According to Fitch, arrears should stabilise in 2024. It added that arrears levels had been at “historic lows” at circa 0.8 per cent, which it said showed “strong asset quality”.
The firm explained that mortgage lending growth had been strong over the past few years due to government support and low interest rates.
“We expect the market to soften, arrears to increase and credit losses to rise to more normalised levels, given higher mortgage rates and affordability pressures; however, losses should remain manageable,” Fitch explained.
Underwriting and affordability standing up well
The company said that underwriting standards were “sound”, and affordability checks were “strong” despite the removal of the Bank of England affordability stress test last year.
It continued that the average loan to value (LTV) of the stock of mortgages was around 50 per cent and 60 per cent for new origination, which should provide a “moderate buffer” against house price falls.
The lower LTVs and secured nature of lending had meant losses for mortgage portfolios had been “typically low”.
Unemployment and rate rises negative drivers
However, it said that rises in mortgage rates and unemployment are expected to be a catalyst for a rise in arrears.
It said that worst case scenarios for banks showed that unemployment rates would rise by between six and nine per cent, which increase expected credit losses “materially”. The report said that on average this would be more than double.
However, the report said that bank’s strong profitability should provide a “solid buffer” to rising credit losses.
The report continued that UK mortgage borrowers seemed to be the “most stressed” compared to developed market peers.
However, Fitch said that mitigating factors included issues like UK banks and building societies had insufficient headroom for “asset quality deterioration” and the expectation that non-mortgage losses would exceed mortgage loan losses.
UK likely to enter recession this year
Fitch said that the UK economic had “held up” in the first quarter of this better than forecasts had predicted, but was still “likely” to go into recession this year.
The company pointed to unemployment rate being likely to rise to around five per cent but would not return to levels seen during the global financial crisis.
It added that bank rate would peak at 4.75 per cent in May this year and no rate cuts were likely until 2024.
The firm said that higher interest rates would increase households’ interest payments and that debt service burden would increase to around 10 per cent of disposable income.
Fitch continued that house prices could fall by up to seven per cent in 2023, which it noted would “wipe out most of post Covid real appreciation”
It continued: “Downside risks are present due to the macro environment, but housing undersupply would limit much steeper price declines. Double digit rental growth is possible, but affordability for renters becomes an issue.”
