Mortgage loan portfolios are generally seen as low-risk. Revenues are stable, pricing is well understood and loss rates are fairly predictable. That perception's been given the stamp of approval by regulators: many mortgage lenders stand to enjoy a substantial reduction in capital requirements under the new Basel Accord.

But the mortgage markets are changing. Mortgage products are becoming more differentiated and, in many cases, riskier than “traditional” home loans. In the closing weeks of 2003, these changes resulted in a series of angst-ridden spasms in both the UK and Australia – two markets that are at almost identical stages of the housing cycle.

In the UK, the BBC’s influential “Money Programme” provoked fierce scrutiny of “self-certification” mortgages - loans intended for borrowers where income is difficult to document, such as the self-employed - by suggesting that enough borrowers were lying about their income to major lenders to threaten the stability of the entire mortgage market.

In Australia, self-certification mortgages are called “low-doc” loans. Low-doc loans have emerged as a new trend over the last year, according to John Harker, Asia-Pacific regional director for Experian in Melbourne, and have also attracted “adverse publicity,” he says. Australia’s banking regulator is currently considering removing low doc loans from the list of mortgage products eligible for capital concessions.

Both the UK and Australian central banks have also been publicly fretting about the ability of borrowers to sustain their increasing debt burdens and the rapid run-up in house prices – this latter factor being cited as the main reason for base rates rising twice in Australia and once in the UK in recent months.

Then, at the start of December, both Barclays and Lloyds TSB claimed that they had sacrificed market share because much of the business being written was too risky. In their trading updates, self-certification was mentioned as a specific area of concern, along with sub-prime and buy-to-let lending.

A new picture of the mortgage market seemed to be emerging – one in which the growth of new segments was lifting aggregate risk levels, making portfolios less stable and losses harder to predict.

But opinion is divided on whether this supposed trend towards riskier lending should cause concern, or even exists. A spokesperson for the main UK mortgage industry group, the Council of Mortgage Lenders (CML) argues that it would be wrong to say that risk levels have risen significantly.

“There is a continuum of risk in the market,” she says. “If you look at average income multiples and average loan-to-value [LTV] ratios, there has been nothing like a step-change. Multiples have been creeping up, but there has not been much change in LTVs.”

Barclays’ finance director and chief executive designate, John Varley, took a different line when talking to reporters last month. “Don't be seduced by the averages,” he said, claiming that Barclays’ decision to step back from riskier lending was “in sharp contradistinction to some of our competitors.”

Both of these apparently contrasting positions may be correct. Industry-wide data suggests that there is little reason to worry about the health of mortgage lenders generally. But it is likely that there is far more divergence between segments of the market, and between individual lenders, than in the past.

One institution that's been noted by market commentators as a prime example of an aggressive mortgage lender is Birmingham Midshires (BM), a unit of banking group HBOS. BM describes itself as a “specialist lender” – it specialises in self-certification, sub-prime and buy-to-let loans – and boasts that it has seen rapid growth.

A spokesman admits that these forms of lending are inherently riskier than traditional mortgage lending, but asserts that BM has the expertise to price accurately for the risk involved. “Our arrears figures are exactly where we want them to be,” he says, claiming that the bank does not expect late payments to increase this year.

Andrew Cunningham, senior vice-president in the European banking group with Moody’s Investors Service in London says that the agency “remains relaxed” about mortgage loan portfolios in general – but has reservations about specific market segments and about certain structural changes taking place in the market.

Cunningham sees no benign explanation for the rise in the popularity of self-certification mortgages, for example. Only 12% of the UK population is self-employed, he says. The other 88% should be able to produce salary slips from their employers, enabling them to certify their income with little difficulty.

“But some lenders have portfolios where 50% of the loans are self-certified," he says. "Intuitively, you have to say that many of these are first-time buyers who have found that [the traditional] earnings multiple of 3.5 won’t get them the house they want.”

There are countervailing arguments though, he says, citing a recent report produced by mortgage lender Nationwide, which suggested that a relative absence of first-time buyers in the market indicates a soft landing for the market is heading for a soft landing.

Cunningham also notes that even in the eventuality that borrowers have hoodwinked banks into breaking their underwriting standards, there are no immediate expectations of a dramatic change in interest rates, which could tip over-extended homeowners into default.

However, he adds that the emergence of new products has produced a greater degree of uncertainty about the market than existed in the past – and it’s unclear how these new portfolios will behave. “We’ve been racking our brains about how these changes could affect the market. We don’t want to be like generals fighting yesterday’s battles.”

Moodys’ Cunningham and Experian’s Harker both suggest that one concern could be the knock-on effect of riskier borrowers entering the mortgage market. These borrowers may be able to keep up with their payments in the current interest rate environment but, says Harker, “it’s entirely sensible to worry about the impact on more discretionary lending.”

If finances do get tighter for these households, the priority will always be to maintain mortgage payments – but non-payment of card debt and auto loans may increase, with Harker suggesting that one area of particular concern could be the level of holiday period “interest-free” retail purchases.

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