Fitch: UK BTL Lenders' Capital Can Absorb Basel Proposals
OREANDA-NEWS. However, the proposals are likely to impact the profitability of BTL 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.
At present, all exposures fully-secured on residential real estate collateral attract a 35% risk weight under the standardised approach for calculating credit risk. Basel proposes steep risk-weight hikes for BTL, property development and construction loans. Borrowings with high loan to values (LTV) and/or those that do not meet strenuous legal and underwriting criteria will attract the most onerous rates.
We assessed the potential impact of the proposals on a sample of Fitch-rated UK building societies and banks, which are active in the BTL market. For lenders assessing credit risk under the standardised approach, risk weightings applied to BTL portfolios will increase from 35% to 91%.
The Basel Committee also wants to impose a permanent capital floor on lenders using the internal ratings-based (IRB) approach to assess their credit risks. The proposal is that IRB lenders should calculate BTL risk weights under both standardised and IRB methodologies and apply the more conservative of the two. IRB-calculated risk weights tend to be lower than those based on the standardised approach and this suggests that IRB banks could be required to hold substantially more capital against these portfolios.
We think UK BTL portfolios could be more risky than owner-occupier mortgage a high proportion of BTL loans 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 BTL 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 BTL borrowers are non-professional investors whose more limited financial expertise could mean they are more prone to falling into debt servicing arrears. However, the fundamentals of the UK housing mortgage, with low supply and high comfortable mortgage affordability, continue to drive good BTL performance.
The Bank of England's (BoE) December 2015 financial stability report highlights the potential risks of a rising BTL market but we think the BoE is unlikely to raise overall capital requirements for UK banks because it has repeatedly stated that the capital held by the banking system as a whole is adequate. 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 BTL lending better reflect the risks presently capitalized under Pillar 2, we expect them to raise Pillar 1 capital requirements.
We expect gross mortgage lending in the UK to increase by 10% during 2016. Changes to stamp duty and tax relief for landlords announced in the November 2015 may hamper BTL growth in 2016 and beyond.
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