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The landscape for UK mortgage lenders will continue to be very fluid, Moody's Investors Service said in a new special comment. This will be against a backdrop of continued uncertainty over the direction of house prices, interest rates and unemployment as well as tougher regulatory capital and liquidity requirements.
"Moody's believes that the next few quarters will be characterised by a number of key credit themes that will culminate in sustained pressure on the sector's profitability," said Marjan Riggi, author of the report. "These themes are expensive funding, flat or negative lending growth, regulatory pressures, asset quality and economies of scale."
In the Moody's new report, the agency has grouped its rated lenders in the UK based on a view of the strength of their current and future franchises, which it believes are key to their level of resilience in this prolonged difficult market environment.
Moody's said it believes that mortgage lenders with more diversified product offerings, a wider and more diversified funding base as well as greater economies of scale are better positioned to weather the challenges ahead.
"Mid-sized societies with niche franchises and a strong, loyal local or regional deposit base and solid underwriting skills or a more diversified revenue base will also be more resilient," said Riggi.
The rating agency considered that there is also a group of smaller lenders that will face some short-term challenges. Characterised by either a strong local presence or niche businesses, they have faced difficulties regarding their profitability and/or their asset quality. However, their established and loyal local franchises mean that they should still be able to withstand the current challenges.
Finally, the report examined lenders that lack scale and are therefore more vulnerable to the market pressures listed above. In some cases, prior rapid growth has further burdened some of these lenders with asset quality challenges, for example by undue exposure to commercial real estate.
"We expect further deleveraging or possible consolidation among these players, but will also closely monitor to what extent these mortgage lenders may try to compensate for their margin pressure with other strategies that may unfavourably tilt the risk-return balance," Riggi added.
The rating agency noted that it assigns a wide range of standalone ratings to these lenders, reflecting its view on the divergence in the intrinsic financial strength of these institutions. The long term debt ratings of mortgage lenders are, however, converging into a slightly more narrow band, incorporating the agency's view on the extraordinary level of implicit and explicit systemic support into the ratings of these
institutions during the financial crisis.
Moody's continues to expect a high degree of systemic support for senior creditors, as long as the markets remain very volatile.
"Any eventual retrenchment of this support may affect the smaller entities earlier, whereas the large banks and building societies are likely to remain systemically important for a longer period of time and until a more sustained economic recovery and restoration of the general financial market takes hold," Riggi explained. In 2009, Moody's removed all systemic support for any subordinated debt instruments issued by UK bank financial institutions, given the visible absence of such support by the UK government.
