The international ratings agency said while lenders’ capital buffers were sufficient to “comfortably absorb” any additional capital requirements, returns may be too small to compensate for these extra stipulations.
Last year the Basel Committee published a consultation document proposing that lenders should hold more capital in reserve for buy-to-let borrowing, with high loan-to-value (LTV) deals and those that do not meet strict legal and underwriting criteria attracting the most onerous rates.
Currently a risk weighting of 35% is applied to buy-to-let loans with lenders required to reserve 8% of this. For example, a £100,000 mortgage has a risk weight of 35%, £35,000, and banks must hold 8% of this loan in reserve, £2,800. However, Fitch estimates this risk weighting could rocket to 91% if the proposals are implemented. For buy-to-let lending at 80% LTV or higher, the risk weighting will be hiked to 120%.
Additional proposals also include a permanent capital floor on lenders using the internal ratings-based (IRB) approach to assess their credit risks. Larger banking institutions use the IRB approach which allows them currently to set their own risk weightings.
This would mean that IRB lenders are forced to calculate buy-to-let risk weights under both standardised and IRB methodologies, with the more conservative of the two being applied. IRB-calculated risk weights tend to be lower than those based on the standardised approach, which according to Fitch could mean that IRB banks are subject to holding substantially more capital against these portfolios.
“The proposals are likely to impact the profitability of buy-to-let lending because returns achieved on these portfolios may be insufficient to compensate for the additional capital requirements. Some Fitch-rated lenders might need to adjust their strategies,” Fitch said.
Fitch added that buy-to-let portfolios could be more risky than owner-occupier deals, as a high proportion of loans to landlords are extended on an interest-only basis with repayment based on rental income rather than affordability criteria.
“Repossession risk is also higher because lenders tend to repossess buy-to-let properties more readily than owner-occupied homes, while borrowers have less incentive to make mortgage payments on a property they do not live in.
“A number of buy-to-let borrowers are non-professional investors whose more limited financial expertise could mean they are more prone to falling into debt servicing arrears.”
The Bank of England has repeated concerns that buy-to-let lending could pose a risk to the UK economy, with the Prudential Regulation Authority currently reviewing the underwriting standards of lenders in this sector.
However, Fitch said the Bank was unlikely to raise overall capital requirements for UK banks, having stated on numerous occasions that the capital held by the banking system as a whole is adequate.
It said: “We understand that UK regulators ask lenders to hold additional Pillar 2 capital to cover heightened concentration risk, such as large exposures to UK mortgage lending. Should the regulators conclude that the revised standardised risk weights for buy-to-let lending better reflect the risks presently capitalised under Pillar 2, we expect them to raise Pillar 1 capital requirements.”
Fitch expects gross mortgage lending to rise by 10% this year, but added that looming changes to Stamp Duty and tax relief for landlords could hamper growth in the buy-to-let sector in the coming years.
