The latest 25 basis point rate cut is sure to lend some stability to the U.K. housing market but analysts say it will be some time before the positive effects are felt on the residential mortgage backed securitization front - where delinquencies continue creeping up.
"Any interest rate move down will obviously have a positive impact. When it will impact current arrears levels is arguable, there will always be a lag," said Fitch Ratings analyst Jeremy Deacon. For the next six-to-nine months, Deacon said he did not expect to see improved performance in delinquencies, and once they begin to improve the arrears that have built up will have to be treated - either worked out or mitigated out, which could lead to some capitalization of arrears if lenders can get delinquent loans current in the present low interest rate environment.
The particular concern over rising delinquencies in the U.K. market has led to better servicing of these deals, according to analysts at Fitch speaking on a European mortgage servicing teleconference last week. Highly rated servicers are taking proactive steps to mitigate any risks associated with the lack of adequate resources and experienced staff, Fitch analysts reported. Some servicers have recently implemented dialing technology that makes pre-recorded calls to higher risk borrowers.
In response to rising arrears across the market and in most of the U.K. RMBS transactions that the agency rates, Fitch updated the criteria it uses when rating U.K. RMBS last month. "Although interest rates are currently low by historical standards, the volume of outstanding debt means that borrowers are vulnerable to even relatively modest interest rate rises," said Fitch Managing Director Stuart Jennings. "The structure of the U.K. market - where the majority of mortgage debt is variable or short-term fixed - amplifies the impact of rate rises. The extension of the agency's default assumptions for higher income multiples reflect this concern,"
The agency's core default assumptions remain largely unchanged. While arrears and repossessions have declined to historically low levels since the last criteria update in 2000, this has been during a period of very benign economic conditions, providing little evidence of default behavior during periods of more stress. However, the number of income categories in the default model has been extended, reflecting the upward trend in income multiples and the increased debt levels that U.K. mortgage borrowers have accumulated.
Fitch also introduced sub-categories of adverse credit for subprime mortgages aiming to give investors a better understanding of the credit profile of the mortgage portfolios backing non-conforming RMBS transactions. "The performance of non-conforming RMBS around Fitch's arrears index is quite mixed," said Inga Smolyar, director responsible for U.K. non-conforming RMBS. "The different degree of adverse credit within portfolios is one of the main influencing factors in transaction performance. All lenders have their own definitions of what they deem to be a light or heavy adverse-loan product."
Deutsche Bank Securities' economists said that home prices are overvalued - and almost identical to levels seen before the early 1990's market collapse. The difference is that current rates and inflation are lower, providing more consumer stability. "If house prices do collapse, rates still go down," said one market source. "House prices are about 40% overvalued and if you look at it from the point of mortgage repayments, prices are about 20% overvalued. Lower rates, coupled with lower inflation, provide better stability for the consumer because mortgage payments are ultimately lowered."
Whether the rate cuts provide a ceiling for the rise in delinquencies depends on the individual transaction - in some of these deals, arrears will continue rising because borrowers are so indebted a rate cut won't really make a difference, added one Fitch analyst.
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