The firm builds under the assumption of a 150bp rise in policy rate over the period while allowing for the compression of mortgage spreads that acts as an offset.
The research said: “Our central case is for around a 10% correction in house prices from 4Q 10210 levels by 4Q 2012. Demand looks set to be relatively unsupportive for prices over the next year and a half or so given our expectation for weak real household disposable income and rising mortgage rates. We don’t expect any significant further increase in availability of higher LTV mortgages and expect only modest improvements in credit availability more broadly. Valuations continue to look stretched on the simple metrics we look at.”
Using Halifax’s national house price data Morgan Stanley have also constructed a bear and bull case where their bear case assumes that house prices undergo a bigger correction for existing overvaluation with overshooting in consideration. While their bull case would assume flat real mortgages over the next year and a half but also allowing for a modest degree of correction from current levels of overvaluation.
From these cases the most positive outlook is an increase in house prices by 10% with the most negative being a 17% drop.
Chris Manners, UK banks analyst at Morgan Stanley, said he expects three negative effects to UK banks. These are higher impairment charges in mortgage books likely, higher capital requirements possible as modelling assumption could become more conservative and elevated funding costs constraining mortgage growth.
He said: “We expect higher impairment charges due to i) higher default probability as arrears rates climb; and ii) higher loss severity in event of default as collateral values (i.e. house prices) fall.
“As prices fall, we expect that UK banks would increase the “loss given default” assumptions they use, as recoveries on collateral would be lower. This would increase the risk weight on mortgage exposures and hence adversely impact capital ratios.
“Currently funding costs are elevated and there is little appetite for re-gearing by homeowners. If house prices continue to drift down we would expect that spreads on UK banks debt would remain elevated. This funding cost would act as a constraint on new mortgage lending and also would act as a drag anchor on house prices as there is less leverage to support the sector.”
