U.K. mortgage lenders are quickly adjusting lending criteria to serve first time home buyers. For instance, HBOS and Abbey National this month announced plans to launch new, higher LTV mortgages aimed at these borrowers. However, going down this route has sparked concerns that lenders might be overstretched in the event of a market reversal.
Abbey plans to lend up to a five time multiple of a borrower's income while HBOS plans to offer mortgages of up to 125% LTV via the Halifax and specialist mortgage lender solutions brands.
According to Fitch Ratings analysts, property value advanced by the lender to first-time buyers declined slowly but steadily to 87% from 95% in 2004, but has notched up to 90% in 2005. During this same period, the median salary multiple advanced to first-time buyers has increased steadily from 2.31 times in 1992 to a high of 3.08 times in 2005. Recent data from the Council of Mortgage Lenders shows that borrower multiples for first-time buyers has increased to 3.24 times in July 2006, while interest payments represent 16.7% of income.
The U.K. financial regulator, Financial Services Authority (FSA), is concerned about the potential mortgage risks associated with these riskier products. In light of news that mortgage lenders are offering mortgage loans at increased multiples of borrowers' salaries, the FSA last week told mortgage lenders to make sure that they could withstand a slowdown in house prices of up to 40%. The FSA also warned that the positive economic growth might not last forever and that lenders should carry out stress tests' to guaranty that the loans they underwrite would be able to hold up under extreme drops in house prices. The regulator emphasized that the banks are not only exposing themselves to financial losses, but are also risking their reputation should there be a significant increase in customers unable to repay their debts.
Phil Adams, director of securitization research at Barclays, said that the market could eventually evolve like the U.S., where products are designed to help affordability. "The U.K. hasn't seen some types of products that have been introduced in the U.S., which is a good thing because it helps prevent overheating the market."
Concerns about borrowers over-leveraging themselves are already being raised. HBOS has two outstanding U.K. prime RMBS master trusts and under the existing trust portfolio criteria, mortgages with 100% plus LTV are not allowed to be included in the securitized pools, excluding the riskier mortgages the bank plans to write going forward. Dresdner Kleinwort Wasserstein analysts said it's likely that investors will pay close attention to the eligibility criteria of Abbey's forthcoming Holmes XI deal to see whether the lender has permitted the inclusion of these mortgages, given the implications for default probability that they have.
Chris Greener, director and ABS senior credit research analyst at Societe Generale, said that its higher LTV loans are already included in Northern Rock's "together" product, which offers a 95% LTV mortgage and a 30% LTV unsecured loan to give a 125% total loan - only the mortgage product is included in the securitization. "We expect that new higher LTV products will be included in the master trusts, and are little different in risk profile to existing 95% LTV loans, where the borrower may take further lending as a separate product," Greener said. "The volumes included in master trusts are subject to rating agency tests based on total portfolio risk."
Standard & Poor's which rated Abbey's latest deal, said that at the moment, the mortgage lender has not signaled any intention to include its new product type under the new securitization structure issued last week. "If they have a new product type that they intend to introduce then we need to have proper notification," an analyst at S&P said. "We don't think they intend to include these higher income multiple mortgages yet but we suspect they will eventually be included."
But for now, the mortgage market is looking optimistic. RMBS issuance totaled 150.6 billion ($192.9 billion) in the first three quarters, an increase of over 70.3% in the same period last year as it continued to benefit from positive housing market trends, the European Securitization Forum reported recently. RMBS issuance now accounts for 53.2% of the European securitized market, compared with 48.1% at this stage in 2005.
"We have seen staggering volumes so far this year, far ahead of last year," SG's Greener said. "New sellers in the market accounted for 44.8 billion, as inaugural deals from Alliance and Leicester, Barclays, Lloyds TSB and Royal Bank of Scotland brought diversity to the sector. Eight of the top 10 lenders now have a securitization program."
According to Rightmove Plc., U.K. house prices rose at the fastest annual pace in November. U.K. house prices increased 12.4% year-over-year and 1.5% on the month, which is up from 11.5% year-over-year in October. "House price inflation continues to be affected by the significant increases in London, driven by foreign investment and bonus payments to bankers," Morgan Stanley primary analyst Sarah Barton said. "The average cost of a home in London's Kensington and Chelsea district topped GBP1 million ($1.89 million) for the first time this month."
