UK MORTGAGE AND PROPERTY REPORT

January 2022

Welcome to the January 2022 edition of the Mortgage and Property Report. In this issue, we look at loan performance through time in Kensington’s portfolio, focusing on trends in early and late stage arrears, as well as the impact of delayed litigation proceedings on the latter. We examine the underlying reasons for these trends and assess how we think they may develop in the coming years.

Key Highlights 

• Overall arrears levels in the UK continue to decrease, with Covid-19 only having a limited impact thus far
• The percent of loans in early arrears in Kensington’s portfolio has steadily decreased over the last 3 years, and is continuing to do so even after the Covid crisis
• The number of loans in very late stage arrears has increased significantly during and following the Covid crisis, as the absence of, and subsequent delay in, the repossession process has meant non-performing loans cannot exit the portfolio
  

Introduction

The performance of UK mortgages has steadily improved since the 2008 global financial crisis, and total arrears levels are the lowest they have been in c. 15 years. It was widely expected that the 18 months of on- and off- again lockdowns in the UK would throw a spanner in this trend but arrears remain at historic lows. In this newsletter, we look in more detail at two trends we are seeing in our own portfolio, as well as the wider market, and examine the underlying causes and potential future developments. The first trend is a continued decrease in the percent of loans in early arrears – those with 1 to 3 missed monthly payments. We look at how customer behaviour in reaction to Covid and the wider economic environment is impacting this. The second trend is an increase in the number of loans in late stage arrears – particularly those with more than 12 months of missed payments. We look at how measures to soften the financial impact of the pandemic on mortgage customers, particularly the moratorium on repossessions, has exacerbated this and how we expect this to develop going forward.

How We Measure Arrears     

Beginning this month, Kensington has made some changes to how we calculate and report payment arrears on all the mortgages we service. Historically, Kensington used a “Month in Arrears” (MIA) concept, calculated by dividing a borrower’s arrears balance by their contractual monthly instalment (“CMI”) in a given month. The MIA was determined at the end of the month when the CMI was due and customers were classified as in arrears when MIA was greater than or equal to one month. In our new methodology, we have moved to a “Missed Payments” concept, where arrears are determined one calendar month following the date the relevant CMI was due (instead of at the end of the same month in which the CMI was due), and on the basis of the number of payments missed instead of the arrears balance divided by the CMI. This will correct anomalous results that occur due to (1) the point in the month in which a CMI is due (e.g. a customer with a payment due date close to the end of the month who pays a few days late would have been reported as 1 MIA at month end, while a customer who has a payment due date in the middle of the month and pays a few days late would not be in arrears if the payment is late by the same number of days but is made before month end), and (2) a rate reset can result in a large change in MIA from month to month when the CMI changes as a consequence even though the customer’s true arrears status has not changed. We believe the new methodology will be a more accurate reflection of arrears through time, and use it throughout this newsletter as well as all future public reporting.

Kensington Portfolio Performance

The KMC portfolio has in recent years seen notable improvement in the percent of loans in arrears, particularly early arrears (as seen in fig 2) and new arrears. In this newsletter, the KMC portfolio is defined as all assets to which we currently have both legal title and in which we have economic interest (in most cases through residual interest in a securitisation). Where that includes assets we acquired from a third party, we include the historical data for completeness, even if it relates to the period prior to our ownership. Where we have sold assets, we do not include them in the data, even for the periods during which we owned them. The amortisation of Kensington’s portfolio of legacy mortgage assets combined with the continued increase in our new originations, means that the composition of our portfolio is moving towards a greater concentration of recently originated assets than was historically the case (as seen in fig 3). This change in composition is one reason for the decrease in arrears we’ve observed, but more notably, we are also seeing a sharp drop in the number of new arrears.

As can be seen in figure 4, the percent of total arrears in our portfolio that are “new” arrears in each month has been trending downwards for some time and has been between 5-7% for the last 6 months, vs. an average of 11% previously (leaving aside an artificial spike in the months immediately after the start of the Covid crisis due to missed payments that should be categorised as payment holidays). Throughout this time, the portfolio size has been relatively constant. As seen in figure 5, we see the same trend when we narrow the dataset to our legacy (pre-2010 originated) assets. Similarly, when we look at Kensington’s full serviced portfolio including third party portfolios, which totals c. £10bn and is more heavily composed of legacy assets, the same trend is clear (fig 6). This means that one of the key drivers of the lower number of early stage arrears is a decline in the number of new loans going into arrears. There are several plausible explanations for this, although establishing definitive causality is not easy, as customer behaviour can be influenced by many factors. One explanation is that some customers chose to take mortgage payment holidays during the pandemic even though they did not need to. This allowed them to build up a nest egg of savings which makes them less likely to miss a mortgage payment when faced with an unexpected bill or expense. As can be seen from figure 7, UK household savings rate increased significantly during the pandemic, as many households benefitted from government income support while also finding few outlets to spend as most of the economy remained shut. Another contributing factor could be the wage inflation observed in the UK over the last year, which has occurred while actual mortgage costs decreased or stayed the same.

Litigation and Enforcement Delays

Although new arrears have decreased across all portfolios, overall arrears levels, though reducing, have seen a more muted decrease due to an increase in late stage arrears, particularly those with more than 12 missed payments. Arrears in the 3-12 MP bucket rose from c. 1.5% to 2.5%, but have since stabilised and started decreasing again. This decrease is due to a combination of loans rolling into the 12+ bucket (which has increased from c. 0.7% pre-Covid to 1.3% today), and other loans curing. The key reason for the increase in late stage arrears has been the moratorium on litigation that was effectively in place for over a year. Because no proceedings could take place, a large backlog of late stage arrears has built up as loans that would normally exit via the repossession route have remained in portfolios. While proceedings have now resumed, the backlog will take some time to clear. The litigation process has seen some changes since the moratorium was lifted, which has caused the overall process to take longer. In the aftermath of Covid, an additional hearing known as the Reactivation Hearing was introduced. The purpose of this hearing is to provide detail on how the customer has been impacted by Covid -19 and is a precaution to ensure lenders are taking the appropriate action. This hearing has to take place before the Substantive Hearing, and effectively doubles the time the overall process takes. Recently, the Master of the Rolls decided each individual court could determine whether they want to operate the Reactivation Hearing, bringing some inconsistency into the process. Moreover, many high street lenders have not yet restarted repossession processes fully, so the back log could get worse before it gets better.

Conclusion

Although some of the positive trends we are observing in early arrears are lessened by the negative trends in late stage arrears, the overall outlook still seems relatively promising. The rise in late stage arrears seems to at its core be an issue of timing rather than a reflection of an underlying long-term economic problem. Conversely, the trend towards lower early arrears has been going on for some time and is observable in the overall UK mortgage market going back several years, suggesting some of the Covid-related causes for improvement we’ve seen in our own portfolio are supplementary to broader drivers such as a move to more prudent lending in the last decade, rather than key drivers themselves. Nonetheless, as we have now become used to, Covid-19 is keeping us on our toes, and any new restrictions to control the fast-spreading Omicron variant could derail these trends.