Bank of England warning on Debt

With UK property prices cooling I would expect P2P lenders to ensure that valuations are realistic in a falling market. London prices are down on a year ago & are set to fall another 1% this year. PCP's have fuelled the car market & the BoE are right to be concerned. Let's just hope that the warning has been noted by P2P lenders rushing in to lend money!

IMHO, the Bank of England's warnings about too much debt would be more credible if they raised interest rates and started to unwind quantitive easing.

We do have a view on this yes. The difficulty the bank faces is that they can't really raise base rates generally to reduce credit demand yet some parts of the economy, more and more over time, are overheating somewhat. So the bank many years ago suggested it would take a tactical approach rather than use the blunt tool of base rates. Hence (joint with Government) attacks on BTL, somewhat overdone in my view, the recent warnings that a crackdown is coming in consumer debt, much needed in our view, regulatory driven downward pressures on riskier mortgage lending, high PRA capital requirements for SME lending to ensure it doesnt get priced in high volume like consumer debt at 3% etc etc. These tactics will get widened in our view before we see any measurable base rate increases and yet they will have a cooling effect on new lending in sectors that are overheating as a result of low base rates in a similar way to raising rates but without causing over indebted borrowers who have overdosed on cheap loans then going bust through rate rises - consumers or businesses.

In essence this means that perhaps using interest rates as the way to control credit flow and hence inflation  is perhaps very last-millennium. Tactical control credit creation (and let's face it banks do 90%+ of that in the UK) by regulation and legislation is one of the new ways they intend to control inflation I suspect. 

So base rates are likely to stay low for a long/very long time still, they can't be raised much because people have got used to the new low and raising them would bust people/ businesses, QE just left to naturally expire over the medium term rather than short term bond sales and of course the next cycle timing being pushed back and back (and possibly skipping a whole cycle) by low base rates and tactical rather than blunt measures - this is the new paradigm this time around I feel.

Does this mean no risk ? Not at all. The opposite as indeed the bank suggests given the overheating in more than a few sectors is now being reined back in a little. So we remain even more cautious on London and the SE from a house price security perspective (some lenders are 80%+ exposed to this geography), we are mindful of residential development needing to ideally have yield support if the music stops for a bit (meaning rents should ideally pay the loan coupon during a potential pause in the housing sales market), we remain cautious on trading businesses' ability to pay their interest and capital repayments, we continue to move up the credit quality curve to weather a potential difficult period better (and as a result you have seen some reduction in lender loan interest rates as a consequence of this caution and an increasing focus on better quality borrowers) and other tactics and strategies that we won't go into here.

Our provision fund has always been predicated on future worst case stress test BOE scenarios rather than assuming these current top of cycle benign conditions continue. This is aimed to have a substantial 3x loss coverage in today's conditions, not just 1x as some aim to provide, as we are in benign conditions and we intend to still ideally cover all loan losses in the worst BOE projections. This is a statistical analysis of course and things can conspire to frustrate the best laid plans but we consider ourselves to be at the more cautious / sensible end of the spectrum and intend to remain so.

Hope this helps.

Thanks. If you wanted to sum up our strategic aim in one word it is sustainability - to perform well through the next cycle and prosper afterwards - that's our lenders, shareholders, staff and indeed borrowers. Simple as that and with all that requires (not so simple clearly!)

I fail to see how would raising interest rates or doing reverse QE solves the structural problem?

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This chart (from the OBR see link, page 77) shows the structural issue in the UK's sectoral balances. It's not "economic theory", its basic conservation of cashflows: the total must add up to zero. Above zero, the sector is saving/investing and if it's below zero it's getting further into debt. We've been running a worsening current account deficit so, given the balance of payments has to be zero, we have a capital account surplus. The "Rest of World" has been saving/investing/buying assets in the UK at an increasing rate since 2009. Corporates have typically not wanted to do capex given low growth expectations, so they are also saving, primarily buying back their stock. This leaves the government and households in deficit. When the UK fiscally stimulated post GFC in 2009, this did temporarily allow households to save (mainly by paying down debt). Once the government reversed that policy then there was simply no choice but for households to go back into more debt (given that corps and foreigners were saving). You can see how the two lines for govt and households are almost mirror images.

Now the current account will improve from here given cyclical issues, say to 3-4% but to improve beyond that is hard. We have poor productivity vs. Europe, US, EM markets. We've devalued the currency and this has had no real impact on exports. So the positive capital account will probably become a bit less positive but it's not going negative. So with a positive capital account surplus, someone has to be getting more into debt. The question is whether it's the government, households or corporates. The government made the decision that households should get into more debt.

Central banks are not there to solve structural issues. Monetary policy is a short-term instrument (18-24 month effective horizon). So the BoE kitchen sinked it post GFC with the tools that they had: monetary policy at the zero bound and doing £400bn+ of QE. The transmission channel, however, is pretty ineffective; it mainly raises asset prices rather than going into the real economy. Now Brexit caused an easing of financial conditions last year due to a weaker currency, lower Gilt yields and tighter corporate spreads. It's arguable they could tighten modestly to offset that. But any substantial tightening would risk a stronger currency (and attract foreign capital, so more saving in the wrong place). It would also raise gilt yields, widen corp spreads; making corps even less inclined to invest given higher debt costs (so again more saving in the wrong place). Obviously it would risk a rise in household and SME defaults, risking a downturn. Macro-prudential measures are probably a better channel to control lending than direct policy tightening or reverse QE.

Tony , stuartassetzcapital , any objections if I move this to General P2x Discussion?  I realise that it was posted in the AC forum, and that we've had interesting commentary from AC staff, but the questioning and subsequent discussion is applicable more widely.........

No objection from me.