Valuations review

Balance sheet risk is a real and present danger

Steve Goodall

MD, e.surv

The country’s finances are in a decidedly difficult place. Lenders were quick to withdraw products from the market amid bond-market chaos and sharply rising swap rates. The levels at which they felt compelled to reprice sent shockwaves through the economy as a result. The day Rishi Sunak was formally appointed prime minister saw several major lenders cut rates back down, reflecting more stable markets and lower costs of funding as a result. Nevertheless, some household finances are on the brink; some are already underwater. Everyone is watching to see how lenders choose to deal with such a bleak turn. It seems likely that capital buffers will absorb a considerable chunk of late or failed mortgage repayments – they cannot defy the as-good-as-explicit instructions issued by both the Bank of England and the Financial Conduct Authority.

That will affect their balance sheet on one side, and it is inevitable the other side will feel a ripple effect. The question is whether this will spark a more risk-centred approach to underwriting security.

There are several challenges facing lenders when it comes to the assets underlying both residential and buyto-let mortgages. But the very thing that differentiates secured lending from every other type is exactly that – the security. It’s thus odd that the condition a property is in at the point of purchase or remortgage is often much lower down the list of considerations than it should be. The use of automated valuation models, particularly on reasonably standard homes, has glossed over the declining condition of Britain’s housing stock over the past few decades. Buy-to-lets are given a particularly rough time of it, but so are homes securing lifetime mortgages. Without physical valuations – not just drive-bys, either – knowing what state the property is in presents a challenge. A property’s condition has a huge impact on its value. Early signs that borrowers are struggling are beginning to show in arrears and possessions. UK Finance figures for the second quarter recorded low arrears, but noted a rise in early-stage arrears, up from the start of the year.

The trade body acknowledged this is likely to reflect early signs of pressure on household finances as cost-of-living stresses really start to bite. Within the total, there were 25,160 homeowner mortgages in early arrears – representing 2.5 per cent to five per cent of the outstanding balance. Where loans-tovalue are at the top end and affordability is in such a tenuous position, with worse to come, property values may also soften. And a new focus on the security now means greater scrutiny of other elements underpinning value.

The government’s net-zero commitment is already taking a noticeable toll on the housing market, skewing dynamics in such a way that huge pressure is growing in the rental market as landlords exit.

The withdrawal of beneficial tax breaks had played a large part in this; now, it is the impending energyefficiency legislation.

Set to require landlords to upgrade properties to a minimum energy performance certificate band rating of C or above by 2025, the sheer cost of work needed is forcing many out of the market.

Statistics published by the Office for National Statistics in October show just how serious this will be for the private rented sector. England and Wales both have a median energy efficiency rating in band D, with scores of 67 and 65, respectively, where the most energy-efficient homes have an energy efficiency rating in band A and the least energy-efficient homes are in band G.

Flats and maisonettes were the most energy-efficient property types in both England and Wales, with a median energy efficiency score of 72 in England and 73 in Wales, equivalent to band C.

In both countries, four in five dwellings used mains gas as a main fuel source for central heating.

Among local authority districts, just 15 per cent had more than half of their dwellings at energy-efficiency band C or above; two-thirds of these local authorities were in London or the South East.

Behind closed doors, estimates put the cost of necessary refurbishments anywhere between £10,000 and £60,000 per home.

Brexit, higher import costs, higher energy costs, higher taxes, higher interest rates, a weak pound – this is a toxic cocktail for the cost of building materials and the training and labour needed to deliver. And that’s so even when property owners have the money to carry out those works.

Consequences will be felt in the residential homeownership market as well – all residential property is billed to be band C or above by 2030. Given the length of mortgage terms, that’s a material risk sitting on balance sheets today.

Ultimately, lenders want to lend. Understanding the balance-sheet risks and opportunities, where appropriate, makes valuations the right foundation on which to ground those decisions. M I