MMR will compress lending, warns Moody’s

19 July 2010 | By Natalie Thomas

It expects the measures to increase costs for lenders and reduce the number of eligible borrowers and the amount that they can borrow in the short term.

It says new loan applicants as well as existing non-standard mortgage holders may find it difficult to access mortgage credit or refinance their loans.

In the short term this will result in a reduced supply of credit to the housing market and may exert negative pressure on house prices and simultaneously compress both lending volumes and margins.

In its Weekly Credit Outlook report it predicts a two-fold impact stemming from the FSA proposals on the mortgage market.

It says at first it will lead to reduced loan generation and borrowing activity in the short to medium term, but it will also result in the improved quality of new origination and eventually have a positive impact on mortgage losses in the longer term.

It says the measures will boost the credit quality of UK bank and building society mortgage portfolios in the long term as new loans will have to undergo stricter underwriting checks compared with existing mortgages in their portfolios.

It says since the quality of each lender’s tests on affordability and verification of income is an important input to our current probability of default analysis, it believes that the FSA’s proposals will be credit positive in the longer term. Tougher tests enforced and monitored through better regulation are likely to decrease lifetime losses.

Another positive result from the MMR will be that the credit quality of residential mortgage-backed securities will improve.

In its report, Moody’s says: “The revolving nature of master trusts means that the credit quality of the trust’s assets would likely improve over the long term as older mortgages with less-stringent underwriting repay and new mortgages subject to the new regulations enter the trust.”

The mortgages currently held in the master trusts, which account for around 20% of total UK mortgage debt, are predominately prime mortgages, but over a quarter of all mortgages in the sector do not have verified income, and around half are interest only.

It says: “Although some existing borrowers will be unable to refinance under the more stringent tests, we see the lack of refinancing options introducing only relatively minor incremental credit risks, such as borrowers reverting to higher interest rates at the end of initial teaser or fixed rate periods.

“A reduction in remortgage activity in the master trust sector could also lower further the historically low prepayment rates and increase extension risk. In some master trust facing extension risk, sponsors have needed to inject cash to ensure notes pay down on schedule.”

It adds: “Although our outlook over the next 12-18 months on the UK Prime RMBS sector is negative as a result of fiscal tightening, the proposal to strengthen mortgage underwriting is a positive credit development for the master trust sector.”