Structured Finance 

Residential Mortgage 
UK 
Default Drivers Among UK
Special Report  Residential Mortgage Loans 
Analysts  Summary 
Atanasios Mitropoulos Fitch Ratings has carried out an extensive analysis of the key drivers of default risk
+44 20 7417 4317
atanasios.mitropoulos@fitchratings.com
among UK mortgage loans. The agency has assembled a unique loan‐level
performance dataset for mortgages originated in the UK to study the differences in
Alastair Bigley default likelihood between loans of varying characteristics such as borrower type
+44 20 7417 6278
alastair.bigley@fitchratings.com (eg self‐employment, adverse credit information, etc) and various different product
types (eg self‐certification, loan‐to‐value ratio, interest rate, buy‐to‐let, etc).
Gregg Kohansky
+44 20 7862 4091 This report provides a useful insight into the relative drivers of default among UK
gregg.kohansky@fitchratings.com 
mortgages in a distressed economic environment. This information is useful for
practitioners involved in credit risk management within retail banking and investors
Related Research in retail assets as well as central banks and financial regulators. While being most
· EMEA Residential Mortgage Loss Criteria relevant for the UK, the insights gained also provide a benchmark for mortgage
(February 2010)
assets in other countries for which data histories are not yet available to the same
· EMEA Residential Mortgage Loss Criteria
Addendum ‐ UK Prime and degree. The key findings can be summarised as follows:
UK Non‐Conforming (February 2010)
1. Most drivers of default for prime mortgages are also relevant for non‐
conforming mortgages (eg original loan‐to‐value ratio, debt‐to‐income ratio,
interest‐only loans and self‐employment).
2. An exception is the status of income documentation, as fast‐track mortgages in
the prime sector do not appear generically more risky than income‐verified
loans, while self‐certification mortgages in the non‐conforming sector invariably
turn out to be more risky than those originated with certified income. On these
grounds, it looks doubtful that fast‐track processing in UK prime lending is
generically comparable to self‐certification in the non‐conforming sector.
3. Drivers of repossessions are largely similar to drivers of arrears. However, some
variables (such as the debt‐to‐income ratio) have lower explanatory power on
repossessions while others have higher explanatory power (buy‐to‐let and right‐
to‐buy).
4. Adverse borrower information dominates any other risk factor. This is
consistent with the market convention to separate prime from non‐conforming
originations.
5. Despite the limited time span of the data history, some trends of risk indicators
over time can also be identified. For example, there is evidence of clear
problems with new‐build properties for the 2006 and 2007 vintages (which can
be attributed to a loosening of underwriting procedures) and an increasing
impact of self‐employment on defaults (which can be attributed to self‐
employed individuals being more vulnerable to general economic deterioration
compared to employees).
The results from this analysis have been taken into consideration in the update of
the UK residential mortgage default criteria, ie in particular, the foreclosure
frequency adjustments (please refer to the report “EMEA Residential Mortgage Loss
Criteria Addendum – UK Prime and UK Non‐Conforming”, 23 February 2010, for
more details). The analysis was used to assess the key drivers of foreclosure
frequency on a loan‐by‐loan basis and the size of their impact within Fitch’s
residential mortgage loss criteria. Both sources of information were then used to
determine the adjustments for loan and borrower characteristics that are applied
to the loan‐level base foreclosure frequency. Please note, however, that the overall
level of foreclosure frequencies is not addressed by this study. 

