CML news & views

The UK economy finally nudged into the black in the final quarter of 2009, but that was preceded by 18 months of recession – so an extended period of rising mortgage arrears and possessions was widely expected. Nonetheless, when we reported our most recent data on arrears and possessions last week, the numbers were more encouraging than many commentators, including ourselves, had originally anticipated. 

Our initial forecast – admittedly made at a time of much greater uncertainty about economic recovery and before the cycle of sharp reductions in interest rates in 2008/09 had been completed – was that there would be 75,000 mortgage possessions in 2009. That proved pessimistic and we subsequently revised it downward last summer, when we said we expected 65,000 possessions in 2009 and that 360,000 mortgages would end the year in arrears of at least 2.5% of the outstanding balance.

However, last week’s data showed a better outcome than even this revised forecast, with 46,000 properties taken into possession in 2009, and 188,300 loans finishing the year in arrears of 2.5% or more of the outstanding mortgage balance. That meant that the number of cases of arrears at the year-end was lower than at the end of the third quarter, although it was 3% higher than a year earlier.

While we cannot be complacent about arrears and possessions at current levels, there is some good news in that numbers are being kept in check by a combination of persistent low interest rates, lender forbearance and a range of government initiatives to provide help. Even last year’s unexpected rise in house prices has been helpful, in some cases helping to offset the erosion of equity for borrowers in arrears.

It is important to stress that payment problems are not directly linked to negative equity. Nonetheless, we estimate that the number of borrowers currently in negative equity (the vast majority of whom will be paying their mortgage in full and on time every month) has fallen to 650,000, compared with around 900,000 in April last year.

Mortgage problems and the recession

Payment problems usually lag a recession, which initially triggers higher unemployment and then feeds through into an increase in mortgage payment problems. But this typical pattern has not been such a clear feature of the recent economic downturn.

During the current cycle, mortgage arrears and possessions began to edge upwards some years before the onset of the recession. Following a long period of economic growth, and low and stable interest rates, mortgage arrears and possessions had fallen to exceptionally low levels in 2003 and 2004, even though the UK economy continued to grow at an annual rate of between 2% and 3% up to 2007. 

When the recent economic downturn began, we saw the number of possessions accelerate – as we would expect – from 25,900 in 2007 to 40,000 in 2008. Despite our expectations, however, growth in the number of possessions then slowed in 2009, as our data has shown.

Interest rates

Low interest rates are clearly helping to keep arrears and possessions in check.

Looking more closely at our statistics on mortgage arrears, we can also see that the number of households with lower levels of payment difficulty has actually fallen recently, while the number with more serious arrears problems has remained broadly unchanged. 

This suggests that the rapid decline in interest rates – and the persistence of the Bank of England’s base rate at its record low level of 0.5% for almost a year now – is helping some borrowers with modest difficulties to get back on their feet. Low interest rates are also helping more households cope with temporary financial difficulty without falling into arrears.

Some of those with more serious problems, meanwhile, are able because of low interest at least to stabilise their arrears, even if they cannot recover them. Where borrowers are able to do this, lender forbearance may be helping to keep them in their homes.

Unemployment has also not grown as sharply as expected during the recession, and that is also helping to keep the growth of payment problems in check. Lenders’ arrears management policies are also helping borrowers in difficulty, along with a range of government assistance schemes. 

What happened in the past…

Generally, borrowers falling behind with their mortgage commitments in the current downturn appear to have found it somewhat easier to manage those circumstances than was possible a generation ago, when we last saw a period of significant economic disruption and growing mortgage payment problems. 

In 1991, with more than a million fewer mortgages than we have today, possessions peaked at 75,500 – significantly higher than we have seen in the current downturn. Back then, however, interest rate movements were much less helpful for borrowers in difficulty – in 1991, for example, the Bank of England base rate hovered between 10% and 14%.  

After possessions peaked in 1991, it took some years before the combination of a slowly improving economy, lower interest rates and an end to falling house prices brought about a significant reduction in the number of borrowers in difficulty. It was only in 1996, for example, that the annual number of possessions (at 42,600) fell below the level we have today. 

Looking back, however, we can now see that the mid-1990s also marked the beginning of what eventually proved to be a strong recovery in the housing market. From the mid 1990s until 2004, a combination of low and stable interest rates, a benign economic backdrop and strong house price growth brought arrears and possessions to their lowest levels since the 1980s.

…and what might happen in the future

The pattern of the early 1990s – in which the annual number of possessions exceeded 40,000 for seven consecutive years up to 1996 – suggests that we should only expect a slow recovery from the peak of mortgage payment problems in this cycle. What we may see is something of a ‘bulge’ in possessions, extending over a number of years, rather than a ‘spike’ with totals rising sharply and falling rapidly.

Such a pattern would be consistent with our forecasts for 2010. Our prediction is that both arrears and possessions are likely to continue to rise modestly this year – from 188,000 to 205,000, and from 46,000 to 53,000, respectively. 

Even at this stage, however, it is possible that these numbers look a little pessimistic, although the economic and political outlook remains uncertain. We must also bear in mind that, even if economic recovery progresses broadly as expected, the path towards a stronger housing market may not be a smooth one.

Payment problems

One of the key determinants of the number of possessions – and the shape and speed of a housing market recovery – will be future movements in interest rates. As we have already seen, rates at current levels are helping borrowers in arrears to manage more effectively. And because low rates mean that a borrower’s outstanding debt grows more slowly – and is capable of being paid off more quickly if his income increases – they can extend the period for which a lender is able to show forbearance.

