Key Takeaways
- Our analysis suggests that one in every five loans in 90+ days arrears backing legacy U.K. buy-to-let (BTL) residential mortgage-backed securities (RMBS) transactions that we rate, is more than 12 months in arrears. This build-up of late-stage arrears may have several causes.
- Although interest rates have increased rapidly since 2022, the absolute level is similar to rates that loans backing legacy U.K. BTL RMBS transactions saw at origination.
- Servicers are reporting that smaller BTL investors have been using BTL as their primary personal income source and have been unable to pass on rate rises and/or have prioritized personal spending above keeping up-to-date on their BTL mortgage payments.
- The build-up of loans in arrears for longer than three months will become a key transaction performance metric, as build-up may indicate the appointment of a receiver of rent is not economically viable.
Delinquencies in legacy pre-crisis originated U.K. BTL collateral continued to rise in the first quarter of 2024. According to S&P Global Ratings' latest European RMBS index, 90+ days delinquencies increased to 7.89% in March 2024 from 2.13% in March 2022, with total delinquencies rising to 11.24% from 3.32% over the same period. This contrasts starkly with U.K. BTL loans originated following the Prudential Regulatory Authority's introduction of underwriting rules in 2016. Total delinquencies increased to 1.9% from 0.94% over the same period for these vintages.
In this report, we take a closer look at this build-up of arrears within legacy U.K. BTL RMBS transactions that we rate. Specifically, we analyzed approximately 118,000 loans originated in pre-crisis originated collateral with a combined value of approximately £11.5 billion. Approximately 85% of the sample was originated between 2005 and 2008. Our analysis reveals that one in every five loans in arrears for more than 90 days has been in arrears for more than 12 months. Furthermore, we consider what's behind the arrears build-up, presenting our insights from discussions with servicers.
U.K. Pre- And Post-2014 BTL RMBS Performance Contrasts Starkly
Chart 1 shows the evolution of delinquencies in both pre- and post-2014 U.K. BTL transactions relative to increases in the Bank of England base rate to the end of March 2024. The pre-2014 U.K. BTL RMBS market is exclusively a variable rate product and as such has not been insulated from rate rises. By contrast, the post-2014 origination vintage is generally a two to five-year fixed-rate market. The fixed-rate nature, and the Prudential Regulation Authority's underwriting rules which, amongst other factors set minimum debt service coverage ratios for most lenders using securitization as a financing tool, account for this performance disparity. Specifically, the combination of these two factors has insulated recently originated BTL loans from payment shock (see "U.K. Buy-To-Let RMBS: Sheltered But Not Immune To Rate Rises").
Chart 1
Table 1
| Aged delinquency profile of loans backing our rated pre-2014 U.K. BTL RMBS transactions | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Arrears group months | Sum of current balance | Number of loans | % of total | % Variable rate | WA average interest rate % | WA remaining term (Months) | Average current balance £ | |||||||||
| 0-1 | 10,283,945,349 | 105,572 | 89.3% | 99.8% | 7.15 | 73 | 97,412 | |||||||||
| 1 to 3 | 385,194,515 | 3,976 | 3.3% | 99.6% | 7.48 | 76 | 96,974 | |||||||||
| 3 to 6 | 288,827,675 | 2,926 | 2.5% | 99.5% | 7.45 | 75 | 98,925 | |||||||||
| 6 to 9 | 181,180,165 | 1,742 | 1.6% | 99.7% | 7.51 | 77 | 103,739 | |||||||||
| 9 to 12 | 137,002,214 | 1,382 | 1.2% | 99.7% | 7.49 | 76 | 98,969 | |||||||||
| > 12 | 244,985,086 | 2,649 | 2.1% | 99.2% | 7.87 | 73 | 92,482 | |||||||||
| Total | 11,521,135,003 | 118,247 | 100.0% | 99.8% | 7.19 | 74 | 97,433 | |||||||||
| Note: Arrears are not fully aligned with our pre-2014 U.K. BTL RMBS index due to methodological differences. Source S&P Global Ratings. | ||||||||||||||||
Table 1 shows that in the loans backing our rated pre-2014 U.K. BTL RMBS transactions most of the features are similar, regardless of the delinquency status. We discuss below which other factors could drive diverging performance in pre-2014 BTL collateral.
Table 2
| Regional breakdown | |||||
|---|---|---|---|---|---|
| Arrears group months | London | South East Inc London | North West | Other | Total |
| 0-1 | 26.8% | 15.1% | 12.0% | 46.2% | 100% |
| 1 to 3 | 24.4% | 13.5% | 13.5% | 48.6% | 100% |
| 3 to 6 | 24.4% | 10.7% | 14.3% | 50.6% | 100% |
| 6 to 9 | 27.3% | 8.5% | 15.1% | 49.1% | 100% |
| 9 to 12 | 15.5% | 8.6% | 16.7% | 59.2% | 100% |
| > 12 | 19.9% | 11.3% | 14.9% | 53.8% | 100% |
| Overall Sample | 26.4% | 14.7% | 12.2% | 46.7% | 100% |
What Has Changed For Financial Crisis Era BTL Borrowers?
