Analysis: UK banks’ mortgage payments come with a sting in the tail

LONDON, Oct 10 (Reuters) – As British households head into a winter marked by soaring energy costs, a plummeting currency and near-10-digit inflation, the country’s banks are on standby of a bright payday as mortgage prices climb after a decade of stagnation.

Banks are finding the home loan market is 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 job of identifying loans that will pay off against those that could cost lenders dearly in the long run.

“The problem is that people who are refinancing at 6%, who were at 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’ supply models do not adequately reflect this 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 that this would mean heavy government borrowing, sending UK government bond prices plummeting and pushing bets on higher interest rates.

The turmoil has led banks to withdraw almost 1,700 mortgage products in the space of a week – the equivalent of around 40% of available products – sparking a stampede among consumers desperate to get the cheapest deals possible.

A senior banker said he saw three times more mortgage inquiries than normal in the week following Kwarteng’s mini-budget and had to redeploy staff to deal with an increase in customer calls.

Some of the completed deals were phased in this week at rates one to two percentage points higher.

The average two-year and five-year fixed rate mortgage was above 6% on Friday – for the first time since 2008 and 2010 respectively, data provider Moneyfacts said.

Those average rates were both around 4.75% on Sept. 23 before Kwarteng’s tax giveaway, and were between 2 and 3% in October last year, according to Moneyfacts data.

Banks are raising mortgage rates to preempt expected rate hikes from the Bank of England, with money market prices in benchmark rates rising nearly 6% next year, based on data from Refinitiv.

But the higher rates will hit borrowers hard.

“Anyone who moves from a fixed rate to a variable rate or a new fixed rate will see their monthly payments increase so dramatically on top of what’s already happening around food and energy costs,” said Jim Leaviss, CIO of public bond at investment manager M&G.

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

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

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

SHORT TERM GAIN, LONG TERM PAIN

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

Jefferies analysts have estimated that three of Britain’s biggest retail banks – NatWest (NWG.L), Lloyds (LLOY.L) and Barclays (BARC.L) – should collectively increase their revenues by 12 billion pounds (13, $43 billion) by 2024 due to spread expansion, 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 earned around £175million in revenue for every 25 basis point rise in rates – assuming it only exceeds half of the increases for savers.

Defaults on bank loans have remained remarkably low during the pandemic and after, but much higher housing costs — piled on soaring energy bills — could change that, analysts say.

UK banks are expected to have “very strong next quarters” ahead of a “challenging” 2023, RBC banking analysts said in a note.

Taking into account the latest mortgage prices, RBC calculated that mortgage payments would increase by £470 to £250 per month for remortgaged households depending on whether they had already refinanced or not.

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

Rising mortgage rates will be a huge blow to the finances of millions of households, said Sue Anderson, media manager at debt charity StepChange.

“Our research suggests that many households can ill afford this extra pressure – almost one in two UK adults are struggling to cope with household bills and credit commitments, up from 30% in October 2021 and 15% in March 2020.”

British lenders have held talks with industry trade body UK Finance on forbearance options for distressed customers, the trade body told Reuters, adding it was ready to react if necessary.

The principal banker said that while mortgage defaults were still low – home loans were usually the last commitment consumers made – 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)

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

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