The FSA is now requiring babnks to check the robustness of their reserves against the scenario of a 40% fall in house prices and 35% of defaulting mortgages going into possession. This is described as a plausible scenario, rather than any kind of prediction.
This may, I suppose, lead to a reduction in bank lending, as they will be required to put up a larger amount of their own capital as a solvency reserve for each new loan. It seems entirely sensible, and rather overdue IMHO.
The amount of solvency reserves required does not seem all that high, even so. Suppose 10% of mortgages are assumed to default, then the banks need to allow for 3.5% of their mortgage book going into possession. If the average loss on those cases is assumed to be 30%, taking into account mortgage indemnity insurance and so on, then the solvency reserve required is only around 1% of the mortgage book.
Banks told to predict effects of a 40% crash in house prices By Patrick Hosking, Banking and Finance Editor
BANKS in the UK have been ordered by financial regulators to assess how they would cope in the event of house prices crashing by 40 per cent.
The instruction to include a housing slump scenario in their stress-testing models comes after the Financial Services Authority found that some banks were failing to include gloomy enough assumptions in their modelling.
The FSA said yesterday that an ?appropriate? benchmark was to assume property prices fell by 40 per cent and that 35 per cent of mortgages in default ended with homes being re-possessed. It stressed that this was not a forecast but a ?severe but plausible scenario? and one that banks should examine when deciding how robust their balance sheets were.
In a speech to the British Bankers? Association yesterday, Clive Briault, the FSA?s managing director for retail markets, remarked on banks? differing views over the size and impact of a house market downturn, hence the need for reference points.
He also warned bankers to ensure that they have properly stress-tested their mortgage portfolios in the wake of decisions by some to lend people greater multiples of their incomes.
In a letter to bank chief executives last month the FSA accused some of failing to consider scenarios in which they might be forced into losses, dividend cuts or capital shortfalls.
?We were struck by how mild the firm-wide stress events were at some of the firms we visited,? wrote the FSA?s director of major retail groups, David Strachan.
A few banks were ?weak in all respects? in stress-testing.
House prices fell about 15 per cent nationwide in 1989-1992, and in parts of East Anglia by 40 per cent, leading to repossessions, write-downs and bank losses.
Banks are obliged to stress-test hypothetical adverse movements in asset prices, interest rates and exchange rates to ensure that they have a sufficient capital cushion. But stress-testing is only as robust as the assumptions made.
The FSA move came as UK house prices grew at their fastest for four years, according to new figures from RICS."
Total properties in possession peaked at end of H1 1992 at 68,490, this was 0.70% of all loans.
Mortgages 6-12 months in arrears peaked at 205,010 at end of H2 1992, being 2.07% of all loans.
Figures for mortgages 1-5 months in arrears weren't published at the time. When they were published in H1 1994 it suggests a total of 4.67% of mortgages were 3 months in arrears or more.
That's interesting, implying my 10% in default was far too high, so the reserve required by FSA would be well under 1% of the mortgage book. That's not going to rein in the lenders, is it?
I suppose this highlights why the lenders continue to throw money about with gay abandon despite the average house price being at something like 6 times average salary (and then some). Joe Bloggs assumes everythig will be OK if they are being allowed to borrow, and in fact on the whole this level of lending probably won't lead to financial meltdown. But Joe Bloggs loses his home or ends up in a negative equity trap for a decade or more, and in that scenario the fact that the economy is doing sort of OK and that the lenders are OK is of little consolation.
Living in a 1 bedroon flat I'm not as heavilly invested in the property market as some, but I personally have decided to sell up and start renting early next year. Financially it just doesn't make sense to me to be so heavily invested in a market that at best might make say 6-7% a year for a while and at worst could fall by 40%.
I also noticed there appears to be an ever growing disparity between rental prices and the mortgage you would pay on a similar type of property. E.g. I was looking at an apartment on rightmove for sale at
180k, for rent only as there is an existing tennant. The tennant pays
595/month. A new 25 year mortgage at 6% would cost about 1160/month.
1160-595V5.
A dubious investment indeed. Whilst your arithmnetic, which gives
1160pm for a 180k mortgage, is correct, it is nonsense because it is not the norm, and certainly not wise, to buy with a 100% mortgage. You should expect to contribute a hefty deposit and borrow less, thus making the monthly payments less too. And there's always the option (risky though it is) of opting for an interest-only mortgage.
As an investment, 595pm for 180k is less than 4% and it would make more sense, if you had 180k in cash, to invest it even in a savings account than in a flat. But if there is (still) capital appreciation to be expected, the investment does start to make sense. If the flat is going to increase in value even by only 4%pa, you're already beating savings and perhaps even the stock market. But you need to assess the risk properly. If the value goes down, you lose money, and if you're gearing your investment, you also risk losing money which you haven't got.
Indeed, much less. You need to allow say 12% of the rent for estate agent's fees and another 8% or so for voids. Then allow for wear and tear on the flat and furniture, say 1k a year. Also insurance and service charges, maybe another 1k to 2k a year.
True net income is almost certainly less than 2%. This investment is simply a gamble on house prices increasing rather than decreasing, and with the low net income you it won't support much of a mortgage.
You mean a letting agent, not an estate agent, and it can be a lot more. About 15% is not untypical (plus VAT). But you don't have to use one.
Perhaps. You can minimise this by judicious choice of what and where to buy. Your choice of whether to use a letting agent may affect how big your void rate is.
Perhaps, though that seems on the high side.
A gross overestimate. Insurance? Less than £500 probably. Service charges? Nil. They're a foreign concept, we don't have them in Scotland.
Your figures are exaggerated but the basic point is valid. Traditionally rental yields have been nearer 8% or perhaps even more, but they have been driven down by house prices increasing faster than market rents.
If gross yield were 8%, and even if it came down to 5% after allowing for all the above overheads, that could still support a sizeable (say 80%) mortgage (interest-only, of course - you've got to do the gambling properly).
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