www.fitchratings.com 26 February 2010 


· Fitch combines
quantitative modelling and
qualitative analysis when
deriving foreclosure
frequency criteria
Default Drivers Among UK Residential Mortgage Loans
February 2010  2
Structured Finance
Most of the results from the analysis have confirmed the existing risk factors in the
UK default model. In some cases, the study has resulted in an increase in the size of
the adjustments (for example, an increase of the foreclosure frequency adjustment
for interest‐only loans and for self‐employed borrowers) or an introduction of a new
adjustment (for example, an additional adjustment by number of county court
judgements). The results from this analysis have been supplemented with
qualitative considerations regarding information insufficiently captured with
existing data (eg effects within debt‐consolidation products) and behaviour in yet
to be observed stress scenarios. Similar analyses are also carried out for other
jurisdictions to derive corresponding assumptions for residential mortgage defaults.
This report is based on the technical paper entitled “Relative Indicators of Default
Risk Among UK Residential Mortgages” by Rida Zaidi and Atanasios Mitropoulos
(2009). For more details on the methodology employed, the data selection, results
and a brief overview of findings from other countries, please refer to this technical
study, which can be downloaded from the Social Science Research Network. 
Implications for UK Residential Mortgage Loss Criteria 
Fitch uses a combination of both quantitative modelling and qualitative analysis
when deriving foreclosure frequency criteria in its default analysis. The results from
the analysis described in this study have been used in the recent update of the UK
residential mortgage loss criteria. They form an important element in the
identification of the key drivers of foreclosure frequency among mortgage loans.
The results also help to size the impact of various loan and borrower characteristics
on the foreclosure frequency. The results from this analysis are not directly
translated into Fitch’s criteria assumptions as they only provide insight into
historical dependencies between foreclosure frequency and certain risk
characteristics. These insights are interpreted in light of the agency’s experience
and understanding of the UK mortgage market and influence Fitch’s view of the
likelihood of foreclosure in an expected scenario and under stress scenarios.
Fitch makes use of qualitative considerations, particularly when the number of
observations or the quality of data appears insufficient to describe the actual risk
factors that are driving borrower behaviour. For example, the agency’s multivariate
analysis set out below shows loans extended for the purpose of remortgaging to be
more risky than loans extended for the purchase of a house. The reason for
remortgaging was unavailable in the data to specifically ascertain the driving factor
behind the results (for example, whether the borrower remortgaged to get a more
favourable interest rate or whether it was done to consolidate debt from several
loan obligations, such as an auto loan or outstanding amounts on credit cards).
A further investigation of the results in light of background information on
marketing and underwriting practices across lenders suggested that the remortgage
activity is not directly related to higher default risk. In fact, remortgaging is a
common phenomenon in the UK prime mortgage market, with borrowers shopping
for a better rate. Instead, it is remortgaging activity particularly related to debt
consolidation that is associated with higher risk. Fitch further reasons that equity
withdrawal via cash extraction is a viable product only in a rising housing market. In
future, remortgages are more likely to be for better financing options than for
lifestyle funding via equity withdrawal. Therefore, the agency does not generically
raise the foreclosure frequency of all remortgage loans. If there is a concern
regarding a lender’s treatment in relation to equity withdrawal, Fitch will consider
this on a transaction‐by‐transaction basis and size potential adjustments based on
the bespoke information received.
There are also cases where Fitch is aware of risks associated with particular loan
types but sufficient evidence has not yet been collected to confirm or refute
concerns with these loan types. Long‐term interest‐only loans are a relevant case in
point. Such loans are considered to have a greater likelihood of default due to the
risk that the borrower may be unable to make the large principal payment upon
 
 Structured Finance
maturity. This risk in interest‐only loans cannot be captured in the data analysis as
the data history is not long enough to cover loans that are close to maturity. In this
case, Fitch uses its theoretical expectations to assign a higher foreclosure
frequency to interest‐only loans for the balloon risk.
The section on results in this report highlights how the criteria have been
developed in light of the analytical results and where additional qualitative
considerations have been employed. 

· The database consists of
700,000 mortgage loans
drawn from Fitch‐rated UK
RMBS
Data and Summary Statistics 
Fitch has collected a unique dataset on over 700,000 mortgage loans drawn from UK
residential mortgage‐backed securities (RMBS) rated by the agency. Most of the
dataset relates to originations between 2004 and 2007 by a variety of UK lenders in
the prime and non‐conforming sectors. The data is representative of the overall
market, as it covers a wide spectrum of originators and shows a typical regional
distribution across the UK.
Coverage of Dataset
Tables 1A and 1B show the number of loans in the dataset by transaction for non‐
conforming and prime, respectively. For the non‐conforming sector, two separate
datasets are shown: first, where performance information was recorded in terms of
repossessions (repossession information) and, second, where performance
information was recorded by number of months in arrears (arrears information).
Most of the repossession information relates to loans that were repossessed in 2007
and 2008 (see Table 2). For the prime sector, only information on arrears was
considered.

