The Credit Crunch has been hitting the UK Mortgage Sector hard as many easy credit mortgage deals have been removed from the high street shelves in recent weeks. Despite central bank actions to ease financing terms and increase liquidity, this does not address the real issues of illiquid mortgage related bonds and expectations that the UK Housing Market will slump on the back of a surge in foreclosures.
UK Mortgage Banking Sector - Northern Rock On the Brink of Going Bust
For an example of the credit crunches impact on the UK mortgage banking sector , we need look no further than at Northern Rock. The mortgage banks stock price has fallen from recent highs of £12.58 to recent lows of just £6.20, a drop of more than 50%. Trading on a PE of just 7.5 and a yield of 4% may now make the stock seem enticing, but the mark down is in anticipation of the much higher risk of mortgage defaults and repossessions in the UK as the housing market starts to nose dive. These repossessions (foreclosures) are already hitting the likes of northern rock with expectations of a tripling in the rate over the next 6 months as compared with the same period last year. This surge in repossessions will impact the earnings of the UK Mortgage banks as they make every larger bad debt provisions and issue profit warnings.
This is in addition to any toxic US Sub prime related exposure. Therefore in Northern Rock's case a PE of 7.5 could jump many fold in a worse case scenario.
UK Adjustable Rate Mortgages (Arms) & Liquidity
If the Adjustable Rate Mortgage Resets are termed as Arm-ageddon in the US, then here in the UK they should be termed as Doomsday, as the more than 90% of ALL mortgages are adjustable rate or floating rate mortgages in the UK. The short-term fixed deals taken out over recent years are now resetting with a vengeance. With UK interest rates at 5.75%, and a chance (albeit diminishing one) of a further rise to 6% in October 2007 (UK Inflation CPI Falls But Interest Rates Set to Rise to 6% By October 2007 18th July 07). The UK Arm resets will have a significant impact on the UK consumer and send the UK Housing market into a downward spiral. To make matters worse the credit crunch ensures that lending criteria will be much stricter with much higher interest rates charged than the base rate would imply, i.e. a greater spread between the Bank of England's rate and the mortgage interest rates.
Already the latest figures for new mortgage approvals for July show a 27% fall over the same period a year ago as liquidity continues to tighten with borrowers facing much tougher refinancing conditions.
The third impact of the credit crunch on the UK Housing market is the loss of 'city bonuses'. If as expected the financial markets remain depressed for at least the next quarter then the year end bonuses may virtually dry up. In the City of London many of the house purchases are reliant on bonuses to pay off capital as mortgages tend to be many, many times salaries. If the bonuses fail to materialize then that will depress London House prices which will send another negative ripple through the whole UK housing market.
UK Repossessions (Foreclosures)
UK home repossessions continue to soar this year and are forecast to total as much as 34,000 by year end, which is double the number of 2006 of 17,000. Going into 2008 we could be seeing repossession not seen since the last housing bust of the early 1990's. The mortgage banks such as Northern Rock are being hit hard, which reported a doubling in the rate of repossessions. The impact of this will mean even tighter borrowing requirements and a similar squeeze on house prices led by sub primers as has occurred in the US. Where expectations are extremely tight credit for those with poor credit histories.
Uk Inflation RPI / CPI / Interest Rates
The Rate rises from 4.5% to 5.75% in a year are having the effect of dissipating the bullish sentiment that has carried UK house prices to such extremes.
The latest Inflation figures fell strongly in July, with the CPI dropping from 2.4% to 1.9% and the RPI falling to 3.8% to 4.4%. However given the extent of the rise in the money supply, further declines are likely to be more muted. The chart trend suggests RPI could decline towards support at 3%.
This is enough to keep UK interest rates on hold for the time being, which increases the probability that interest rates may now peaked, as by the time the UK Housing market nose dives and the economy slows to borderline recession, a further rise in interest rates will no longer be on the cards and infact the expectations will be for cuts in UK interest rates.
Interest Rate Conclusion - The Market Oracle expectations are for UK interest rates to target 5% during the second half of 2008.
