British banks may end up extending existing mortgage payment holiday schemes to a year, even as one in seven mortgages in the U.K. are now subject to such an exemption, potentially affecting bank liquidity.

The government said in March that banks were required to grant temporary reprieves on mortgage repayments to help families struggling financially during the coronavirus crisis.

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Existing payment holidays are due to expire in June or July, and the U.K. Financial Conduct Authority is considering extending them for a year or more, according to The Times. Sources talking to the Financial Times said Chancellor Rishi Sunak is in advanced talks with the regulator to extend the scheme.

Banks are also considering options for those who may need further support. Trade body UK Finance is working with government and regulators to find the best solutions for all involved, a spokesman for the group told S&P Global Market Intelligence.

Liquidity concerns

John Cronin, an analyst at stockbrokers Goodbody, said yearlong payment breaks would raise questions around whether borrowers would ever get back on track, and so could raise bank liquidity concerns.

Interest continues to accrue during the period of nonpayment, though for the average mortgage holder the payment holiday amounts to £755 a month of suspended payments.

U.K. banks' liquidity coverage ratios, which measure their ability to withstand cash outflows, were in relatively good shape compared to their European rivals going into the coronavirus crisis, but Royal Bank of Scotland Group PLC, Barclays PLC and Santander UK Group Holdings PLC all suffered year-on-year declines. The ratio is calculated by dividing a bank's stock of high-quality liquid assets by total net cash outflows over a 30-day period.

"On balance, there is some merit in extending payment breaks for a certain cohort of borrowers, but it is imperative that this cohort is well-defined and relatively small," Cronin said in a note to investors. Mass take-up of yearlong payment breaks is likely to throw up significant problems, he said.

"This would provide struggling borrowers with extra breathing room, while banks would continue to accrue interest on the loans and the can would effectively be kicked down the road in recognizing significant increase in credit risk on certain accounts coming out of payment breaks and thus increasing provisioning," he said.

So far, British banks have provided 1.6 million mortgage payment holidays of up to three months, according to UK Finance. They have also provided almost 700,000 payment holidays on credit cards and 470,000 on personal loans, while 27 million customer accounts now offer the option of interest-free borrowing for three months on the first £500 of their arranged overdrafts.

This comes at a time when banks are making provisions for potentially huge losses down the road, with GDP growth plummeting and unemployment rising. In the first quarter, U.K. lenders made provisions against losses of more than £7.5 billion, nearly 6x the amount set aside in the same period last year. S&P Global Ratings has estimated that systemwide U.K. domestic credit losses will rise to £18.5 billion in 2020.

Mortgage market stasis

Banks have also seen the mortgage market come to a virtual halt during the crisis. RBS, for instance, said it saw £10.4 billion of new gross mortgage loans in the first quarter, but only about £1.4 billion in April, though it has extended all of its mortgage offers so they are valid for six months.

RBS CEO Alison Rose said the bank was comfortable with the level of risk on its books even in the pandemic. On a first-quarter earnings call she said the bank has agreed about 190,000 mortgage payment holidays, or about 18% by value of its book.

It is too early to tell what the issues are, but in many cases customers have asked for holidays "from a prudent perspective rather than from a stress perspective," she said.

Rose said the bank's average loan-to-value in its mortgage book was 57%.

"Of course, it isn't average mortgages that lose money," she said. "However, at the higher risk levels only 13% of the book had loan-to-values above 80% and we had no particular concentration."

Lloyds Banking Group PLC was also keen to reassure investors that its payment holiday regime presented few dangers. CFO William Chalmers said the bank had an average loan-to-value in its mortgage book of 44%, with 90% of the book having a loan-to-value below 80%.

Lloyds' mortgage book from 2006-2008 now has an average loan-to-value below the rest of the mortgage book at 43%.

Barclays said it had increased its mortgage book by £1.8 billion in the first quarter and by £7.9 billion year over year, but its mortgage book had an average of 50% loan-to-value. The bank has given mortgage payment holidays to about 10% of its mortgage holders, most of whom were up to date with their payments, said Group Finance Director Tushar Morzaria.

"The reason I'm a little bit more sanguine on mortgages is the amount of overcollateral in our mortgage book is very substantial," he said. "So, we'll see where house prices go but by any forecast that we're seeing at the moment will be substantially overcollateralized on our mortgage book."

HSBC Holdings PLC, meanwhile, said it had low average loan-to-value in its mortgage book with $72 billion out of about $147 billion of its U.K. mortgages at below 50%, though $32.5 billion is over 70% loan-to-value.