Mixed Picture Emerges for Repossessions

publication date: Mar 7, 2011
author/source: Guest Article by Gary Styles, Strategy, Risk and Economics Director, Hometrack

Mixed Picture Emerges for Repossessions

Economic data remains patchy and concerns about inflation and inflationary expectations have increased in recent months. Purchasing Managers Index surveys indicate that the fall in gross domestic product in Q4 was a blip and that both the service and production sectors have seen a strong bounce in Q1.

The impact of higher VAT and strong growth in world commodity prices has made assessment of underlying inflation difficult but on balance it looks like headline inflation will be significantly lower in 12 months.

Having produced forecasts for the economy and mortgage market last month I wanted to turn my attention to the outlook for repossessions and arrears under a various economic scenarios. Evidence from the US and other markets suggests large increases in localised repossessions can have a major impact on house prices in the medium term. So far in this recession the rise in arrears and repossessions has been modest compared with other downturns.

The graph (below) shows the profile of three-month and six-month-plus arrears since the early 1980s. In the 1990s downturn, three-month-plus arrears reached over 6% of all mortgages while in the current cycle this is expected to peak at around 2.6%- around 240,000 mortgages.

Mixed Picture Emerges for Repossessions

As in the last recession lenders have been under pressure to exercise forbearance with repossession as a last resort. The percentage of customers in arrears who have agreed a rescheduled payment plan with lenders rose sharply in 2009 and 2010 to over 30% - or 70,000 customers - although there is some evidence this eased slightly towards the end of 2010.

The combination of lower arrears compared with recent downturns and flexibility from lenders limited repossessions to around 36,000 in 2010. There was a record peak of 75,000 in 1991 compared with 2009’s 48,000. But it is too soon to assume repossessions will fall during 2011 and 2012.

A combination of higher interest rates, weak house prices and a long period of forbearance from lenders make it increasingly likely that repossessions will rise in 2011 and 2012. Many customers already struggling to pay at current mortgage interest rates will find it more difficult in 2011/12 as interest rates rise by 1.5% or 2% and employment income is further squeezed by higher short-term inflation.

Our central forecast shows a slow economic recovery with modest house price falls in both 2011 and 2012. The gross mortgage market is expected to be broadly flat in 2011 then increase modestly thereafter and forecast to reach around £170bn in 2015.

Lenders are struggling to restructure their balance sheets so competition in the mortgage market will remain muted until 2013/14. There could be some injection of competition from the Banking Review recommendations in September but any policy changes will take several years to take full effect.

The table summarises the outlook for possessions under three broad scenarios. The base forecast expects possessions to rise to 43,000 in 2011 and 2012 from 36,000 last year.

Thereafter the gradual recovery in the mortgage and housing market and a more positive outlook for personal incomes results in possessions easing back to around 34,000 at the end of the forecast period.

The Taylor Rule scenario - higher interest rate - shows interest rates rising earlier in response to higher inflation relative to target and a narrowing in the output gap.

Interest rates reach 2% by the end of this year and 4% by 2014. Under this scenario possessions peak at 55,000 during 2012/13 as the household experiences an even sharper monetary policy squeeze combined with somewhat lower inflation than in the base forecast.

The final scenario shows the impact of holding current interest rates into the medium term. Under this crude scenario house prices start to rise sharply by 2014 and 2015 and net lending reaches over £40bn.

We know interest rates in the medium term will rise to around 4% but the speed of this will have a major bearing on the outlook for arrears and repossessions. Lenders have exercised great restraint in this downturn and have helped borrowers cope with the impact of the sharp downturn.

As the mortgage downturn becomes more protracted this will become more difficult for some customers. Possessions look set to increase in the short term and the situation will be much worse if interest rates have to increase more sharply than generally expected.



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