Analysis: British banks’ mortgage payday comes with a stinger in its tail

LONDON, Oct 10 (Reuters) – As British households head into a winter of soaring energy costs, a falling currency and near-double-digit inflation, the country’s banks are hoping for a good payday as prices for mortgages rise after a decade of stagnation.

Banks are finding that the home loan market is stacked in their favor after years of low mortgage rates, but they are also aware that higher mortgage bills could spell trouble for cash-strapped customers.

Some investors and analysts are already questioning whether banks’ risk models are up to the task of identifying loans that will make a profit from those that could cost lenders dearly in the long run.

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“The problem is that people who refinance at 6%, who were at, say, 2%, are going to have massive cash outflows to support those mortgage payments,” said John Cronin, banking analyst at Goodbody.

“My concern is that banks’ provisioning models don’t adequately reflect that affordability challenge in the context of low unemployment.”

Britain’s mortgage market was thrown into chaos last month when the country’s new finance minister, Kwasi Kwarteng, unveiled a so-called “mini-budget” that promised billions of pounds in unfunded tax cuts.

Markets spooked at the prospect that this would mean heavy government borrowing, driving down UK government bond prices and fueling bets on higher interest rates.

The turmoil prompted banks to withdraw nearly 1,700 mortgage products in the space of a week, equivalent to around 40% of available products, sparking a rush among consumers desperate to secure the cheapest deals possible.

A senior banker said he had seen three times as many new mortgage applications as normal in the week after Kwarteng’s mini-budget, and had to redeploy staff to cope with a surge in customer calls.

Some of the offers made were gradually reintroduced this week at rates between one and two percentage points higher.

Both the two-year and five-year average fixed-rate mortgage were above 6% as of Friday, for the first time since 2008 and 2010 respectively, data provider Moneyfacts said.

Those average rates hovered around 4.75% on September 23 before the Kwarteng tax draw and were between 2-3% in October last year, Moneyfacts data showed.

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Banks are raising mortgage rates to get ahead of expected rate hikes from the Bank of England, with money markets pricing in benchmark rates reaching nearly 6% next year, according to Refinitiv data.

But higher rates will hit borrowers hard.

“Anyone who goes from fixed to variable, or from fixed to a new fixed rate, will see their monthly payments rise dramatically on top of what’s already happening with food and energy costs,” said Jim Leaviss, CIO of Fixed Income public in the investment manager M&G.

“It is difficult to see that we will not see a substantial slowdown in economic activity in the coming months and, indeed, throughout 2023,” he added.

Mortgage payments as a proportion of gross household income averaged around 20% in June, according to BuiltPlace, a property market consultancy. They could rise to around 27% – the highest level since the early 1990s – if mortgage rates rose to 6%, the consultancy said.

Mortgage market conditions were a “hot topic” of discussion at a meeting between bank executives and Kwarteng on Thursday, with affordability “the main concern”, according to a source briefed on the discussions. read more

SHORT-TERM GAIN, LONG-TERM PAIN

Banks benefit from higher rates as they make money on the difference between what they charge on loans and what they pay on deposits.

Analysts at Jefferies estimated that three of Britain’s largest retail banks, NatWest (NWG.L), Lloyds (LLOY.L) and Barclays (BARC.L), collectively increased their revenue by 12 billion pounds ($ 13.43 billion) by 2024 due to widening margins, including on mortgages. These banks reported £48 billion in revenue in 2021.

Lloyds CEO Charlie Nunn told a banking conference last month, ahead of Kwarteng’s mini-budget, that the lender made around £175m of revenue for every 25 basis point increase in rates, assuming that only half of the increases will be passed on to savers.

Defaults on bank loans have remained remarkably low during the pandemic and after, but much higher housing costs, compounded by skyrocketing energy bills, could change that, analysts said.

British banks are expected to have “a very good next couple of quarters” ahead of a “difficult” 2023, banking analysts at RBC said in a note.

Taking into account the latest mortgage price, RBC calculated that mortgage payments would rise by between £470 and £250 per month for remortgaging households depending on whether they had refinanced earlier.

Private rents could also rise by £280 a month if landlords pass higher mortgage costs onto tenants, RBC analysts said.

Rising mortgage rates will hit the finances of millions of households, said Sue Anderson, head of media at debt charity StepChange.

“Our research suggests that many households cannot afford this extra pressure: almost one in two British adults are struggling to keep up with household bills and credit commitments, up from 30% in October 2021 and 15% in March 2020.”

British lenders have been in talks with industry trade body UK Finance about forbearance options for distressed customers, the trade body told Reuters, adding it was ready to react as needed.

The chief banker said that while mortgage defaults were still low (home loans were often the last commitment consumers fell behind on), they were not complacent.

“We expect it to be on a larger scale than normal, and it hasn’t started yet.”

($1 = 0.8937 pounds)

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Reporting by Iain Withers, Sinead Cruise, and Lawrence White. Additional reporting by Andy Bruce in London. Edited by Jane Merriman

Our standards: the Thomson Reuters Trust Principles.

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