CML news & views

The Financial Services Authority’s (FSA) mortgage market review proposals could squeeze lending volumes and margins and “exert negative pressure on house prices,” Moody’s Investor Services has warned.

In its recently published Weekly Credit Outlook, Moody’s said it saw a two-fold impact from the FSA’s proposals, the first part of which would be a reduction of in loan generation and borrowing activity in the short- to medium-term.

Moody’s said that in the short term the enforcement of FSA proposals to impose stricter affordability tests and mandatory income verification was likely to increase costs for lenders, and reduce the number of eligible borrowers and the amount they would be able to borrow. Those views echo our own assessment of the impact of the proposals.

The Weekly Credit Outlook endorses our view that new loan applicants, as well as existing holders of non-standard mortgages, could find it difficult to obtain mortgage credit or re-finance their existing loans if the FSA implements its proposals.

However, although the FSA’s plans are likely to bear down on lending volumes, Moody’s believes that they would boost the credit quality of UK lenders’ mortgage portfolios in the longer term.

The Report said: “Since the quality of each lender’s test on affordability and verification of income is an important input to our current probability of default analysis, we believe that the FSA’s proposals will be credit positive in the longer term. Tougher tests enforced and monitored through better regulation are likely to decrease lifetime losses.”

Moody’s also saw longer-term benefits for the credit quality of UK residential mortgage-backed securities (RMBS). The measures would have “positive credit implications for the £250 billion of UK RMBS issued by master trusts because new loans added to the trusts will have to undergo stricter underwriting.”

Moody’s said: “The revolving nature of master trusts means that the credit quality of the trust’s assets would likely improve over the long term as older mortgages with less stringent underwriting repay, and new mortgages subject to new regulation enter the trust.”

However, loans currently held in master trusts are already predominantly prime mortgages. They account for around 20% of total UK mortgage debt.

The Report said: “Although some existing borrowers will be unable to re-finance under the more stringent tests, we see the lack of re-financing options introducing only relatively minor incremental credit risks, such as borrowers reverting to higher interest rates at the end of initial teaser or fixed-rate periods.

“A reduction in remortgage activity in the master trust sector could also lower further the historically low pre-payment rates and increase extension risk. In some master trust facing extension risk, sponsors have needed to inject cash to ensure notes pay down on schedule.”

It added: “Although our outlook on the UK prime RMBS sector is negative as a result of fiscal tightening, the proposal to strengthen mortgage underwriting is a positive credit development for the master trust sector.”