Table 1A: Number of Loans by Transaction Series (Non‐Conforming)

Repossession information Arrears information
Bluestone 7,767 7,767
Eurosail ‐ 16,231
Leek 21,461 11,709
Ludgate ‐ 1,447
Mansard 3,271 1,935
Money Partners 10,062 ‐
RMAC 12,895 4,957
RMS 13,053 ‐
Total 68,509 44,046
Source: Fitch

Table 1B: Number of Loans by Transaction Series (Prime, Arrears

Information Only)
Arkle 314,874
Arran 1 25,316
Gracechurch 72,508
Granite 285,159
Total 697,857
Source: Fitch

Table 2: Number of Loans by Year of Repossession

Repossession year Number of loans Total (%)
2004 2 0.07
2005 92 3.39
2006 407 15.01
2007 977 36.03
2008 1,174 43.29
2009 60 2.21
Source: Fitch

Default Drivers Among UK Residential Mortgage Loans

February 2010  3 

· Two proxies for default
were examined:
repossession and having
been in arrears for more
than 90 days
· The dataset mainly covers
origination between 2004
and 2007 and tracks
performance up until
March 2009
Structured Finance
Measures of Default
Two measures of default are used in this study. The first measure proxies default by
indicating whether a loan has ever been in arrears for more than three months in its
life (henceforth referred to as 90ever). The second measure relates to actual
repossession. The use of the two default definitions combined also allows Fitch to
test whether the main drivers of repossessions are the same as those for the 90ever
status.
Information on both arrears and repossessions are available up until March 2009. As
arrears and repossessions have only begun to rise since Q3 2007, the data only
captures the first part of an economic downturn.
Chart 1 summarises the default rates: percentage of loans repossessed
(repossession rate) and percentage of loans that were in 90ever (arrears rate) by
origination vintage. As older vintages have had more time to go into repossession or
arrears, they have higher default rates as compared to more recent vintages. It is
worth noting that some of the differences are also specific to the transaction. For
example, for the prime data, the different vintages also have a different mix of
transactions with different loan‐to‐value and debt‐to‐income ratios, which may also
be driving the results. This will be controlled for in the multivariate analysis.

Chart 1: Default Rates

By origination vintage Non‐conforming repossession information (LHS)
Prime arrears information (LHS)
(%) (%) 
Non‐conforming arrears information (RHS)
repossessed (non‐conforming))

16 60
(Loans 90ever (prime)/

14 50

(non‐conforming))
12

(Loans 90ever
10 40
8 30
6 20
4
2 10
0 0
Missing Pre 2000 2000‐2002 2003 2004 2005 2006 2007

Source: Fitch

Descriptive Statistics on Key Risk Factors 
The key risk factors that are analysed in this study are set out below.

Original Loan‐to‐Value Ratio (OLTV)

Chart 2: Average OLTV

By origination vintage

(%) Pre 2000 2000‐2002 2003 2004 2005 2006 2007

100
80
60
40
20
0
Repossession information Arrears information Arrears information

Non‐conforming Prime

Source: Fitch

Recent literature on mortgage default drivers usually associates the OLTV with the
willingness to pay since the leverage of the borrower indicates the degree of
commitment to the investment. Between 2005 and 2007, UK lenders relaxed

Default Drivers Among UK Residential Mortgage Loans

February 2010  4 

· 14 key borrower and loan
characteristics have been
investigated
Default Drivers Among UK Residential Mortgage Loans
February 2010  5
Structured Finance
underwriting criteria to allow for increasingly high‐OLTV loans (ie loans with
particularly little equity by the borrower). This is evident also in the dataset with
average OLTVs having increased between 2000 and 2007 from around 70% to above
80% in the non‐conforming sector and from around 62% to 70% in the prime sector
(see Chart 2).1
Debt‐to‐Income Ratio (DTI)
A borrower’s ability to meet the monthly mortgage payment is dictated by the
relationship between their income and the monthly payment. There are two widely
used measures for the perceived affordability of a loan: the income multiple (IM)
and the debt‐to‐income ratio (DTI). The IM simply expresses the size of the loan
advance as a multiple of the borrower’s annual gross income. The DTI is viewed as a
more precise measure of affordability since it takes into account the debt payments
and net income. The average DTI has also shown small increases over time as
evident in Chart 3.
Chart 3: Average DTI
By origination vintage
(%) Pre 2000 2000‐2002 2003 2004 2005 2006 2007
50
40
30
20
10
0
Repossession information Arrears information Arrears information
Non‐conforming Prime
Source: Fitch
Loan and Borrower Characteristics
Tables 3 and 4 summarise key borrower and loan characteristics in the dataset.
While several more borrower and loan characteristics were considered, those
reported in these summary tables and in the list below are the ones that turned out
significant in one of the logistic regressions.
Key loan and borrower characteristics:
· self‐employed;
· self‐certification;
· fast track;
· interest‐only loan (owner‐occupied);
· interest‐only loan (buy‐to‐let — BTL);
· remortgage loan;
· right‐to‐buy (RTB);
· buy–to‐let (BTL);
· new‐build;
· adverse credit;
· county court judgement (CCJ);
· arrears in the last seven to 12 months before origination;
· arrears in the last zero to six months before origination; and
· bankruptcy or individual voluntary arrangement (IVA).
1
Weighted‐average LTVs are higher by 3‐5% but the overall trends are preserved. Fitch does not
report weighted‐average LTVs because the multivariate regressions are numbers‐based and
weight each observation equally
 
