After 10 years of strong performance, activity levels in the U.K. mortgage and residential mortgage-backed securities (RMBS) markets are showing signs of softening. Transaction volumes are decreasing, and the property price growth in some regions has entered into negative territory.
Sluggish worldwide economic growth, historically high property prices, and the political uncertainty around the terms of Brexit raise questions on the future performance of the mortgage and RMBS markets. That said, S&P Global Ratings remains cautiously positive about the market's performance in the near to medium term.
A Decade Of Strong Credit Performance
Ten years after the peak of the global financial crisis, the U.K. mortgage and RMBS markets have proven resilient. The proportion of loans in arrears currently stands at historically low levels: as of fourth-quarter 2018, total delinquencies in our prime RMBS index amounted to 1.8% compared with 2.3% in first-quarter 2008. Over the same period, the percentage of delinquent loans in our nonconforming index decreased to 12.7% from 21.7% (see chart 1).
Late stage arrears, defined as loans that have been delinquent for a period of 90 days or more, have followed the same trend, with their proportion having reduced to 0.8% from 0.9% in our prime index, and to 6.1% from 10.6% in our nonconforming index.
Chart 1
According to the Bank of England (BoE), the percentage of regulated loans (both securitized and non-securitized) in arrears decreased to 1.0% as of third-quarter 2018 from 2.1% in first-quarter 2008. In absolute terms, this translates into a reduction of the total balance to £11.4 billion from £16.7 billion. The stock of repossessed properties has decreased by 80.3%.
As of third-quarter 2018, the cumulative default rate on U.K. RMBS outstanding notes issued before second-quarter 2007 was only 0.1% (comprising Eurosail-UK 2007-1NC PLC's class E1c and ETc notes), reflecting the solid performance of the asset class even during the course of the financial crisis.
Consistently positive economic growth and a more favorable labor market--compared to that of the eurozone--since the end of the financial crisis have been the main drivers for the market's strong performance. Additionally, the unemployment rate, which currently stands at one of its lowest levels over the last 40 years at 3.9%, is highly correlated with the evolution of arrears in our U.K. RMBS indices (see chart 1).
The low interest rate environment also contributed to the solid credit performance of the U.K. mortgage market: before rising to 0.75% in August 2018, the BoE Base Rate (BBR) oscillated between 0.25% and 0.50% since first-quarter 2009, easing the burden of mortgage debt servicing for borrowers' BBR-based mortgage interest rate. In addition, borrowers with loans linked directly to LIBOR have also benefited from the low interest rate environment.
More stringent regulation also underpins performance
The outcomes from the Mortgage Market Review (MMR) (introduced in April 2014) partly underpin the mortgage market's stable performance as they limit the origination of certain higher risk loans. Whereas loans granted to borrowers who self-certify their income, fast track loans, and interest only (IO) loans without a repayment strategy had become mainstream products before the crisis, lenders must now abide by prescriptive and industry wide underwriting criteria. The MMR rules impose loan affordability tests in the form of interest rate stresses (BBR stressed, over the loan's first five years, and three percentage points higher than the prevailing rate at origination), and a thorough assessment of non-mortgage related households' expenditure, credible repayment strategies for IO loans, and validation of borrowers' income for owner-occupied loans.
The Prudential Regulation Authority (PRA) started to regulate consumer buy-to-let (BTL) loans in 2016 and the professional landlord BTL segment in 2017. It introduced affordability rules requiring lenders to stress interest rates to 5.5% for the first five years of the mortgage loans (or at a long-term fixed rate). When BTL loans are IO loans, the lender must validate a credible repayment strategy. As a macroprudential measure to constrain higher risk lending, the PRA requires that, on a four-quarter rolling basis, lenders do not grant more than 15.0% of their new mortgage loan production at a loan-to-income (LTI) multiple higher than or equal to 4.5x.
This regulation has improved the overall credit profile of asset pools securitized in newly originated transactions in the U.K.
London and South East HPIs trail other regions
The Land Registry U.K. House Price Index (HPI) reached its lowest point in March 2009. Since then, regional HPIs have grown steadily across the entire country, except in Northern Ireland, on the back of a solid economic recovery following the financial turmoil, and low interest rates, which boosted affordability and triggered more demand. The highest increase of regional HPIs occurred in London where property prices are now 1.9 times higher than in March 2009, followed by a 1.7 times HPI increase in the East and South East over the same period.
Chart 2
However, the trend has reversed since July 2017 and property prices growth decelerated across the country except in the Northern regions and Wales, where growth has remained positive. At the same time, the HPI in London decreased by 3.2% between November 2018 and July 2017, while it increased moderately by 0.9% in the South East.
This slowdown in the capital is the reflection of current affordability stretches as property prices have reached historical highs and outpaced wages. Also, political and economic uncertainty following the Brexit referendum has reduced transaction volumes and foreign investment.
Lower Transaction Volumes, A Sign Of Overheating?
The Brexit referendum marked a tipping point in residential property transaction volumes: the 12-month rolling net advances for both regulated and unregulated loans started to decline in third-quarter 2016 after three years of solid growth. Since then, they have decreased by 10.5% to £47.7 billion as of third-quarter 2018. In our view, this is likely to continue until the U.K. government and the EU reach an agreement on the terms of Brexit.
