UK RMBS set to weather recession

The outlook for UK RMBS remains uncertain - despite optimism over borrower wealth buffers - as the country enters into its third government in three months. Amid such a rapidly changing policy environment, monetary policy and inflation rates – which continue to rise – are expected to be the two chief trends determining prospects for the housing market as the country heads into recession.

Panellists at a Moody’s housing conference held last month - following the announcement of former Prime Minister Liz Truss’ mini-budget - agreed that despite a gloomy global and internal macroeconomic picture, the UK housing sector is likely to be far from the worst hit market by any upcoming financial strife. Although the UK securitisation market could be vulnerable to the broader impacts of the macroeconomic environment, given that the UK is at more risk in terms of low supply of housing, it is set to also benefit from having a larger servicer industry than other jurisdictions.

Expectations for the rest of Europe - and specifically the euro area - were not so positive, as high energy prices continue to cast a bleak picture for the region, with many panellists predicting to see a ‘real recession’ for those countries reliant on Russian gas supply. The primary factors in determining the impacts of the somewhat nuanced economic recession are unsurprisingly the continuing war in Ukraine, the energy crisis and the lasting effects of Covid-19.

Panellists shared an outlook of close to zero real GDP growth overall – and just 0.3% for the UK over 2023-2024, which is not due to return to its potential level of 1.5% until 2026. Unpredictable consumer habits following pandemic lockdowns are due to set this recession apart from previous recessions heading into next year, with the pandemic housing boom expected to slow down and the supply of housing as well as first-time buyers to decrease.

Indeed, the risk of a housing downturn across Europe grows as interest rates continue to rise. Those most exposed to the housing downturn are likely to be Nordic banks, although banks across Europe all share substantial exposure to residential mortgage loans, as they account for approximately half of their domestic exposure.

Denmark, Ireland and the Netherlands are the most exposed – with Moody’s finding that residential mortgages represent close to 55% of each country’s banks’ total loans. In the UK, housing loans account for just over 30% of banks’ total loans. Nevertheless, banks are expected to be well supported by robust capital across these regions.

Overall, no significant collapse is expected for the housing market - although uncertainty remains around house prices, as negative pressures from inflation and rising interest rates are likely to persist. Although a 100bp rise in mortgage rates is expected, the UK’s mortgage market is likely to remain sturdy, as borrowers have access to greater disposable income and benefit from protection in the form of a larger wealth buffer.

As housing prices decline, risks rise for RMBS transactions, especially for those with greater exposure to recent-vintage mortgages. RMBS with greater exposure to housing boom-originated mortgages are expected to incur greater loss severities.

France stands as the most exposed European market to recent mortgage vintages, with 48.53% of its 2021 originated loans and 23.97% of its 2020 originated loans in outstanding RMBS portfolios having negative equity in the case of home prices dropping by 15%. Meanwhile, percentages for UK RMBS in negative equity in that scenario would be 0.39% for 2021 originated loans and 0.05% for 2020 originated loans, and for UK buy-to-let RMBS it would be 0.18% for 2021 originated loans and 0.05% for 2020 originated loans.

Borrowers in UK BTL RMBS are also likely to be exposed to greater refinancing risk, especially for loans approaching reset dates, due to rising interest rates. A Moody’s study found in a sample of 52,141 buy-to-let loans backing 34 UK BTL RMBS that 33% have reset dates falling before end-2023, when interest rates are set to peak.

For refinancing, buy-to-let borrowers have to meet certain affordability criteria – including meeting a minimum ICR – which can be destroyed by rising interest rates. Moody’s does, however, expect low indexed current LTVs to bolster the impact of plummeting ICRs, with panellists at the conference expecting to see landlords increase rents to boost their ICRs. Rents in the UK have already reached a level of 20% above pre-pandemic prices.

The buy-to-let industry is also due to see some major changes across multiple jurisdictions in Europe, as policymakers determine minimum EPC ratings for borrowers to let the properties.

Claudia Lewis