Over the last few months there has been a lot of talk in the newspapers about the sub prime crisis in the United States. What does this mean?
It is quite a complex story, but the bottom line is that many lenders in Australia will be affected and rates will go up. Although most if not all lenders will be affected in some small way, it is the non-bank lenders that will feel pressure the most. RAMS has already gone to the wall and have had their brand-name purchased by Westpac. This does not mean that existing borrowers it anyway under threat, it just means that RAMS, and lenders like it, had had their funding dried up, meaning they can no longer take on new lending.
The main area of lending that I think will be affected the most falls in the category of non-performing loans, or bad credit lending. These lenders obtained most if not all of their funding from the United States sub prime market. Until now, they have been a great resource of lending to people who will fall outside the normal lending criteria of mainstream banks. They give a second chance to people with credit problems or people who have had some problems in the past and have had their applications to client by the main lenders.
We have already witnessed one of the main non-conforming lenders in Australia, Pepper Home Loans, withdraw a number of products from the market, lower their racy oaths, and increase interest rates applicable to their loans. Existing borrowers are at the stage still safe, but the future is by no means clear.
The upshot at this quite early stage of developments is that nonconforming and bad credit loans will be under the hammer and will remove one of the key options available in the market. Although it is only a small percentage of the overall lending market, it takes a lot of potentially good borrowers, including a lot of self-employed people, out of the market completely. This may reduce competition for mainstream banks, that they themselves still have small exposure to borrowing in this market, in that they do obtain some of their funding from the sub prime lending market in the United States.
This will place it in the unusual position of having to consider a rise in interest rates even if the reserve bank does not raise them officially.
