By increasing the availability and lowering the cost of high LTV lending, the government mortgage guarantee scheme supports the housing market in the short term but arguably it poses risks to the longer term performance of the UK mortgage market, by encouraging riskier lending and/or leading to further overvaluation in house prices,’ says a new report from Fitch Ratings.
But it adds that these risks are mitigated to some extent by strict affordability tests, the limited duration of the scheme to three years and the fact that lenders remain exposed to some losses of loans originated under the scheme.
The report sums up the last 12 months and points out that in 2013 the regional divide in house prices increased starkly. Year on year change in London house prices from 2012 to 2013 has been nearly 15%, while regions in the north and Scotland have seen a rise merely of 2% to 4%.
The South East, East Anglia and Outer Metro have seen more moderate house price rises of about 7% to 8%. But in the fourth quarter of 2013 the house price gap reached a new high. Average house prices in the South East are 83% higher that of average house prices in the North.
‘This divergence in house prices is driven by many factors. London and South East house prices have been boosted by government schemes such as HTB and Funding for Lending. In addition in these regions there is a shortage of new houses to meet the rising demand. Affordability is also higher in the current low interest rate environment,’ the report explains.
Based on a long term comparison of house prices with income and rents, Fitch believes that prices are currently overvalued around 15%. In 2014, Fitch expects house prices to rise by around 5% nationally. Regional imbalances will continue to exacerbate historic house price disparities.
Measuring affordability by house price to income ratios, Fitch believes that, the in London and South East affordability is stretched at 15 to 20%, while on the other hand in the North it is at a more reasonable figure of 10%.
Fitch expects to see further divergence in house prices in the short term, driven mainly by the government schemes and the demand-supply dynamics. In the longer term Fitch expects house prices to correct more in London, South East and areas where affordability is being stretched compared to North and Scotland.
The report also points out that pre-crisis, the UK had an active non conforming mortgage market that catered to either borrowers with less than perfect credit history or that would not fit prime origination criteria for other reasons. By definition these products were more risky and were hence the first to be withdrawn at the onset of credit crisis.
At the same time, prime lenders also tightened their underwriting criteria by increasing credit score cut off’s, withdrawing higher LTV products, implementing stricter documentation requirements and making very few exceptions to their policies.
‘Fitch has observed an increase in non-prime lending volumes in 2013, albeit from a very low base. The new products are also very different from the pre-crisis ones in that they are targeted towards borrowers who have only marginally failed prime lenders’ scorecards and have good affordability and equity in the property. The initial performance of these new non-prime products seems significantly better than that of the pre-crisis non-conforming loans,’ the report explains.
‘If wholesale funding remains available, lending is likely to further increase in this space. However, it will continue to represent only a fraction of historical non-conforming lending levels. The increased risk appetite of prime lenders could reduce potential origination in this sector, as they may struggle to increase lending volumes while maintaining very tight criteria. For both reasons, criteria creep is a key risk factor for both non-conforming and prime lenders,’ it adds.
