The question and message of the FSA’s proposed regulation to second charge lending is still uncertain and up in the air, so Bridging & Commercial thought it would be a good idea to look into second charge lending. We define what it is, what previous proposals have said, what the latest MMR stated and what some of the industry experts think about the proposed further regulation and its likely outcomes.

What is second charge lending?

Second charge lending is where borrowers take out a second loan on top of their original mortgage. Most consumers refer to second charge mortgages as ‘second mortgages’. The second charge mortgages are typically shorter-term and much smaller than first charge mortgages. Second charge mortgages can be used as a substitute for either unsecured credit or variations on first-charge mortgages.

It is simply a way of securing a loan, using any residential value, or equity, in the property as the security. Second charge loans are often used for reinvestment back into the property, such as home improvements; but the money can be used for anything the borrower wishes.

There is a risk of repossession in using one’s home as security if the borrower falls into financial difficulty. This is only taken as a last resort, once all other reasonable alternatives have been exhausted.

In recent years, second charge mortgages have also been increasingly used by borrowers as debt consolidation loans, in particular by borrowers with impaired credit records. Borrowers experiencing problems with their existing unsecured loans have used second charge mortgages to consolidate their debts into a single loan.

A second charge is subordinated to a first charge: in the event of default and the sale of a property a first-charge mortgage lender will recoup its money first and the second charge mortgage lender’s interests in the property are only activated after all liabilities to the first-charge mortgage lender have been settled.

The Finance & Leasing Association believes that second charge mortgages play an important and valuable role for many consumers, helping them to consolidate existing debts at lower and more affordable rates of interest. This provides real support for customers who may be struggling with their finances.

The FSA revealed that based on its data between the period of 2007 to Q2 2011 those lenders’ non-regulated business including second charge and buy-to-let loans has more than doubled.

Regulation

Regulation will be one of the key topics in 2012 and the proposed changes to the regulation of second charge lending is just one area which many are keeping their eyes on.

Proposed regulation to second charge lending was first raised in 2004, when the Government extended the scope of FSA regulation to include first charge residential mortgages. Regulation of other credit business, including second charge mortgages, was set out in consumer credit legislation and was superintended and enforced by the OFT.

The FSA’s review of the mortgage market began in 2005 when they launched the first of two studies of the effectiveness of the mortgage conduct regime introduced in October 2004. Those early reviews looked at responsible lending practices in the areas of sub-prime, interest-only, self-certified mortgages and lending into retirement. The FSA did find weaknesses in responsible lending practices and had started working with the industry to try and raise standards.

In March 2009, the Government announced that it would review the current split of OFT and FSA regulation in relation to second charge mortgages. On 8th July 2009, HM Treasury published ‘Reforming financial markets’, setting out the Government’s proposals for the reform of the financial system, which announced that the Government would review the case for transferring regulation of second charge mortgages to the FSA.

October 2009 saw the FSA state, in DP09/3, that it would be desirable to extend the scope of the current mortgage regulation in some aspects, both to ensure a high (and continuing) standard of consumer protection and to avoid potential gaming risks. These issues were further considered by the previous government in consultation on the case of extending FSA regulation for second charge lending, unregulated purchasers of mortgage books and buy-to-let.

In the HM Treasury paper published in December 2009, entitled ‘Mortgage regulation: a consultation’, it stated the Government is committed to ensuring that the regulatory framework remains robust and up to date.

In the feedback subsequently published in March 2010’s ‘Mortgage regulation: summary of responses’, the previous government confirmed its intention to transfer responsibility for second charge lending from the OFT to the FSA.

The FSA’s latest Consultation Paper CP11/31, entitled 'Mortgage Market Review: Proposed package of reforms', was published on 16th December 2011.

Industry response to proposals

Some believe that the proposed regulation of second charge lending would have an enormous impact on a lot of lenders and regulatory changes could potentially remove a number of the short term lenders from the market because the process of becoming regulated is quite onerous and expensive.

Speaking on the proposals Stewart Barnes, Director at Portman Finance, said: “In principle, we are not against regulation. It plays its role and can protect both lender and borrower if done well. However, it causes us great concern that second charge lending will be tarnished with the same ‘regulation brush’ for current regulated lending and could suffocate the second charge lending industry. Second charge lending is very much a niche area and it is very rare that we would ever see two cases the same. Therefore, it will be a very hard task to regulate this industry in the same way that they have for first legal charges.”

