started with mortgages as that is what we know best but we see similar attributes in those areas of finance as in mortgages because people have adverse credit but still want a car loan.

“The other lending areas will be in a year or two down the road but we have a big machine in the UK that is scalable. We can originate, process, manage and service a variety of different asset classes.”

Although Pepper UK now has a small office in Savile Row, the bulk of the workforce is moving from Kensington to much larger and more cost effective premises in Uxbridge, which it can grow into as the company expands.