The new U.K. Enterprise Bill introduced in the U.K. relaxes personal bankruptcy rules, which is troubling to some, as personal bankruptcy is already on the rise. Opinions differ as to how this will impact U.K. ABS, though most sources believe that negative implications to consumer-related deals will be felt over the long term. In the meantime, U.K. deals remain sufficiently safeguarded to weather immediate rises in defaults as a result of the law.
According to market reports, the new rules seek to reduce the cultural stigma associated with bankruptcy by reducing the bankruptcy period to a maximum of 12 months, compared with three years. The bill's intention is to create more incentive for entrepreneurship. "The law will certainly create a more debtor-friendly bankruptcy regime, bringing the U.K. more into line with other countries, such as the U.S.," said analysts at Deutsche Bank Securities.
Of course, there are serious concerns of a spike in personal bankruptcies if consumers see the more lenient terms as an easy way out of debt. In figures released by the Department of Trade and Industry, personal bankruptcies in the U.K. during the fourth quarter 2003 rose by 30% over levels during the same period a year earlier.
"As we have stated in the past, we expect that U.K. bankruptcies will increase as more borrowers take on consumer credit and the traditional stigma of bankruptcy erodes," said analysts at JPMorgan Securities. "The overextension of some U.K. borrower segments, with debt burdens so large they can barely meet interest payments, is concerning. These borrowers are not always homeowners, so they lack an option to consolidate unsecured debt using their mortgage equity."
Analysts at Deutsche Bank estimated that, at the end of last year, more than GBP170 billion of unsecured credit and GBP750 billion residential debt stood outstanding. U.K. credit card debt alone has risen to GBP1,140 per individual, which is twice the levels recorded in 1998, while homeownership as a percentage of households is just 31%. The lower-tiered consumer is most likely to take advantage of the reformed rules, which could mean rising defaults for non-conforming, non-prime pools.
However, while the new laws will promote more risk taking by the consumer, some major disincentives should keep filings at bay. Consumers face stiff penalties if they are deemed to be cheating the law, and first-time filers of bankruptcy who are also homeowners could lose their homes. By contrast, in the U.S. a homestead exemption clause allows for an allotted amount of homeowner equity to be exempted from a creditor's claim. U.K. consumers are only allowed to keep clothing and work-related possessions. And while the discharge period is a window of only 12 months, filers will continue to have their wages garnished for three years after filing for bankruptcy, unless the debt is paid off within that time.
Prime mortgage holders will likely still be dissuaded from bankruptcy by these measures, which should leave prime mortgage deals largely unaffected. On the other hand, a rise in bankruptcies will expand the subprime universe. According to Deutsche Bank analysts, since the bankruptcy period has been shortened, there should be a notable increase in post-bankrupt borrowers going forward.
Add rising expenses
On the credit card side, prime portfolios mainly back securitization pools. Fitch Ratings believes the recent hike in interest rates has yet to hit the average consumer and is concerned that spending remains unfettered.
"A recent indication that some borrowers have already overextended themselves financially came in the form of a dramatic increase in the number of personal bankruptcies," reported the agency. While performance in credit card deals has yet to deviate from the base case expectations, if interest rates continue to rise as anticipated, delinquency rates could rise as well and charge-offs could follow.
Most anticipate a 50 basis point hike by the end of the year, which could push overstretched consumers into bankruptcy. But unlike Chapter 7 in the U.S., U.K. credit card debt follows the borrower through bankruptcy. According to Deutsche Bank, most lenders would be inclined to recover as much as possible before charging off.
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