In the mid-to-late 1990s specialist firms such as Kensington Group largely dominated the so-called sub-prime market — lending to people with patchy credit records. The big and ugly mortgage players, such as Halifax (now HBOS), steered clear partly because of a perceived stigma about lending to riskier customers.
Unsurprisingly, the specialists made hay. Margins were fat and profits were juicy. Too fat it seems — while margins on mainstream mortgages can be wafer thin at 1%, the returns on sub-prime are double if not treble that amount. So, it was inevitable that the big boys would look to muscle in — HBOS and Nationwide building society are now sub-prime players. But the more striking trend has been the emergence of the investment banks. Merrill Lynch and Lehman Brothers have been expanding aggressively in the sector.
It is easy to see why. The investment banks are undercutting traditional specialists because the cost of their funding is lower. Loans are securitised and sold to hedge funds. It seems only a matter of time before other investment banks wade in.
All this means that the market is becoming more about scale than nimble specialists. Kensington, which is a good company and has
a strong track record of handling riskier lending, has been hit hard. Last week, its shares dived by 15.5% in three days after the company warned that competition meant profits would be at the lower end of the City’s forecasts.
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Kensington is a well-run company, but it is in a bind. It is difficult to see why a larger rival may want to buy the business. Alliance & Leicester, for instance, has opted to enter the sub-prime market through a deal with Lehman.
A slowing housing market may ease some of the investment banks’ rapacious appetites, but the likelihood is that competition is going to get tougher.
IG Group
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SHARES in IG Group, the spread-betting firm, have had a stellar run since the company was refloated on the stock market at 116p in April last year. With the shares at 278p, IG Group is valued at almost £1 billion.
Over the past five years, IG has ridden the boom in spread betting, which offers the chance to bet on falling as well as rising prices. Full-year profits in July jumped by 51% this year and the number of customers rose 26% to 300,000.
IG is adding 1,000 customers a month. Punters are getting more adventurous — five years ago most bets were on equity indexes, now many people take a flutter on commodities and foreign exchange.
The challenge is to maintain the pace. IG is vulnerable if markets are dull, while some analysts have raised concerns that binary bets — allowing punters to gamble on two possible outcomes — have not yet taken off. Even if the market is booming, maintaining growth in Britain of between 40% and 50% looks tricky. That makes expansion abroad crucial.
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So far there are signs that it is working. Revenues from the Irish division are up tenfold on last year, while Tim Howkins, the chief executive, reckons the Australian business could be even bigger than the British one. The shares are not cheap at about 20 times earnings, but are still worth holding.