This recent slowdown in transaction volumes results from a weaker household demand, whereas lenders' risk appetite has increased, as shown by the greater availability of higher loan-to-value (LTV) ratio products. The return to the market of high LTV mortgage loans could pose credit risks in the medium term, in our view.
The share of BTL mortgages decreased by 1.8 percentage points since the Brexit referendum as a result of compressed yields on these investments and uncertainty about likelihood of capital gains. As for first-time buyers, their proportion has proven resilient at 20.95% of total volumes as of third-quarter 2018, almost twice as high as pre-crisis levels.
The "Help to Buy" scheme, which the U.K. government implemented in April 2013 to help first-time buyers with modest deposits acquire their first property, did not boost transaction volumes: the share of total mortgage origination under this scheme has remained modest. The cumulative amount of completed transactions through the scheme only accounts for a few percentage points of the total of loan completions over the same period.
Wage growth has not offset property price growth
Despite an increasing year-on-year wage growth of 3.4% as of fourth-quarter 2018 and a recent deceleration of the HPI across the country, U.K. Finance data indicates that borrower affordability has not improved. Between November 2017 and November 2018, the average LTI multiple stabilized at 3.6 and 3.4 for first-time buyers and home movers, respectively.
Historically, the combined LTI multiple increased by 27.5% between March 2009 and November 2018, indicating that affordability has been materially stretched over the period. This is reflected in the average LTV ratio now amounting to 84.7% and 72.9% for new lending to first-time buyers and home movers, respectively. The average original loan size as of November 2018 was £142,500 and £180,000 for first-time buyers and home movers, respectively.
Chart 3
A broader range of mortgage products does not keep transaction volumes up
During the past decade, the continuous discrepancy between property price and wage growth has increasingly stretched affordability. This recently broadened the scope of the mortgage product offering, while mortgage lenders also have to comply with the prescriptive rules set by the MMR, as well as with the macroprudential measures applied by the PRA for loans granted based on an LTI multiple exceeding 4.5x.
The average original loan balance since the aftermath of the crisis rose by 60% to £194,900 as of December 2018. This rise in average loan balance led to a higher proportion of high LTV ratio loans, yet in a lower proportion than before the crisis (see chart 4). Loans with an LTV ratio equal to or higher than 90.0% account for 4.9% of gross advances granted in third-quarter 2018, lower than the 15.5% in first quarter 2007 (see chart 4). On the other hand, the percentage of loans with an LTV ratio of lower than or equal to 75.0% decreased in 2018.
Some high street lenders such as Barclays Bank PLC and Lloyds Bank PLC, as well as some challenger banks started to advertise 100% LTV ratio mortgage loans, a product that had disappeared as the crisis started to affect the whole market (see "U.K. RMBS 2.0 Origination And Structural Evolution Combine To Reduce Credit And Reinvestment Risk," published on Jan. 7, 2019).
Fixed-rate mortgage loans accounted for 90.6% of gross advances as of third-quarter 2018, double the amount of first-quarter 2009, in part because borrowers expect rates to increase (unlike in 2009). The current low interest environment allows borrowers to lock in advantageous interest rates for periods of two, three, or five years. Mortgage lenders also offer less popular seven- and 10-year fixed rate mortgage loans. Whereas two-year periods used to be the most popular tenor, recent trends show an increased inclination from borrowers to lock interest rates for five years, partly because the gap between the average two-year and the average five-year fixed rates for 75% LTV ratio loans has tightened to 0.32 percentage points in February 2019 according to the BoE.
Chart 4
Brexit Looms Large And Wide
The outcome of the Brexit negotiations remains uncertain, as do the mortgage and RMBS markets' reaction and performance in the foreseeable future.
A no-deal Brexit could push the U.K. economy into a moderate recession, representing a cumulative loss of about 5.5% GDP compared with our baseline forecast over 2020-2021. Although severe, this projected loss is still only about 60% of that caused by the 2008 global financial crisis. In case of a no-deal Brexit, we expect unemployment to reach 7.4% by 2021, inflation to peak at 4.7% in mid-2019, and house prices to decline by 10% by 2020 (see "Countdown to Brexit: No Deal Moving Into Sight," published on Oct. 30, 2018).
However, a no-deal Brexit does not constitute our base case. We therefore remain cautiously positive about the performance of the U.K. mortgage market in the near to medium term.
Related Research
- U.K. RMBS Index Report Q4 2018, Feb. 19, 2019
- U.K. RMBS 2.0 Origination And Structural Evolution Combine To Reduce Credit And Reinvestment Risk, Jan. 7, 2019
- European Economic Snapshots For 1Q2019 Published, Dec. 18, 2018
- Countdown to Brexit: No Deal Moving Into Sight, Oct. 30, 2018
- Countdown To Brexit: A Disruptive Brexit Would Mean Increased Losses In U.K. ABS And RMBS Transactions But 'AAA' Ratings Will Be Stable, Sept. 5, 2018
This report does not constitute a rating action.
| Primary Credit Analyst: | Geoffrey Guillemard, London (44) 20-7176-6635; geoffrey.guillemard@spglobal.com |
| Secondary Contacts: | Arnaud Checconi, London (44) 20-7176-3410; ChecconiA@spglobal.com |
| Alastair Bigley, London 44 (0) 207 176 3245; Alastair.Bigley@spglobal.com |
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