British households will take on more mortgage debt even if house prices fall and rates rise, according to new report from UBS banking analyst Jason Napier.
In a client note, Napier examined the outlook for UK credit growth as a key driver of GDP. And, from where he sits, home loans matter the most. To Napier, growth – or the lack of it – in the residential mortgage debt pool will determine whether household credit expands.
“At 88 per cent of household debt, home loans are (almost) the whole ball game," he said.
Despite predicting a halving in GDP growth to 0.7 per cent in 2018, rising unemployment and modestly lower house prices, UBS is expecting a 2 to 4 per cent increase in mortgages outstanding over the next five years.
“This is driven by the upside from leveraging the 50 per cent of UK homes which are mortgage-free and applying more leverage to the currently-indebted," said Napier. “Our analysis shows it is logical for banks to expand this business, which already makes up 86 per cent of retail lending profit.”
Even without the uncertainty of the Brexit negotiations, the UK elections or the three acts of terrorism in the last three months, Napier pointed to areas of the UK economy which appear due for a pause. Chief amongst these is the recent high rate of unsecured credit growth.
“More important to the aggregate economy, however, is the role of rising housing wealth and leverage as a driver of growth," he argued. “It matters more whether banks continue to lend against housing rather than when the unsecured market slows to more sustainable levels.”
Napier believes that there is room for more leverage in UK housing even though the nation screens high from a household income leverage perspective. In fact, he argues the mortgage market could potentially triple on re-leveraging of the already-geared homes.
“Borrower paydowns and past strong house price inflation combine for a mortgage market with plenty of room to grow.”
The UBS analyst is not saying that the full leveraging of the national housing stock is possible or healthy. But he is pointing to further growth in the UK mortgage market as homes change hands.
“In the post-crisis period this proportion of homes owned without debt has increased, presumably as some families have used unusually low debt repayment burdens as rates have fallen to pay down their debt," he said.
"If this notion has merit – we think the only question is how significant a cohort this group of sensible, but economically-fortunate borrowers, is – then one may see mortgage growth accelerate when rates increase as the financial ability to pre-pay for these owners falls.”
While he expects house prices to soften, Napier noted that mortgage cancellations are roughly at the levels of the last eight years - despite the obvious uncertainties in the near-term outlook.
The big unknown
Moreover, while deal volumes might come under some pressure as the complexities of Brexit negotiations become more obvious, Napier pointed out that the supply of properties for sale remained low relative to demand. Ultimately, of course, the banks want to lend.
“For their part, banks don't appear panicked about the outlook and are not signaling an intention to curtail home loans in the very near term at least," he said. "Neither are they signaling significant concern about the outlook for house prices in the differentiation of mortgage rates at different loan-to-value ratios.”
Though the analyst’s earnings forecasts allow for a significant deterioration in credit quality relative to current charges, UBS expects loss rates to remain below 1990 averages.
The big unknown relates to the economic stimulus from cheap central bank liquidity and government support of new house buyers through the Help to Buy funding scheme which is likely close to its peak, in his view.
“So, unless the Bank of England funding schemes loans are extended, we may see debt costs rise in 2018. The fate of the new build market will also likely be influenced by what happens to the scheme following its 2021 expiry date.”