Two trends have been emerging; widespread market contraction and the increased surveillance and regulatory scrutiny around emerging risk categories such as energy efficiency and climate risks such as flooding.

Beyond the accurate valuation of the back book using tools such as an AVM, lenders should also be able to spot emerging risks and market dynamics that could affect the value and security of the assets on their back book.

With enhanced back book insights lenders can better manage their portfolio of assets. They can make more informed decisions at origination, improve product decisioning, quantify their risk exposure and improve the accuracy of loss provisioning.

Exposure to market shifts

Understanding how market dynamics uniquely affect your style of lending and risk exposure is key to effective back book management and could support your front book lending strategies.

It is well understood that following the mini budget announcement in 2023, headline house price growth has slowed. However, despite slow headline growth in 2023, several regions have still achieved positive year-on-year rises, including, Scotland, Wales and the West Midlands. This means that depending on a lender’s geographic back book exposure, they may be more or less exposed to the recent negative house price shifts.

Furthermore, more granular leading indicators of market health such as regional supply, demand and the percentage of asking price being achieved can highlight additional areas of back book risk exposure.

How any one lender is impacted by market dynamics captured by market metrics such as regional HPIs and supply and demand metrics, will mostly depend on their regional concentration of lending and how that compares to the market. Is the lender concentrated in regions with higher levels of price growth or lower? Do they have a greater exposure to properties located in areas of low demand or high?

Market health metrics that have been tailored to lenders’ individual geographic exposures can be used to inform forced sale discount (FSD) modelling and capital provisioning as well as support front book lending decisions.

Understanding property risk

A lender’s property risk exposure can shift and grow over time as the environment around their assets evolves or factors affecting the value or status of the property change or deteriorate.

Property risks can include how close the security is to a commercial business, its proximity to the HS2 development, detrimental leasehold factors or if an owner-occupied property has been listed for rent without notifying the lender.

A lender holding a property for more than a decade, for example, may not know that since origination a petrol station, or other commercial operation, has sprung up nearby.

Approximately 10% of properties are within 100 metres of undesirable commercial sites such as industrial, agricultural and landfill which can affect the property’s saleability. Understanding the exposure to this risk is particularly important in more distressed market conditions.

Having a better understanding of property risk exposure can inform lenders’ loss modelling and origination strategies.

Clock ticks down on short leases

Diminishing lease terms are another property risk lurking in lenders’ back books.

There are almost five million leasehold properties in England alone, 70% of which are flats. While some new leases are now sold with 999-year terms, older leases were granted on terms of 99 or 125 years. When the lease term falls to below 80 years, the leasehold property begins to lose value because the cost of extending the lease term goes up.

Our analysis of Land Registry data found that almost a quarter of mortgaged leasehold properties have less than 100 years left on the term.

Lenders, particularly those with a high concentration of flats on their back books, need to know the proportion of properties they hold with short leases in order to undertake accurate risk modelling and loss provisioning.

Filling in the energy efficiency gaps

Energy efficiency and climate are emerging risk categories which are attracting increased regulatory scrutiny.

Energy Performance Certificates (EPC) are key to identifying a home’s energy performance yet 33% of homes are missing one. The certificates were only launched in 2007 and did not become a legal requirement for landlords until the following year. Any lenders who offered a mortgage on properties before then, and still hold them, will be in the dark over their EPC rating. And the 10-year validity period means the first wave of EPC certificates will have now expired.

It’s well understood that there are gaps in energy efficiency on lenders’ back books.

EPC modelling of the SAP score and the rating can fill in these gaps where there is a missing valid EPC.

Accurately measuring and estimating energy efficiency of the portfolio is essential for understanding transition risk to energy efficient homes, the running costs of the property, retrofitting costs and exposure to carbon emissions.