 Structured Finance
Other variables tested included second‐charge loans and first‐time buyers, among others.

Table 3: Distribution of Loan Characteristics

Non‐conforming Prime
Repossession Arrears Arrears information
Characteristic information (%) information (%) (%)
Self‐employed 31.3 39.1 10.8
Self‐certification 59.8 61.4 ‐
Fast track ‐ ‐ 16.5
Interest only 50.4 50.3 26.4
(owner‐occupied)
Interest only (BTL) 89.5 90.8 0.0
Remortgage loans 59.3 57.2 39.2
Right‐to‐buy 6.6 18.9 0.0
Buy‐to‐let 6.6 6.5 0.0
New‐builds 7.1 6.1 8.8
Source: Fitch

Table 4: Adverse Credit Characteristics in Non‐Conforming Sector

Repossession information (%) Arrears information (%)
Adverse credit 26.1 42.0
Country court judgement (CCJ) 18.0 28.7
Arrears in the last seven to 12 months
before origination 7.2 7.9
Arrears in the last zero to six months
before origination 6.0 5.9
Bankruptcy or individual voluntary
arrangement (IVA) 1.5 2.2
Source: Fitch 

Multivariate Results 
Both a univariate analysis and a multivariate regression were carried out, using the
default indicators and loan and borrower characteristics as introduced in the previous
sub‐section. The univariate analysis helps to gauge the potential predictive power of
single risk factors, but does not control for the influence of other factors
simultaneously. The multivariate regression is a more sophisticated technique as it
allows one to consider the simultaneous interaction of the risk factors. For these
reasons, only the multivariate analysis results are reported here. For details on the
univariate analysis, please refer to the technical study by Zaidi and Mitropoulos (2009).
Methodological Remarks
The following logistic model is estimated to predict the factors driving probability
· A logistic regression was of default of a mortgage loan:
applied
Pr(Default)= 1/(1+exp(‐bx)) (1)
Whereby b is the vector of coefficients to be estimated and x is the vector of risk
factors, ie borrower characteristics, loan characteristics and control variables such
as dummy variables for the originators. The disturbance term follows a logistic
distribution with a fixed variance.
Regressions have been performed on both the 90ever indicator and the indicator for
repossession. All key variables listed in the section entitled Loan and Borrower
Characteristics were used in a series of regressions, taking into account the limited
availability of some factors for certain transactions.
Interaction effects were also introduced to determine any risk‐layering in different
product and borrower types. A number of interactions were tested, including
various combinations between high OLTVs, self‐certified, self‐employed, adverse
credit, remortgaging and interest‐only loans.

Default Drivers Among UK Residential Mortgage Loans

February 2010  6 
 Structured Finance
Results
The regression results are summarised in Charts 4 to 6.

Chart 4: Multivariate Regression Results

Non‐conforming repossession information

(%) 2005 2006 2007 All vintages

300
250
200
150
100
50
0
OLTV DTI New build Adverse Remortgage RTB BTL Self Adverse Interest
credit certified credit * self only
certified
Source: Fitch

Chart 4 shows, vintage‐by‐vintage, the percentage change in probability of

repossession in the presence of particular borrower and loan characteristics. The
effects for OLTV and DTI measure the effect of a 10% increase in OLTV/DTI on the
probability of repossession. Vintages where the variables were not statistically
significant do not show any bars. Chart 5 shows the impact of the risk factors on the
probability of arrears among non‐conforming loans. Chart 6 shows the impact of the
risk factors on the probability of arrears among prime loans.

