The core thrust of the Bank of England annual cyclical stress test focuses on the 7 major UK banks and building societies who present a systemic risk to the stability of the UK financial system. All other sector firms must also design their own specific stress testing system. To enable this analysis, the PRA publishes scenarios every 6 months to serve as a guide for such firms.
When the 2019 scenarios were announced, some eyebrows were raised at the level of the UK residential property price fall stress (33%). This is more plausible however against a backdrop of the continuing withdrawal of buy-to-let investors plus the ‘credit creep’ environment that continues. Although the 33% stress level is more severe than that experienced by the UK during the global financial crisis, it is comparable with several past severe housing market downturns in other advanced economies.
It is reassuring that firms have passed the recommended stress tests. We are finding more firms, including investor and non-deposit taking firms, now want to carry out deep dive analysis of their portfolios, over and above the required stress tests. It appears that firms are sensitive to media and regulator concerns that companies are accepting greater risk and not pricing for it appropriately and they clearly want to make sure their own house is in order.
There is no doubt that there has been a widening of criteria coupled with ‘margin squeeze’; in fact headlines that include ‘mortgage price war’ don’t adequately describe the current environment. Not surprisingly we are being asked to comment on a greater number of data points in our ‘Agreed Upon Procedures’ [AUPs] when looking at pre-securitisation or pre-sale/purchase reviews.
We are also being asked to comment on ‘risk layering’ where different risk layers are merged and therefore, compounding potential risk. We have seen inappropriate risk layering in the past where firms developed different product strategies, e.g. buy to let or impaired credit focussed products which later get merged to form products entitled ‘Impaired Credit Buy to Let’. The competitive environment today is showing increases in LTV percentages and reduced rates, but a real difference this time round is that investors want to fully understand the risks they are taking on.