Arrears warning on UK RMBS
Jonathan Livingstone, vice president senior analyst Moody’s, said in light of the higher unemployment, greater difficulty that borrowers in the regions face in refinancing and the softer home price outlook, transactions from mid-sized UK lenders who have higher concentrations in these areas will have relatively greater arrears than transactions with portfolios with larger concentrations in the South of England.
Currently, three-month arrears are 15% greater in the regions compared to the national average and 32% higher than the South of England.
As arrears and negative equity are strongly correlated, over 9% of borrowers in the regions are in negative equity compared with less than 3% in the South of England.
Moody’s said it expects both of these trends to continue but added deals from mid-sized lenders also have pools with less risky characteristics such as lower loan to value ratios, so the overall impact will be limited.
The two worst performing regions are the North West and Northern Ireland, which both have three-month arrears of at least 2.5%.
London and the South West remain the two best performing regions, with only 1.4% of borrowers in the capital having missed three payments on their mortgage.
The trends are broadly the same as in the prior year with overall three-month arrears in the UK RMBS deals analysed having risen to 2.1% from 1.6% and will continue.
Moody’s said the difference in mortgage performance between the South of England and the regions will remain at current levels, in line with unemployment differences seen between the two regional segments.
With affordability being strong for borrowers with a stable source of income due to historically low interest rates, unemployment is the key driver of arrears and defaults.
The strength of the labour market in the South of England is likely to be the key driver behind its more robust performance and should form the basis of the trend continuing.
Currently, unemployment is 8.0% in the UK but ranges from 5.8% in the South West to 10.4% in the North East.
While London is the only region in the South of England that does not have unemployment below the national average, it was one of only two regions to register a year-on-year decline with the unemployment rate falling to 8.7% (April 2012 – June 2012) from 9.5% (April 2011 to June 2011).
Livingstone said: “As with the prior year, the areas with the highest arrears levels are also those with the greatest levels of negative equity, such as the North West and Northern Ireland.
“Over a quarter of all borrowers in Northern Ireland have a mortgage that is greater than their house valuation compared with around 11.9% of borrowers from the North West and 5.8% for the UK as a whole.”
Moody’s said the trend towards stronger house prices in the South of England will continue while that in the regions will be weaker.
Livingstone added: “The recovery in the housing market in the South of England has been stronger than that in the regions and we expect this trend to continue.
“While the initial decrease in house prices following the credit crunch was slightly steeper in the South of England at 21.3% (vs. 18.5% in the Regions and 19.9% across the UK), its recovery has been stronger with house prices down only 10.9% from their peak (vs. 17.7% in the regions).
“As such, current property prices in the South of England are equivalent to those in Q3 2006 (vs. Q1 2005 in the regions).”
He also warned that the higher indexed LTVs of borrowers in the regions are negatively affecting their ability to refinance onto new fixed rates or lower discounted variable rates.
Indexed LTVs in the regions stand at 68.2% (prior year 67.0%) versus 62.6% (prior year 62.9%) in the South of England.
The current tight credit conditions mean that the most attractive rates are only available to those with a current LTV of less than 60%.
Borrowers with less than 20% equity in their property are particularly exposed to being unable to refinance onto a new rate.
Also, a number of lenders have recently increased their standard variable rates. Borrowers who are unable to refinance elsewhere are faced with increased mortgage payments which will affect their ability to remain current on their mortgages.
Livingstone said: “Credit risk management in the mid-sized lenders often benefits from the conservative culture present in mutual organisations.
“As such there is usually a lower proportion of high LTV ratios at origination and lower numbers of borrowers in negative equity, and fewer interest-only loans.
“Additionally as the majority of these deals have only closed recently with the selected loans being current at the time of securitisation, all borrowers have been stress-tested post credit crunch.”
While not anticipated, interest rate rises could lead to back-end losses in the South of England, the ratings agency said.
“The level of interest-only loans remains higher in the South of England and may lead to a higher proportion of back-end losses in our adverse scenario, in which there are significant interest rate increases,” said Livingstone.
“However, our central scenario contemplates stable mortgage rates. Interest-only borrowers will find it harder to refinance as lenders have tightened their criteria on non-repayment loans following the Financial Services Authority’s mortgage market review, which reported proposed reforms in December 2011.
“Levels of interest-only loans remain higher in the South of England with 51.3% (51.0% in 2011) of loans being non-repayment, reflecting the more stretched affordability at the height of the boom.
“The overall level of interest-only loans has fallen to 44.1% from 47.9% in 2011. However, there is significant regional variation in the reduction, driven by an average reduction in interest-only levels in the regions of 8.0% over the past year.”