Buy to Let Sector
The Buy to let sector continues to expand strongly with a record number of buy to let mortgages taken out during the first 6 months of the year despite the rising interest rates and falling rental yields. The result is an increasing number of buy to let investors unable to cover their mortgage repayments from rents and therefore are relying on capital gains to provide profits. Should, as expected house prices take a tumble then a mad rush by weak buy to let investors to cut losses could hasten the decline in UK house prices during 2008.
UK M4 Money supply
UK Money supply growth shows signs of having peaked at 14%, however, whilst the money supply remains at the elevated rate of 12.9%, this still suggests higher inflation in the future. And would require a much more significant reduction to below 10% before inflationary pressures are expected to ease.
The Market Oracle UK House Price Ratio
The above chart clearly shows that despite the strong rise in house prices from 1996 to 2006, house prices remained affordable in terms of earnings and historically low interest rates which enabled house buyers to meet mortgage repayments.
However this year the ratio clearly broke above the upper range and has led to an increase in relative costs of servicing mortgages to an extent not seen since 1992. This will become more evident as the impact of mortgage fixes taken out when interest rates were at or below 4.5% expire as the increased risks in the mortgage sector result in ever higher floating rate mortgages, especially for those deemed to be if higher risk with poor credit histories, who may see their mortgage interest rates double i.e. from say 4% to more than 8% !
UK House Prices
London and the South East led the way during the 1980's Boom, rising much further than the rest of the country, with the rest of the country continuing to rise as London peaked.
Similarly today, the South of England has risen to a much greater extent than the rest of the country, and thus is expected to fall especially hard given the credit crunch in the city of london.
The resulting bear market will undoubtly seek to contract the spread between London and the rest of the country by at least 50%. Which implies a decline of 30% in the Greater London Area, and an overall UK decline of some 14%. however the decline in real terms when inflation is taken into account will be much greater.
UK Housing Market Conclusion:
The UK Housing market is expected to decline by at least 15% during the next 2 years. Despite the 2012 Olympics, London is expected to fall as much as 25%. UK Interest rates are either at or very near a peak, as there is an increasingly diminishing chance of a further rise in October 2007. After which UK interest rates should be cut as the UK housing market declines targeting a rate of 5% during the second half of 2008. The implications for this are that the UK economy is heading for sharply lower growth for 2008.
What to Do ?
1. Home Owners - If you are thinking of selling your home then the time to act is now ! Waiting whilst the credit crunch continues to tighten is a big mistake, especially given the fact that further sharp falls are in the financial markets are just around the corner.
2. Cash - Invest in Fixed Interest Bonds issued by large strong banks , avoid issues from mortgage banks such as Northern Rock. Keep in mind that In the UK savers have protection at 90% of holdings of the first 35k of investments in fixed bonds and savings accounts so bare that limit in mind. Also ensure you have used up your Tax Free ISA allowances.
3. Government Bonds - Invest in Government Bonds, be prepared to hold to maturity so as to reduce risk of market volatility.
4. Government Certificates - Invest in national Savings Certificates such as the and Index Linked Tax Free Certificates, which are an excellent vehicle for higher rate tax payers.
5. A Stock Market Crash or Slump Would be A Buying Opportunity. The stock market is expected to be volatile since we are moving into a new risk climate. Despite a high probability of further sharp falls, and even a crash, there are plenty of long-term plays out there especially in the big cap oil sector. I would also look at bargain hunting metals and mining on further sharp falls or a crash. Similarly for the utilities sectors such as Water. The best plays are probably via investment trusts, of which there are many. I favor investment trusts over unit trusts as they are traded on the stock exchanges exactly as any stock is. Whereas, as I recall in previous financial crisis you may find the phone off the hook on the other end of the line when you try to call to buy or sell unit trust positions.
6. Emerging Markets - I would avoid china, the market is not pricing in risk and is primed for a crash. India and Russia look enticing especially on any sharp falls in sympathy to global market sell offs.
Whatever you do, remember that today's Idyllic pleasant picture in the UK is very shortly in for a rude awakening, much as the US home owners are experiencing in increasing numbers. The bull market in housing is over for now, better to realize this now whilst you have the opportunity to do something about it rather than be forced into a decision later on.
Article originally published on 22nd August 2007
