A Brexit-driven rise in the UK’s inflation rate through 2017 would bring a depreciation in the British sterling that could create negative connotations for mortgage, auto loan and other consumer debt securitizations, according to Moody’s Investors Service.
Among the hardest hit may be the buy-to-let borrowers of investor-owned residences in the UK, where inflationary trends could hit wage earners in a country where rents take up a significant portion of consumer monthly income.
Although default rates will vary by asset class, Moody’s noted that “most” securitizations have credit enhancement, excess spread and portfolio diversification factors that would allow the deals to “weather potential inflation-related default spikes and avoid tranche-level losses.”
"Price increases affect low-income borrowers mostly because they are less able to absorb higher costs,” stated Rodrigo Conde, an assistant VP and analyst at Moody’s London office.
“Potential mitigants for inflation, such as incurring more debt or wage increases, are limited due to already-high household debt, increasing unsecured lending and slow income growth compared with inflation,” he wrote.
The volatility that was expected to arise from the Brexit turmoil has failed to materialize. But the depreciation of the sterling against the Euro reached 13% and 17% against the U.S. dollar by mid-November following the June 23 UK referendum in which British voters elected to leave the European Union. That depreciation had abated to 11% against the Euro by last week, according to statistics from the Office for National Statistics.
That depreciation will feed inflation as companies pass on increased costs to consumers through higher prices, “most significantly in the goods sector,” the report stated. When considering the impact on borrowers in the lowest income quintile bracket, the rating agency's data shows a 5% rise in inflation from the current level could entail: (1) a 0.84% increase in UK non-conforming mortgage defaults and; (2) a 6.9% increase for auto loan defaults.
Moody’s report indicates the agency expects inflation to grow by 1.5% by year’s end 2.6% in 20147, in to what amounts to 4.1% by year’s end 2017.
“Given the UK's negative trade deficit, Moody's expects import-driven inflation to drive up the cost of consumer goods, eroding borrowers' disposable income and reducing their ability to make payments on loans backing rated securitisations,” the Moody’s report stated.
“If the price of basic goods increases by 15%, Moody's says the disposable income for multi-income families in the lowest income quintile bracket would fall by 8%, with an exacerbated impact on single income families.”
While mortgage and autos would be the most impacted in the securitization market, also feeling the effect would be credit card, store card and consumer-loan securitizations (although Moody’s does not rate many of those UK deals).
“Moreover, credit card borrowers could potentially stop paying their balances and roll the payments to future dates (with high financial costs), which would not be a default but would reduce affordability,” the report read.