Chart 5: Multivariate Regression Results

Non‐conforming arrears information

(%) 2005 2006 2007 All vintages

100
80
60
40
20
0
OLTV DTI New build Adverse Remortgage Adverse Self Adverse Self Interest
credit credit * certified credit * self employed only
remortgage certified
Source: Fitch

· Most Drivers of Default for
Prime are Also Relevant
for Non‐Conforming
Most Drivers of Default for Prime are Also Relevant for Non‐Conforming
The regression results suggest that — aside from adverse credit information (such as
CCJs, bankruptcy orders, IVAs or prior arrears) that characterise the subprime
segment — there are very similar drivers of default in both sectors. High‐OLTV loans,
interest‐only loans and remortgages are defaulting significantly more often than
average for both prime and non‐conforming.

Fitch’s analysis finds a larger loan‐level impact of OLTV on arrears and

repossessions compared to the DTI ratio for both non‐conforming and prime loans.
The smaller impact of DTI may be related to the low interest‐rate environment that
has been prevalent in recent years. The agency expects that an increase in interest
rates in the future would further strengthen the relationship between DTI and
default. For these reasons, Fitch continues to consider DTI as an important driver of
defaults and considered borrower affordability when assessing the foreclosure
frequency.

Default Drivers Among UK Residential Mortgage Loans

February 2010  7 

· Drivers of Repossessions
are Similar to Drivers of
Arrears
· Some Variables Have a
Different Effect on
Likelihood of Repossession
Than on Arrears
· Adverse Borrower
Characteristics Dominate
Any Other Borrower or
Product Characteristics
Default Drivers Among UK Residential Mortgage Loans
February 2010  8
Structured Finance
Drivers of Repossessions are Similar to Drivers of Arrears
Comparing Charts 4 and 5, it is evident that among non‐conforming loans the same
borrower and loan characteristics that influence arrears are also important in
influencing repossessions.
Two additional products in the non‐conforming market, however, appear to be
significant risk indictors for repossessions, but not so for arrears: loans made under
the right‐to‐buy (RTB) scheme and buy‐to‐let (BTL) mortgages. While RTB and BTL
loans do not necessarily have higher arrears compared to non‐RTB and owner‐
occupied loans, respectively, the likelihood for these loans to enter repossession is
much higher. For BTL loans, this means that among two borrowers who have been
unable to manage their personal finances in the past, those who are then trying to
engage as property investors are less likely to prevent repossession compared to
those who purchased the house they are living in.
The results on RTB loans are likely to reflect the functioning of the government
scheme. Council tenants have the opportunity to purchase their own homes through
the UK government’s scheme. This gives tenants the right of first refusal to
purchase the home that they are renting from their local authority at a discount to
the effective open market value. Should the property be re‐sold within five years,
the purchaser is liable to repay a portion of the discount, relative to the length of
time since the property that was bought. Seasoned RTB loans of more than five
years hence benefit from the discount on the property value, which allows them to
sell the property and repay all outstanding liabilities.
More recent originations, however, do not have this option since they are still
exposed to the liability against the local authority. Given the house price decline
over recent years, it is thus likely that those borrowers are less likely to recoup all
their liabilities from selling the property. Moreover, the best houses were bought
early on when the scheme was first introduced nearly 20 years ago. Arguably what
is left and more importantly what is reflected in Fitch’s dataset, are a portion of
the least desirable housing stock. This might make incentives to sell the house to
clear arrears higher as there may be a larger forced sale discount for this type of
property.2
These findings confirm the need to raise the foreclosure frequency on RTB and BTL
loans relative to non‐RTB and owner‐occupied loans. Within Fitch’s criteria, the
increasing concerns surrounding BTL loans, in conjunction with the rising arrears
and the regression results, have resulted in an increase in the adjustment for BTL
loans in the non‐conforming sector.
Some Variables Have a Different Effect on Likelihood of Repossession Than on
Arrears
In terms of economic magnitude of the drivers, there is a slightly stronger influence
of OLTV in the regression on repossessions relative to the likelihood of long‐term
arrears. The results show that not only are high‐OLTV loans (ie little equity in the
property) more likely to fall into arrears compared to lower OLTV loans, once they
are in arrears they are also more likely to be repossessed. This is reflected in
Fitch’s base foreclosure frequency matrix where high OLTV loans are assigned a
substantially higher foreclosure frequency compared to loans with typical OLTVs.
Adverse Borrower Characteristics Dominate Any Other Borrower or Product
Characteristics
The indicator for adverse credit history for a borrower is highly significant for both
arrears and repossessions among non‐conforming loans. Fitch’s foreclosure
frequency adjustments for adverse credit loans are in line with its existing
assumptions. The results also show that the number of CCJs is a more significant
2
Note that these results only relate to non‐prime lending. Fitch’s database does not contain RTB
and BTL loans in the prime sector so no comparison between the two sectors can be performed
 