Chart 2 shows that, broadly, interest rates were at the same level as they were when the pre-2014 BTL vintages were originated. Given the interest-only nature of the product and that most loans are now linked to a variable rate such as Bank of England Base Rate or Sterling Overnight Index Average (SONIA), current monthly payments now are, broadly, the same as they would have been underwritten to. Chart 2 shows the evolution of rental levels in England since 2007. Although rental growth has differed regionally, all regions have seen growth since 2007.
Chart 2
So, if the overall macro environment of rates does not entirely explain credit deterioration, what factors do? We highlight below factors that weigh on the sector. On a case-by-case basis, a combination of these factors and the rapidly changing rate environment will likely explain performance migration for individual borrowers.
For example, there was limited incentive up until 2017 to own property inside an incorporated entity. A change in taxation treatment meant that U.K. BTL assets held outside an incorporated entity generally incur higher tax charges.
Another factor is higher exposure to smaller scale landlords. The size of a landlord's BTL portfolio is not reported in loan-level data, and if it were would only be as accurate as the day it was compiled. However, given the prevailing underwriting standards, and the subsequent professionalization of the sector, we believe that financial crisis era BTL collateral has a higher exposure to small scale landlords.
Our discussions with servicers highlight that income derived from defaulted borrowers' BTL properties was a material part of their personal income. When faced with rising rates borrowers have used rental payments to prioritize their own personal expenditure (for example, mortgages on their own house/car loans) ahead of paying their BTL mortgages.
Late-Stage Arrears Have Many Causes, Some Likely More Significant Than Others
Delinquencies beyond 180 days are a material portion of total U.K. delinquencies. BTL lenders can generally utilize the Receiver of Rent, a provision of the Law of Property Act 1925 when the loan defaults, which is generally three months past due. When appointed, the receiver can divert rent to the lender to pay off interest and principal under the loan and sell the property without court approval.
We understand some mortgage servicers are taking a portfolio-led approach, where they are actively working with borrowers who may have multiple properties, and together arriving at solutions such as selling certain properties in the portfolio, with a view to deleveraging the whole portfolio and clearing arrears balances at the same time. If properties are not rented in this situation, arrears will not be cured immediately, and individual loans may become more delinquent before such a strategy bears fruit. We understand that such polices are particularly useful in regional arrears where local property supply and demand dynamics means that selling a large portfolio is considered possible to depress house prices. In such scenarios servicers are effectively making the assessment of whether such a strategy can be justified by the property's current loan-to-value ratio.
However, not all late-stage arrears will be resolved in such a constructive manner. From speaking with servicers, we understand these delinquencies are attributable to properties that are unlet and potentially unlettable. In other words, their condition is such that they cannot be let at a rate that will cover current mortgage payments.
Over the coming months we may see existing 90+ days arrears start to clear as servicers, faced with limited upside in a higher rate environment, adopt a more reactive strategy.
If this happens, we expect to see individual assets with high loss severities crystalize. Certain BTL transactions currently have lifetime loss severities of about 40%. Differing calculation methods can apply to loss severity, for example, some include unpaid interest, others may not. Although U.K. house price growth has been strong since 2007, localized areas will inevitably buck the national trend. Indeed, some evidence from the loan-by-loan analysis in table 2 suggests late stage arrears are more prevalent outside London, the South East, and the North West. Properties in poor condition will likely face steeper discounts within the current market. In some cases, certain transactions may benefit from cross-collateralization, whereby losses on one loan may be covered through the sale of other properties. This may insulate losses in some scenarios. However, such protection may not be present in all cases.
That said, we cannot rule out loans in earlier stage delinquency moving into late-stage arrears. From a ratings performance perspective, the extent to which individual transactions' structural protections will protect them from future losses and higher delinquencies will be key.
Related Research
- European RMBS Index Report Q1 2024, May 16, 2024
- U.K. Buy-To-Let RMBS: Sheltered But Not Immune To Rate Rises, Nov. 24, 2022
- S&P Global Ratings' U.K. Buy-To-Let Market Primer, June 1, 2021
- Buy-To-Letdown? Recent RMBS Loans Will Struggle With The Perfect Storm Of Regulation And Tax Hikes, Jan. 24, 2018
This report does not constitute a rating action.
| Primary Credit Analyst: | Alastair Bigley, London + 44 20 7176 3245; Alastair.Bigley@spglobal.com |
| Secondary Contact: | Feliciano P Pereira, CFA, Madrid +34 676 751 559; feliciano.pereira@spglobal.com |
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