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Cladding scandal could lead to modest RMBS losses and negative equity – DBRS Morningstar

  • 10/03/2021
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Cladding scandal could lead to modest RMBS losses and negative equity – DBRS Morningstar
The cladding crisis has resulted in risk of adding £140 to high-rise flat owners' monthly mortgage payments and producing losses on sale of repossessed properties by residential mortgage-backed securities (RMBS) pools, DBRS Morningstar has said.


Analysis from DBRS Morningstar on the impact of cladding looked at 64 securitised UK mortgage portfolios comprising 670,000 loans worth £70bn. 

Some 106,000 of these mortgages were taken out on flats in England with 57,000 being owner-occupier and the remaining 49,000 buy-to-lets.


Negative equity 

Based on data from September, the credit rating agency deduced house prices would have to fall by 20 per cent to put most high-rise flat owners at risk of falling into negative equity. 

South West London would be least affected by such a decline, with just 2.8 per cent of homes falling into negative equity. Newcastle flat owners would be most impacted, pushing 37 per cent of mortgage holders into negative equity.  

Although most flat owners would be relatively unscathed by declines in property prices, the analysis found four per cent of leaseholders in Newcastle would need to see just a 10 per cent dip in house prices to fall into negative equity. 

In a milder environment, a five per cent price drop would put less than one per cent of most flat owners into negative equity. 


Cost of repairs and LTV tiers 

Despite the low possibility of large declines in house prices, DBRS Morningstar said borrowers would still be financially impacted by loans to fund repairs. 

Last month, the government announced leaseholders of flats in buildings shorter than 18 metres could take out government-backed loans capped at £50 a month, but details on rates or the length of the loans are yet to be confirmed. 

The loan will also be attached to the property, not the leaseholder, potentially making the property less desirable and causing its value to drop. 

This means even where a drop in value does not result in negative equity, those who are able to remortgage could find themselves paying up to £15 to £140 more if price changes move them to a higher loan to value (LTV) tier. 

DBRS based this on rate differences between products under 60 per cent LTV and those above. 

The analysis found the owner-occupied flats sampled had an average LTV of 49.6 per cent and the buy-to-let loans had an average of 42.1 per cent LTV.

The analysis suggested a five per cent fall in house prices would move at least three per cent of mortgagees into LTV tiers above 60 per cent, potentially resulting in them paying higher rates.

At the lower end of the scale, this would account for 3.2 per cent of borrowers in East London, while 9.3 per cent of mortgage holders in Portsmouth would be in LTV bands above 60 per cent. 

As for borrowers moving into LTV tiers above 75 per cent, where rate differences are often more stark, a five per cent fall in house prices would impact West London flat owners the least, pushing just 3.1 per cent into higher LTV bands.

Manchester leaseholders would be most affected, with 13.8 per cent shifting onto products with potentially higher rates if prices fell by five per cent.


Added remediation costs 

Additionally, DBRS Morningstar said the £5bn fund covering properties taller than 18 metres would fund some costs but did not include fire safety repairs unrelated to cladding. 

The analysis suggested the cost of such remediation would not vary as much as property value.

With this in mind, DBRS said a repairs bill of £35,000 would account for 36 per cent of the average value of a flat in Newcastle and seven per cent in West London. 

Therefore, a £35,000 devaluation of a cladding-affected property to offset the loan could put 56.3 per cent of Newcastle borrowers in negative equity, compared to 27.7 per cent in Glasgow and just 0.3 per cent in West London. 

Even with lower costs, a £10,000 devaluation would still push 9.4 per cent of Newcastle flat owners and 1.2 per cent of Glasgow flat owners into negative equity.  

None of the other 18 locations analysed – including Manchester, Brighton and Southhampton – would see more than 1.4 per cent of leaseholders fall into negative equity with a £10,000 house price drop. 

Ketan Thaker, head of European RMBS and covered bonds at DBRS Morningstar, said: “Borrowers are likely to face higher mortgage costs because of an increase in their mortgage LTVs ratios, either as result of reduced flat values or additional debt undertaken to fund repairs. 

“DBRS Morningstar’s analysis shows that, assuming that borrowers can remortgage, they may still face higher monthly payments in most cases. Furthermore, the impact could be much more severe for borrowers if they cannot get a new mortgage and have to move onto the lender’s standard variable rates, which tend to be higher.” 


RMBS portfolios at a modest risk 

The analysis estimated fire safety issues would lead to defaults and losses in RMBS portfolios but said this was less of a concern as more than half of the high-rise buildings in England were estimated to have no cladding. 

Data from the Ministry of Housing Communities and Local Government (MHCLG) published in November estimated that as of April 2020, 44 per cent of the 88,000 high-rise buildings in England were unclad. 

This suggests that with an EWS1 form, the majority of leaseholders will be able to remortgage or sell their properties. 

Repossessions pose the most threat to RMBS investments but with the progress being made to remediate properties, DBRS said this could take years to be realised if leaseholders are unable to continue paying for repairs. 

In the 12 months before the lockdown and restrictions on evictions were imposed, there were 7,750 repossessions, accounting for 0.06 per cent of total mortgage stock. While an increase is expected after the pandemic, DBRS said this would remain low resulting in a modest impact on RMBS investments. 

Across the portfolios sampled, a 10 per cent haircut on repossessions – the below market price on property that is being resold – would lead to losses of no higher than 0.5 per cent. 


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