· Self‐certified loans,
interest‐only loans and
remortgaging loans appear
more risky than standard
loans; the latter is likely
to be driven by debt‐
consolidations
· Fast‐track loans and loans
to first‐time buyers do not
appear more risky than
average after controlling
for other characteristics
Default Drivers Among UK Residential Mortgage Loans
February 2010  9
Structured Finance
driver of defaults than the value of CCJs. Consequently, Fitch will apply foreclosure
frequency adjustments to loans on the basis of the number of satisfied and
unsatisfied CCJs.
A Summary of Additional Findings
Self‐Certified Loans
The results show that there is a higher probability of arrears and repossession for
self‐certified loans. The magnitude of this impact is also in line with the
assumptions in Fitch’s UK default model criteria. There is also some evidence of risk
layering, whereby other borrower and loan characteristics when combined with an
impaired credit history leads to a further increase in the likelihood of default. The
effect of self‐certification and adverse credit history combined was larger than the
combination of the two separate effects. The magnitude of the interaction effect is
relatively small and therefore no additional adjustment is proposed for this risk
layering in the criteria.
Fast‐Track Loans
The evidence from Fitch’s regression analysis also shows that, in most cases, UK
fast‐track loans have a lower probability of default compared to fully income‐
verified loans. As this evidence is not consistent across all lenders and the economic
magnitude of this effect is small, Fitch will consider the treatment of fast‐track
loans on a transaction‐by‐transaction basis and based on the lenders’ origination
and servicing practices.
Interest‐Only Loans
The effect on a relative basis of interest‐only loans varies across prime and non‐
conforming regressions but is in the order of between 7% and 30%. There are two
types of risk associated with interest‐only loans: (i) borrowers select interest‐only
mortgages due to affordability constraints and hence have a higher likelihood of
default; (ii) the borrower is unable to make the large principal payment upon
maturity. The regression only accounts for the former effect because the dataset
does not span a long enough time to allow for observations of interest‐only loans
that have reached maturity.
However, Fitch accounts for both these effects when deriving its assumptions for
the foreclosure frequency adjustment of interest‐only loans. Based on the
regression results, the agency assigns a new product hit of 10% to interest‐only
loans and retains the additional 10%‐30% balloon payment hit based on the
remaining term to maturity of the loan.
First‐Time Buyers
Finally, first‐time buyers do not have significantly different probabilities of default
when all other factors are controlled for. Any difference in overall default
probability between first‐time buyers and those who are moving house can be
explained by other factors, eg differences in the OLTV.
Remortgaging
Fitch’s regressions show that remortgage loans have a higher probability of default
than loans extended for property purchase. This was explored in more detail in the
technical paper by Zaidi and Mitropoulos (2009). The analysis suggests that the
significant coefficient is actually functioning not only as an indicator for ordinary
remortgaging but also as a proxy for debt consolidation. Borrowers may withdraw
equity from their home to consolidate (and repay) debts that they have built up.
But since debt consolidation is rarely recorded as the motivation for remortgaging,
it is difficult to clearly distinguish between debt consolidation and standard
remortgaging. There was also some evidence of risk layering between those
borrowers remortgaging and adverse credit history. While this coefficient was not
robust across all vintages, it does suggest that remortgaging may have been used
during these periods of house price rises (by all borrowers, but particularly adverse
 