Bob Sturges, Head of Communications at Omni Capital, believes: “The debate regarding the future regulation of second-charge lending is nothing new. To my certain knowledge, we were discussing it as far back as 2005. Since then, little has happened. But with the FSA’s Mortgage Market Review entering its final consultation phase, change may finally be on the horizon.

“I should add here that Omni Capital does not presently offer FSA-regulated products. But that shouldn’t preclude us from having an opinion, or stake, in the unfolding process. Indeed, we fully recognise the move towards more regulation, not less, and have begun our own prudent preparations accordingly.”

Stewart Barnes warned that there may be adverse effects on the sector if the proposed regulation of second charge lending came into force. He said: “If the market is to be regulated it will need to be done very carefully and with a lot of guidance taken from the lenders within the industry. If it is done incorrectly then it could stifle and potentially kill the industry and at this current time with the banks reluctant to lend and SMEs in need of capital, we are an important life line to the economy.

“If the industry does become regulated then it is possible that we will see a number of lenders, especially the smaller ones, withdraw from the market because of the onerous and costly task of become regulated. It could also make it much harder for borrowers if the number of second charge lenders decline.”

Bob Sturges stated: “It would, of course, be incorrect to assume the second-charge sector is wholly unregulated. While some elements remain broadly outside the remit of formal regulation, such as lending to companies and high-net worth individuals, much of the sector’s activities are governed by the Consumer Credit Act and enforced by the Office of Fair Trading. The sector has also benefited from having as its principal trade body the Finance & Leasing Association (unlike the unloved and now defunct Finance Industry Standards Association – a master class in how not to run an industry trade body!).

“Whether this has been sufficient or effective in protecting consumers is one of the key issues in the continuing debate. Others include the desirability of having a single regulator oversee all forms of secured lending, and how new regulation might impact a sector already badly damaged by the effects of the credit crunch.”

Stewart Barnes concluded: “Regulating second charge lending feels slightly like a panic reaction from the FSA. Having had their fingers burnt, rather than learning from their mistakes as well as mistakes made by the industry, they are just regulating everything.

“Over the last 6 years we at Portman Finance have seen big changes in the second charge lending industry. We would argue that with the help of associations like NACFB, AOBP and some involvement of the FSA there is no need to regulate us in this way, as we are able to self-regulate.”

Mark Posniak, Head of Marketing & Operations at Dragonfly Property Finance, told us: “It’s too soon to comment on it [proposed changes to second charge lending] at the moment, but we will work closely with our compliance and legal teams as and when any changes occur.”

Bob Sturges summed up his fears on the issue. “What still remains unclear is the FSA’s final definition of a regulated mortgage contract. That will be determined in due course. But at this time, it looks as though most forms of second-charge and buy-to-let lending will become fully regulated under the auspices of the FSA or, more correctly, its successor. Some aspects may yet be exempted, but we cannot be certain of this.”

He added: “If regulation is to be so extended, we at Omni Capital would far rather it be done under the authority of a single regulator. Regulatory fragmentation simply doesn’t work well, and it is our view that the FSA is best positioned to assume overall responsibility. There will inevitably be an impact in terms of added cost and work that may force some players to exit the sector. But in the interests of long-term sustainability and enhanced reputation, it is a price we believe to be worth paying.”

There are many that believe there is a place for regulation, but that the proposed second charge lending is not it.

It is understandable why the FSA is looking more at regulation in the face of the economic climate and potential impacts from the European Mortgage Directive but the niche area of second charge lending is rather different to first charge lending and the FSA should be careful when making their full decision on the topic.

However, according to page 201 of the latest MMR paper, ‘Proposed package of reforms’, it maybe some time before second charge lending could be regulated.

The Review published says that in the first draft in 2009 ‘we explained that a key risk to achieving the overall aims of the MMR is the ability of firms and consumers to “game” our changes; seeking to avoid the stricter standards applying to first-charge lending by accessing other forms of credit, such as second charge and buy-to-let’.

However, while the government has announced its intention to transfer responsibility for regulating second charge lending to the FSA, the latest MMR stated: “This transfer has been delayed until a decision is taken on the wider transfer of consumer credit. This means that any transfer will not take place until at least April 2014 or beyond.”

The FSA has called on the industry to feedback on its consultation proposals, which runs until 30 March 2012. Following consultation, the FSA Board will make a decision on the final form of rules in summer 2012, but implementation will not be before 2013.

By Jason McGee-Abe