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UK Households on Amber

31 January 2017 by Douglas Charleston

Recent Brexit defying economic data paints a healthy and confident picture of the UK economy, the 0.6% (+0.1% vs consensus) Q4 2016 quarter-on-quarter growth in GDP is the latest example of this. With a period of uncertainty ahead and a sense that the consumer has not yet been subjected to any meaningful currency or inflation related headwinds, we are closely monitoring the health of the average UK household and its shock absorption capacity.

The consumption levels of UK households have been a key driver of UK economic strength. Consider that a 4.8% unemployment rate is near its cyclical floor, real disposable income growth has accelerated since 2014 whilst the savings ratio has ticked down from 6.6% to 5.6% in the year to Q3 2016 (Source: ONS (30 September 2016)). These factors have driven strong retail sales and sizable new car registrations; the GDP growth mentioned above was in part exacerbated by consumers bringing forward spending ahead of anticipated period of inflation ahead.

On the other side of the household balance sheet, consumer debt is widely available, cheap and increasing. Confidence has fuelled leverage from very low levels, but households cannot delay lifestyle consumption indefinitely; cars do break, houses need renovation and £4k TVs are essential. Consider that unsecured loans can be accessed by prime borrowers at 3.5% – net consumer credit has risen steadily from zero to £1.7bn in November, still below but nearing the early 2000s rate. Similarly, outstanding credit card debt is running at its highest level since the BBA’s records started in 1997. We also keep a keen eye on the proliferation of alternative forms of lending such of payday loans, second lien loans and algorithmic p2p platforms as a relatively small but growing potential source of systemic credit loosening.

It’s a slightly different story when it comes to mortgage lending, where volumes remain modest and despite swap rates backing off in Q4 2016, rates are cheap and credit standards have not loosened far, partly as a result of the implementation of the FPC’s macro-prudential standards aimed at safeguarding the financial system. Mark Carney recently acknowledged this risk and stated the BoE would remain ‘vigilant’.

Each of these trends leave UK households more vulnerable to increases in inflation, unemployment and over the medium term, interest rates (with a 57% chance of a rise by March 2018 currently forecast). We do take comfort from several differences in this re-levering phase when compared with pre-crisis. First, underwriting standards are more closely governed by the FPC, but also we think better internal risk management at lenders should provide improved stability. For example, elevated house price levels and modest income growth have not yet led to a material increase in average LTV and loan to income ratios as the BoE’s November Financial Stability Report illustrated. In fact, the proportion of high LTV mortgage lending is at its lowest since the late 1970s. The other comfort we take is that asset losses for the most part were not severe during the last downturn and banks and building societies are currently well capitalised and well-funded.

The health of households is something relevant to all fixed income investors from a top-down perspective, because as an ABS investor where our underlying exposures are often mortgages, auto loans and unsecured credit, it has a very real micro significance. While we feel that the economy is better insulated in the event of a downturn, the access to granular loan data and ongoing due diligence is increasingly relevant now when picking bonds.

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