December 21, 2020

U.K. Mortgages Reach 13-Year High

by Tajinder Dhillon.

The Financial Times reported that Lloyds Bank and NatWest plan to re-introduce 90% loan-to-value mortgages (LTV).  Due to COVID-19, banks removed 90% LTV products from the market for most of the year to reduce lending risk.  Higher LTV mortgage products are incredibly popular as it allows homeowners to save thousands on a deposit.  For example, a homeowner looking to purchase a property worth £500k can save £25k on a deposit by obtaining a 90% LTV mortgage instead of an 85% LTV mortgage.

However, despite the removal 90% LTV products, the demand for mortgages skyrocketed in the second half of the year due to the temporary removal of Stamp Duty Land Tax (SDLT) which will expire in March 2021.  The new measures allow homeowners to save up to £15k in taxes when buying a new property.  This created a housing market frenzy as both buyers and sellers looked to take advantage of the new rules.  Looking at Exhibit 1, the number of mortgages approved in October reached at 13-year high at 97,532, which is a year-over-year (YoY) increase of 51.1%.  October’s figure is ten times higher compared to the trough of 9,355 approvals in May 2020 when SDLT was still in effect.

The demand for 90% LTV mortgages will be highly anticipated by the market.  However, banks have anticipated this pent-up demand and have significantly raised interest rates on 90% LTV products.  According to Refinitiv Datastream, the average interest rate on a 2-year fixed 90% LTV mortgage has risen sharply to a five-year high of 3.67% in November, compared to 1.89% in April 2020.

Exhibit 1: U.K. Mortgage Approvals

The temporary removal of SDLT revived the housing market in 2020 and led to higher prices across the country despite COVID-19 and a possible no-deal Brexit.  As shown in Exhibit 2, the U.K. Nationwide average house price in November 2020 stood at £229,721, resulting in a 6.5% year-over-year increase.  This compares to the average home price of £215,282 at the beginning of the year.

Over the last four quarters, the strongest gains have come from the South-East region (6.2%) followed by East Midlands (5.2%) while Scotland (0.9%) has seen the weakest gains. COVID-19 resulted in a change of buying behaviour, as flexible working arrangements led to greater demand in rural areas with more greenspace.

Exhibit 2: U.K. Average House Price

Housing Activity and Future Expectations

As SDLT sets to expire on April 1, 2021, it is expected that housing activity will moderate and ease in momentum.  The Royal Institution of Chartered Surveyor (RICS) provides near-term forecasts on the housing market and is shown in Exhibit 3.

At a national level, new buyer enquiries, agreed sales, and sales expectations have declined in the latest month.  New buyer enquiries over the past month has fallen from a peak of 75.0 in July 2020 to a current reading of 27.2. Newly agreed sales over the past month have also followed a similar path and currently stands at 24.8, declining in each of the past three months.

Finally, seller expectations of future sales in the next three months turned negative in November at -4.2 from 15.2 in October.  The decline in sentiment corresponds to the same timeframe when SDLT expires on April 1, 2021.  The surge in mortgage demand has increased the time it takes to complete on a house purchase.  If a transaction does not complete by April 1, 2021, the buyer will miss out on stamp duty tax savings, which will put pressure on near-term activity.

Exhibit 3: U.K. Housing Metrics

Homebuilders Analyst Sentiment

Turning to U.K. homebuilders, the impact of COVID-19 resulted in 15,930 new homes starting to be built across the country during Q2 2020.  This was an all-time historical low, compared to a 30-year quarterly average of 35,840 new homes.

However, analyst sentiment remains bullish for the industry.  Using the Aggregates app in Eikon, we find that the FTSE 350 Household Durables industry group has a StarMine Analyst Revision Model (ARM) score of 79.   Persimmon PLC (76), Barratt Developments PLC (79), Taylor Wimpey PLC (97), Berkeley Group Holdings PLC (84), and Bellway PLC (81) all have percentile ranks in the top quartile.  Strong ARM scores generally represent upward analyst revisions across revenue, EBITDA, EPS, and changes in recommendation.

According to Refinitiv I/B/E/S data, the 2021 EPS YoY growth rate for the FTSE 350 Homebuilding sub-industry is expected to be 40.6%.  This follows a decline of 44.4% in 2020 which means there is still further earnings growth required by the industry to return to pre-COVID levels.  In 2021, Countryside Properties PLC (201.6%), Taylor Wimpey PLC (140.2%), and Vistry Group PLC (120.1%) are expected to have the highest YoY earnings growth.

From a valuation perspective, the industry is trading at a discount to the broader index.  The FTSE 350 Home Construction Index trades at a forward P/E of 11.0x compared to 15.3x for the FTSE 350.

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