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The Bank of England is worried.
The Bank’s latest Financial Stability Review is a litany of concerns about the current state of the global economy, and the potential impact of a credit meltdown on the City. Among the threats on the minds of England’s central bankers are UK household debt, corporate debt, and the banking system’s exposure to it all.
Of course, you could argue (as we do) that central banks should have been worrying about all this quite some time ago, before they encouraged everyone to go on a mass spending spree by keeping interest rates at rock-bottom levels.
But let’s put that to one side for now. You don’t have to go far to see what the Bank is talking about.
In fact, pretty much every one of its concerns makes an appearance in the results of one sub-prime mortgage lender – Kensington Mortgages…
Kensington Mortgages reported a pre-tax profit of £30.3m for the six months to the end of May, up 24% on last year. But shares crashed 14% to 885p. Why? Because the mortgage lender – which specialises in lending to customers with poor credit records – revealed that bad debt charges had more than doubled since last year.
The loan impairment charge surged to £24.5m. That’s a 117% jump on the same period in 2005. Meanwhile the number of accounts three months or more in arrears rose to 9.6% of overall assets, from 9.2% a year ago, while bad debt provisions rose to 0.68% from 0.66% in 2005.
That was bad enough. But shareholders were also unnerved by news of growing competition. Despite rocketing bad debts, there is no shortage of rival lenders lining up to steal business from Kensington.
“The UK specialist mortgage market in 2006 has become very competitive and the credit environment is more challenging than in recent years,” said chief executive John Maltby.
We covered the rush to sell ‘junk’ mortgages a couple of weeks ago – you can read more about it here: How hedge funds affect house prices.
As competition has squeezed the profit margins on its main mortgage lending business, Kensington has expanded further into ‘second charge lending’ – that is, lending more money against a property that already has a mortgage outstanding on it. These are the so-called ‘consolidation loans’ that are so popular with day-time TV advertising departments.
Mr Maltby told Bloomberg that lending growth was being driven by households ‘refinancing’ other loans in order to lower their monthly payments.
“People have a lot of exposure to expensive, unsecured debt which is costing them a lot each month. Using the equity in their home is a way of reducing these payments each month,” he said.
It makes it all sound so sensible, so neat, when you put it that way, doesn’t it?
But don‘t be fooled by the jargon. ‘Using the equity’ in your house isn’t like pulling money out of a piggybank. It’s just another form of debt, basically the same as borrowing money on a credit card. We wrote about this in detail last week – you can read the piece here: Why housing wealth is an illusion.
Of course, there are two significant differences between your home and a credit card. When you borrow against your property, you tend to pay off the debt over a far longer period, so you pay a lot more (Antonia Senior explained this very neatly in Saturday’s Times – click here to take a look: On the house? Don’t fall for it.)
And if you don’t pay up, the lender can repossess your home.
This is exactly what’s been happening to the less fortunate of Kensington‘s clients who opted to ‘unlock the equity’ in their homes but then found they were unable to pay it back.
As house price inflation slows, lenders are becoming less keen to give borrowers the benefit of the doubt when they fall behind with their payments. After all, they don’t want to be left holding a load of repossessed two-bed flats when the house price crash arrives.
So if it looks like someone’s going to default, Kensington is making sure it takes their home back while there’s still the chance of at least covering its losses.
The company said as much, attributing the jump in bad debts to its “deliberate strategy of accelerating the repossession process in a period of more modest house price inflation.”
And that‘s one trend we expect to continue this year as the economic climate continues to become more difficult. Unemployment rose again in June. The number of people out of work and on benefits rose to 957,000, the highest level since June 2002. And the unemployment rate, at 5.4%, is now the highest in six years.
Its little wonder that Kensington was cautious on prospects for the coming months. “We do not expect market conditions to get any easier during the rest of the year,” said Mr Maltby.
On that point, we can agree.
Turning to the wider markets…
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The FTSE 100 was barely changed by the end of Wednesday, climbing 3 points to 5,860. Miners were among the main gainers as copper, nickel and gold made strong gains, while a series of brokers upgraded their metal price forecasts. Xstrata was the top riser, up 5% to £21.32. For a full market report, see: London market close.
Over in continental Europe, the Paris Cac 40 rose 27 points to 4,941, while the German Dax gained 21 to close at 5,637.
Across the Atlantic, US stocks closed sharply lower, with fears rising that the second-quarter earnings season will disappoint. The Dow Jones Industrial Average fell 121 to 11,013, while the S&P 500 closed 13 points lower at 1,258. The tech-heavy Nasdaq dropped 38 to 2,090.
The Wall Street sell-off hung over Asian markets. Japan’s Nikkei 225 fell 151 points to 15,097. Technology-related stocks such as digital camera maker Canon declined, following US technology shares lower.
This morning, oil hit fresh record levels in New York, trading at around $75.65 a barrel, after rising as high as $75.89. Brent crude was also higher, trading at around $73.50, as tensions in the Middle East continue, and amid reports in The Guardian of an attack on Nigerian pipelines.
Meanwhile, spot gold eased back to trade at around $650.30 an ounce, after rising as high as $655.30 on Wednesday. Silver was lower too, trading at around $11.49 an ounce.
And in the UK this morning, publisher Emap has said that first-half underlying revenue will be ‘marginally down’ on last year, with full-year revenue set to be flat because of weaker magazine advertising market.
And our two recommended articles for today…
Should you buy into Rosneft?
– The flotation of Russian oil giant Rosneft is guaranteed to be one of the most-hyped in recent corporate history. Why? Ostensibly because Russia’s vast oil reserves are the answer to the world’s impending energy crisis – but more likely because investment banks are set to make over £250m in fees from the exercise, say Bedlam Asset Management. If you’re thinking of investing in Rosneft, there are some essential facts you need to know about the company first. To find out what they are – including why you may have bought their shares once already – click here: Should you buy into Rosneft?
Which Latin American countries should you invest in?
– With China’s rapid growth soaking up raw materials at an exceptional rate, the resource-rich countries of Latin America are booming. MoneyWeek recently gathered together a panel of investment experts in order to discuss the pros and cons of investing in the continent. To find out which markets look most attractive right now, and what the wave of nationalism and socialism sweeping the continent means for your investments, see our Roundtable article: Which Latin American countries should you invest in?