Could mortgage holidays return after Covid crisis ends?

At the beginning of the second Covid-19 lockdown in the UK, an indebted mortgage customer hurried on to an anonymous internet forum to post:

“I’ve already taken a three month payment mortgage holiday with Skipton earlier in the year. I’m back paying full payments now — but I’m about to be furloughed and my partner’s new job has fallen through.”

The borrower wanted to apply for a further “payment holiday”, possibly for another two or three months. The customer emphasised they wanted to wait until the last possible moment until asking for the second deferral.

Below the post, several other users posted links to UK Financial Conduct Authority (FCA) advice, making it clear that borrowers have until January 31, 2021 to request a payment deferral.

At the height of the pandemic, nearly two million UK house owners were facing a similar choice. Out of all UK mortgages, approximately one in six had borrowers opting to take a payment deferral at the peak of the virus, choosing to skip payments for three months, though this would increase mortgages costs in the long run.

For some specialist mortgage providers, nearly a quarter of their mortgage book was taking a mortgage holiday by mid-April. Some worried that if deferral rates continued to climb, then more than half of their customers would end up on a payment holiday before the pandemic was over. If a large proportion of these missed payments moved into default, this would be a disaster for lenders.

But by the summer, most UK borrowers who had taken a payment break were back to repaying. Mortgage holiday rates in the UK ranged from 1% to 6% in November, depending on the lender.

The high rate of UK payment holidays at first was partly because borrowers could self-report, asking for a break for any reason or none. Other jurisdictions, such as the Netherlands, required borrowers to prove Covid-19 had hurt their income.

“On a total portfolio of about 4,000 loans, we have seen 35 request, of which we have granted only nine,” said a Dutch mortgage lender and RMBS originator. “In the total year, it has been lower than 1%.”

On the UK side, Lloyds Banking Group’s payment moratoria levels peaked at 23% of its mortgage book, with 83% of those having resumed payment as of October 2020.

UK unemployment is expected to peak at 6.3% in 2021, according to S&P Global Ratings, which could mean many of the most stretched borrowers are unable to resume payments. Some worry that in turn this could lead to a ‘cliff edge’ of payment defaults hitting RMBS investors during the second quarter of 2021, following a second round of payment holidays.

UK investors predict that many of the borrowers who have taken the maximum payment holiday of six months will struggle to get current on their payments again, and risk defaulting without some kind of reduced payment scheme. However, RMBS deals are equipped with sufficient buffers to protect against losses in the single digits.

“You are not able to necessarily predict what take-up there will be at any point in time,” says Andrew Vickery, securitization partner at Linklaters, outlining the dilemma facing investors.

Lobby group UK Finance said in May that a second moratorium option was not always in customers’ best interests, warning that a blanket approach was obscuring how many borrowers could actually no longer afford their mortgages.

“If, say, 10% [of the book] are on a mortgage holiday, you just don’t know how many will return to paying or struggle to pay in the future as restrictions persist,” says Erik Parker, ABS strategist at Nomura. “Until mortgage payment holidays are behind us and we can get a true sense of the scale of arrears, versus people returning to pay the full amount, it is difficult to accurately assess how performance is going to evolve.”

But investors have been encouraged by the resumption of payments across many portfolios, and RMBS spreads have tightened as the year has continued.

“I think it is fair to say that, for the most part, most worries about them have gone away,” says Rob Ford, co-founder of investment firm TwentyFour Asset Management. “The vast majority of people who took a mortgage holiday have started paying again.”

Even non-conforming deals which showed payment holiday requests at more than 40% of the total portfolio have now dropped back to lower than 2%.

S&P predicts that RMBS arrears will be slower and lower when compared with the 2008 financial crisis, largely as a result of improved underwriting and the implementation of mortgage holidays, as long as a cliff edge is avoided.

“Underwriting and affordability assessments — as well as changes in the policy at a capital market level, including risk retention — mean that the lenders which are making these lending decisions still have some skin in the game,” says Alastair Bigley, RMBS analyst at S&P. “All these things have combined together to help de-risk the market compared with 2008.”

In the rest of Europe, banks have already begun rolling off mortgage moratoria. The Netherlands has already opted to leave it up to banks, rather than governments, to determine when a borrower’s payment holiday ends.

As a result of the mortgage holidays, the economic impact of the virus on homeowners is likely to be staggered, which helps stabilise the RMBS market.

For borrowers that can’t pay after six months, lenders are likely to offer reduced payment plans or loan restructurings to keep them paying something rather than falling into default. 

Such measures are also expected to keep the majority of struggling borrowers out of court, something the FCA appears keen to avoid.

Mortgages are secured on collateral, but it can be hard for lenders to get their hands on it — particularly during a pandemic. The UK government froze repossession proceedings from March 27 to the end of September. During those six months, the courts froze applications for evictions initiated by landlords against tenants, as well as those brought by mortgage lenders against owner-occupiers in payment default.

“No evictions are expected to be enforced until January 25, 2021 at the earliest,” said the UK government guidance on eviction, apart from in exceptional circumstances including illegal occupation and domestic abuse.

Court ordered eviction is a last resort, because it comes with major risks to the lender, while low interest rates also make it less worthwhile.

“Lenders are very focused on public relations issues around repossessions. If the only issue is that borrowers find themselves in a job that no longer exists because of Covid-19, it is going to be incumbent on the lender to show that that borrower’s case is hopeless,” says Bigley.

The burden of proof is on the lender to show that the customer they are enforcing on is not unable to pay solely because of the coronavirus, and that burden of proof will probably be exceptionally high.

“It’s not just a case of being seen to do the right thing,” continues Bigley. “It may not in all instances make sense to repossess properties. Lenders are not accruing interest at high rates like in the early 1990s; interest rates are very low, so if you do make the decision to repossess… the risk that legal costs are incurred that increase the possibility of a loss is a real one.”

“It is inevitable that there are going to be a residual number of people who need some help, and that that number is going to be higher than it was before Covid-19,” said Ford. “For the most part, it will be forbearance rather than foreclosure.”

While Italy had already adopted payment holidays as a tool to use in times of emergency, other jurisdictions in Europe are treading into unfamiliar territory. But the tool could become a regular features of the crisis-fighting toolkit.

The next financial crisis could well see mortgage holidays rolled out again to prevent mass unemployment and joblessness, as experienced during the global financial crisis.

“This, to me, has become a blueprint for perhaps the next time we have a recession or a crisis,” said Parker. “This may become a go-to solution, offering payment holidays. Any future crisis is likely to be different from this one, and certainly different from 2008/09, but this response may be repeated.”

Governments have reused many of the new financial tools structured to deal with the fallout of the 2008 crisis. With mortgage moratoria, European authorities might have found the latest tool to add to the toolbox.

“It is just very different from the previous crisis — for those working in finance our whole industry was destroyed [in 2008],” said Vickery. 

“This time it has a very different feel. The credit sector has had some disruption, but the problem is more macro‑economic. It is one of unemployment and business failure and, of course, public health. Now, the finance sector has an important role to play in being part of the solution rather than the cause.” GC