The Financial Conduct Authority (FCA) has expressed "significant concerns" with regards to lending decisions taken by some firms within the second charge sector and has questioned the role of affordability assessments in determining loan approvals.
It has criticised a failure to carry out due diligence or authenticity checks in relation to applications and highlighted examples of "a number of poor practices" that have led to decisions based solely on equity, debt to income ratios or income multiples.
Furthermore, the watchdog has "identified instances in which firms were vulnerable to fraud by accepting evidence of income that could be easily manipulated by the customer" and has urged executives to review their processes in an open letter published at the beginning of March.
The conclusions are based upon a review of second charge lenders carried out over the past six months and their efforts to implement conduct rules and compliance regulations introduced by the European Mortgage Credit Directive (MCD) in 2016.
It has also been designed to assess overall industry practices and to ensure that customers are treated according to principles of fairness.
So, how should we view these findings and what do they tell us about the second charge sector at the present time? Are they indicative of a general malaise within the industry, or of a small number of lenders getting it badly wrong?
Should we be concerned by the evidence or should we regard it as a suitable starting point for a new era of market transparency?
In short, should we actually welcome the findings?
Without feedback, improvement is unlikely so the answer has to be yes.
There is little doubt that the pace of MCD regulatory change and the transfer of regulation from the FCA consumer credit regime to its mortgage regime (which put second charge lending on a par with first mortgages) has impacted heavily on the industry over the past two years.
Figures have pointed to a peak in loan activity in the lead-up to March 2016 - the point at which the MCA was implemented - and an inevitable period of market disruption in the months that followed (especially when taken in tandem with the results of the 2016 European referendum).
This new era of uncertainty was reflected by an apparent downturn in market conditions over the 12 months leading to February 2017.
Over this period, new business fell by 2 per cent and the number of second charge mortgages decreased by 10 per cent, according to data from the Finance and Lending Association (FLA), as lenders continued to grapple with the onerous demands of regulatory upheaval and brokers struggled to come to terms with more restrictive underwriting.
However, with consumer perception responding positively to the ‘legitimacy’ of regulatory security and the strenuous efforts of second charge lenders to ensure that all related requirements have been implemented, there has been a welcome upsurge in borrowing levels over the past 12 months.
Indeed, according to the latest data from the FLA, new business loans increased by 10 per cent in the year leading up to December 2017, with total values increasing by 14 per cent.
In addition, the number of new loans for the fourth quarter of 2017 demonstrated a 7 per cent rise on figures for the same period of 2016, with loan values climbing 9 per cent - a truly impressive reversal of fortune.
Given this context of shifting market conditions and fundamental industry upheaval, it's likely that many of the indiscretions identified within the FCA letter are attributable to the short period of time with which lenders have been expected to implement the new MCOB requirements, as well as a resulting failure to adequately design and oversee the multitude of overlapping strands at this time of great duress.
But that's no excuse as some lenders appear to have got it right with exactly the same challenges.
The FCA has already conceded that, where required, those firms which had been subject to a process of investigation have each taken subsequent steps to improve on their affordability assessments and many industry insiders, such as the FLA’s head of consumer finance, Fiona Hoyle, have insisted that lenders will be grateful for those insights, which will "help firms to fully embed" the new compliance regime.
Following the FCA review on mortgage advice it was clear that not everyone had the same interpretation, and the subsequent FCA report was hugely beneficial to show advisers there was a level playing field.
Similarly, the seconds lenders need to take this opportunity to reassess their businesses in light of this feedback and make changes if required.
Of course, many state they are already in good shape with experience from their established first charge divisions standing them in good stead.
The industry is on a sound financial footing and making great strides towards fulfilling regime requirements.
It has undergone a period of intense pressure and is now returning to pre-MCD levels of business.
It isn’t quite perfect yet, but it will be.
Steve Walker is managing director at Promise Specialist Lending