The Royal Institution of Chartered Surveyors October house price index reached its highest level in four years - 48% - up from 45.7% in September. More chartered surveyors reported higher home values, as economic growth and increasing employment are allowing house buyers to shrug off the latest interest rate hikes, Barton explained.
Additionally, U.K. mortgage lending remains robust in October. According to the British Bankers' Association (BBA), net mortgage lending increased by GBP5.5 billion, up from GBP5.4 billion in September, but lower than the monthly average of GBP5.6 billion. Total mortgage approvals amounted to GBP4.3 billion in October, up from GBP3.9 billion a year earlier but down from GBP4.7 billion in September.
"The market is looking reasonably healthy," Barclays' Adams said. "There has been some deterioration in credit performance but this varies from prime to subprime RMBS. Prime and buy-to-let RMBS have seen some deterioration but, coming from great performance levels, this is not a concern at the moment. Even with deterioration everything is safe. Losses are running at less than one basis point per year so there is an enormous cushion before losses would begin to become a genuine credit risk."
And Greener said that spreads have proved remarkably stable for all ratings, as strong demand mirrored heavy supply. "The U.S. dollar bid has provided much demand, especially for short dated paper, absorbing much supply," he said. "We expect some tightening next year, mainly based on the Basel II trade, as lower risk weightings tempt further bank investors. In the near term, we do not expect heavy volumes and therefore spreads will likely hold around current levels."
But the tide on the buy-to-let side might begin to change. According to the Department for Constitutional Affairs, mortgage repossessions actions entered in the third quarter rose 15% year-over-year, A total of 34,626 mortgage possession actions were entered in the third quarter and 24,017 orders were made, a rise of 22% on the same period last year. An article in the Financial Times this month cited that properties owned by buy-to-let investors currently account for around half of all repossessed homes sold at auctions, significantly disproportionate to the size of the buy-to-let share of the overall U.K. mortgage market. "There is little evidence as yet of this credit weakness in U.K. buy-to-let RMBS portfolios, which continue to show superior performance relative to the prime market," Deutsche Bank analysts reported.
Bradford & Bingley's Aire Valley mortgage master trust reported 42 new repossession cases in the past month, but the overall rate remains low at just 41 basis points. Paragon, which lends primarily to the professional landlord market, boasts negligible defaults in its RMBS pools."
Not as cheery on the subprime side
On the subprime side, the story is developing more unambiguously. "The increase in arrears and losses has been concentrated in nonconforming and subprime RMBS. On average, arrears in this sector have increased to 15% from below 10% in early 2005, but transaction performance has been more idiosyncratic," Barclays' Adams said. Some losses have occurred over a concentrated period of time and thus resulted in a draw on reserve funds but don't necessarily lead to a ratings action. Adams said that it has nonetheless affected investor perceptions of these deals.
The transactions in trouble have had large detachable A coupons (DAC), SG's Greener explained, stripping excess spread senior to building the reserve fund. "Arrears are highly dependant on lending style, with heavy adverse products reporting much higher arrears than for near prime loans," he said. "Non-conforming loans are priced with much higher margins than prime products, therefore significant delinquencies and losses are already priced into the product."
Farringdon Mortgages 1, a U.K. nonconforming RMBS transaction marked the first downgrade on record for the sector earlier this year. The single-A, triple-B and double-B rated notes were lowered to single-A minus, triple-B minus and single-B, respectively. The ratings actions result from a high level of arrears and expenses in the deal that culminated in a reserve fund draw for FM1 in April 2006. The draw, a total of GBP216,187 ($404,555), represented 15.76% of the available first loss and took the reserve fund below the level it was at closing. Fitch found that there were insufficient credit enhancement and liquidity support available for the mezzanine and subordinated tranches to survive Fitch's stress scenarios at the rating levels originally assigned.
Last week, Fitch placed three tranches of Farringdon Mortgages No.2 on Rating Watch Negative following increased losses in the quarter, which led to a reserve fund draw. The agency said that it would carry out further analysis on the deal upon receipt of further information on the January 2007 interest payment date.
SG's Greener said that the use of large DACs early in these transactions is a concern. "In the case of Farringdon 1 and 2, heavy arrears early in the transaction reduced excess spread and caused draws to the reserve fund," he said. "Without the DACs removing excess spread, their reserve funds would have built much faster and a quarterly shortfall would have been avoided."
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