But while low interest rates give more breathing space to borrowers and lenders, it is important to understand that extending forbearance is no guarantee that a borrower will succeed in getting back on track. In those circumstances, lender forbearance may only delay possession, and possibly leave the borrower with higher arrears.

Other factors affecting the outlook for arrears and possessions include future movements in house prices and progress towards wider economic recovery. But despite last year’s unexpected upturn in property prices, the housing market remains weak, and future movements in prices are uncertain.

Progress towards economic recovery is also unpredictable. But a strengthening economy will improve employment prospects, and therefore have a bearing both on the number of borrowers falling into arrears and on their ability to find a new job quickly enough to recover their position.

Conclusion

There are still upward pressures on mortgage arrears and possessions, but they are not as strong as we originally anticipated. Low interest rates, the ability of lenders to extend forbearance and a range of different government initiatives are all helping to provide more helpful circumstances for borrowers in difficulty than was possible in the last recession. 

It is, however, likely that the number of borrowers affected by arrears and possessions will only subside slowly. Interest rate movements and progress towards economic recovery will play a crucial role in shaping the final outcome.

We welcome Treasury proposals to widen the scope of mortgage regulation, but do not believe that it should be extended to include buy-to-let lending.

Proposed regulation of buy-to-let is inappropriate because it does not address the key issue of advice on whether or not to invest in property. In our view, that is the main source of potential consumer detriment – not the decision to borrow to complete the transaction. If regulation were extended to buy-to-let, it would also capture what is essentially a range of commercial transactions.

Our response to the Treasury argues that risk in the buy-to-let sector – including the exposure of lenders to fraud – would be best addressed by prudential measures, rather than extending the conduct of business rules. Inappropriate regulation risks damaging the sector and could undermine wider government policy objectives by deterring investment in private rented accommodation.

Our response was submitted shortly after we published data showing a modest upturn in buy-to-let lending in the second half of 2009, following two years during which the sector shrank significantly.

The data showed growth in buy-to-let lending up for the second consecutive quarter, with 25,800 new loans, up from 23,700 in the preceding three months. But growth in the second half of the year came from a very low base, following seven consecutive quarters of decline.

In the year as a whole 93,500 loans were advanced, 58% fewer than in 2008 (222,700). Gross advances in the final three months of the year totalled £2.4 billion, up £300 million on the preceding quarter. Lending for the year totalled £8.5 billion, down from £27.2 billion in 2008.

Despite the welcome recent upturn in the sector, buy-to-let lending remains well below the level needed to fund the private rented sector. The wrong kind of regulatory intervention could damage government aspirations to provide more good-quality privately rented homes – and to widen the choice for people who either cannot afford home-ownership or do not quality for social housing.

Our response to the Treasury, however, welcomed proposals to extend regulation to cover second-charge lending and to ensure that borrowers are properly protected when books of mortgage loan are sold on from one firm to another.

On second-charge loans, our long-standing position is that all secured lending should be regulated by the Financial Services Authority. That would create a coherent, comprehensive framework, aligned with European regulation. 

We also agree with extending regulation to protect consumers when mortgage books are sold on – if the new owners have control over interest rates, charges, service levels and arrears management. But where power over these decisions has been delegated to another regulated organisation, there should be no “double” regulation.  It is also important to ensure that extending regulation does not create unintended problems for securitisation and covered bond transactions.

A rush to complete transactions before the end of the stamp duty holiday boosted lending in December, our data showed. The number of loans to first-time buyers during the month was at its highest for two years, with a high concentration of purchases priced between £125,000 and £175,000.

December’s total of 24,900 loans to first-time buyers – the highest since November 2007 – is likely to mean that lending will remain subdued in the early months of 2010. At £2.9 billion, lending to first-time buyers in December was 26% higher than in the preceding month.

During the month, 55% of house purchase loans were on properties costing less than £175,000 and therefore exempt from stamp duty. Mortgages funded 21,500 purchases between £125,000 and £175,000, 56% more than in November. Stamp duty would have added a further 1% to the cost for these buyers if their transactions had been completed in January.

The numbers boosted house purchase lending overall, with 63,000 loans worth £8.5 billion in December, up from 51,000 (worth £7.1 billion) in November and 33,000 (worth £4.4 billion) in December 2008. 

Remortgaging, however, remained flat. The total number of loans, at 28,000, was the same as in November, although the value of this lending declined from £3.5 billion to £3.4 billion.

A depressed market in the early months of 2009 meant that the year overall was weak. Lending in 2009 totalled £143.6 billion, 43% lower than 2008’s total of £254.1 billion and 63% lower than the record £362.6 billion lent in 2007.

House purchase loans in 2009 nudged up to 517,000 from 516,000 in 2008. But that was only around half the total of 1,015,000 recorded in 2007. First-time buyer loans accounted for 198,000 of these, up slightly from 194,000 in 2008 but down 44% from 357,000 in 2007.

Stockbroker Evolution Securities has joined the CML as an associate. Evolution is an investment bank specialising in UK and European equity and debt markets. It offers a range of services including equity and fixed income research, institutional sales and trading, equity market making, corporate finance and broking.

The CML has 109 members and 74 associates. Our members now generate around 94% of total UK lending, ensuring that our data continues to provide a whole-of-market perspective.