Why arrears will tick up but banks will not be threatened by rising mortgage costs
Arrears will tick up as interest rates rise but banks will not have to deal with a major credit event, experts at ratings agencies told City AM.
Mortgage rates have spiralled in recent weeks as a result of stubbornly high inflation, meaning consumers will have to pay thousands of pounds a month more for their mortgage.
Soaring costs have raised concerns that there will be a surge in customers struggling to pay their debts. S&P’s financial institutions analyst Richard Barnes said that this is a “big stepchange…you’d expect to see arrears increase”.
Similarly, Farooq Khan, a senior analyst at Moody’s told City PM “spiking rates will continue to erode debt affordability as mortgage borrowers rollover onto now even high rates, creating rising asset risks for lenders.”
However, the ratings agencies argued that this would not necessarily pose a major risk to the banks – for a variety of reasons.
Banks have been much more cautious in who they lend to since the financial crisis, limiting loan-to-value ratios and making more thorough checks on potential borrowers. They have also set aside much more capital to cope with losses that do arise.
As Khan said, “banks and building societies have largely prime, low LTV, loan books and maintain solid provisioning levels which will limit loss given default.”
Although smaller banks have been more willing to take on riskier debt, William Edwards financial institutions analyst at S&P, said they don’t have a much “greater risk appetite than the high street banks. Its mainly that the restrictions on lending at the high street banks are very narrow.”
Edwards also pointed out that mortgage debt at all banks is concentrated among higher earners.
While there will likely be an increase in arrears, this will come from very low levels historically.
According to the most recent figures from UK Finance, just over 76,000 households were in arrears in the first quarter, the same as the first quarter of 2020.
Both Khan and Edwards noted that the most important factor for the level of arrears across the economy is unemployment.
“The key determinant of how much risk actually rises for lenders will be how unemployment, which is currently at 70-year lows, changes,” Khan said.
So far the labour market has withstood the Bank of England’s aggressive rate hikes, with unemployment staying more or less consistent at 3.9 per cent.
Although Moody’s expect it to rise to 4.5 per cent, this is still comfortably below the long-term average of 5.9 per cent.