· Self‐employed borrowers
and new build properties
show distinct trends over
time
Default Drivers Among UK Residential Mortgage Loans
February 2010  10
Structured Finance
credit borrowers) to refinance out of financial difficulties. On the basis of these
results, Fitch has increased the foreclosure frequency adjustment for remortgage
loans in the non‐conforming sector.
For prime loans, Fitch did not have information available on remortgages for all
transactions under analysis. A separate analysis using fewer transactions supports
the finding that remortgage loans have a higher probability of default. However,
the agency lacks data on debt consolidation to verify the ultimate drivers of this
effect. However, Fitch is also aware that equity withdrawal for cash is a product of
a rising housing market or where people have actually been repaying capital. In the
future, remortgages are more likely to be for better financing options than for
lifestyle funding via equity withdrawal. Therefore, instead of applying a backward‐
looking adjustment to all remortgage loans, Fitch will consider, on a transaction–by‐
transaction basis, a treatment for remortgage loans.
Trends Over Time Mostly Mild and as Expected
Self‐Employed Borrowers
The regressions on prime loans confirm that self‐employed borrowers are more
vulnerable to economic decline than employees as their income is more directly
related to the economic environment. The coefficient has grown between 2004 and
2007 vintages. Fitch has therefore raised the foreclosure frequency adjustment
applied for loans made to self‐employed borrowers.
New‐Build Properties
The most striking trend can be observed with respect to new‐build properties. Loans
secured on new‐build properties appear significantly more risky than loans on older
properties. This is visible, however, only for the 2006 and 2007 vintages; the former
only for repossessions. The results indicate — as was recognised in the aftermath of the
boom phase prior to the recent economic crisis — that mis‐incentives for this product
were not prevalent during 2005 but grew tremendously in the subsequent years.
However, it is expected that this has been reversed with the onset of the economic
crisis and the subsequent significant tightening of underwriting criteria across all UK
lenders. Therefore, Fitch will consider the under‐valuation of new‐build properties
(from 2006‐2007 vintages) on a transaction‐by‐transaction basis and based on lenders’
origination and servicing practices. 
Summary of Findings and Concluding Remarks 
Fitch’s study broadly confirms many conventional assumptions on the relative
indicators of default risk of UK mortgage loans. In particular, the agency find’s that
some risk factors commonly viewed as most important for the risk assessment are
indeed reliable predictors of relative risk for both the prime and the non‐
conforming sectors, in particular, the original loan‐to‐value ratio and to some
degree the debt‐to‐income ratio. Fitch also finds that the separation into prime and
subprime lending can be justified on the grounds that adverse credit information is
a major predictor of default. Otherwise, standard indicators of relative risk, such as
interest‐only loans, self‐certification and self‐employment, can be confirmed in this
study. The report does not confirm that waiving the income verification as done for
fast‐track mortgages in the prime sector is similarly detrimental as the option of
self‐certification in the non‐conforming sector.
In addition, this report is able to show that most risk factors are robust to the
default definition, ie there is no significant difference between the results on
90ever delinquencies and repossessions. This is helpful for future research as
delinquency data are more abundant and useful as leading indicators compared to
repossessions, which are recorded only with several months delay. A few exceptions
to this are the limited explanatory power of the debt‐to‐income ratio and the
strong positive significance of the indicators for buy‐to‐let and right‐to‐buy
mortgages in the repossession data.
 
 Structured Finance
Finally, despite the limited time span of the data history, this study can also
identify some trends of risk indicators over time. For example, there was an
adverse trend with loans secured by new‐build properties towards the 2006 and
2007 vintages, which can be attributed to a loosening of underwriting procedures at
the time. Finally, the analysis also identifies over time an increasing impact of self‐
employment on defaults, which can be explained with a higher income sensitivity of
self‐employed borrowers to the general economic environment compared to
employees.

Comparison to Other Countries

· There are no major
divergences between
countries despite the
heterogeneity in
regulatory framework,
market practices and
cultural background
While the focus of this report is on the UK mortgage market, it is useful to compare
the drivers of default identified in this study with experiences made in other
countries.
Table 5 summarises these key findings (using logistic regression analysis) with
respect to the predictors of default across various European countries and the US.
The results from internal Fitch studies were pooled and analysed using similar
techniques as this study and a US‐based study by Demyanyk and Hemert (2009),
“Understanding the subprime mortgage crisis”, a forthcoming study in the Review
of Financial Studies. There are no major divergences between the findings for the
countries despite the heterogeneity in regulatory framework, market practices and
cultural background. The two most important drivers across all countries are
household equity and ability to pay. The key differences arise in terms of the
effects of the various products and loan characteristics that differ across countries.

Potential Future Enhancements

One extension of this study would be to replicate the analysis once data is available
over a longer time horizon, covering the full extent of the recession in the UK. This
would allow for insights into default timing by borrower and product type as well as
the study of borrower behaviour throughout a business cycle at a loan level.
As mortgage credit risk is driven equally by loss severities as it is driven by default
rates, a study on determinants of loss severities would provide a useful complement
to this study. Such an analysis based on a similarly composed pool of data on
defaulted mortgage loans in the UK is underway.

Table 5: Cross‐Country Comparison of Default Drivers

UK US Portugal Netherlands Greece Germany
OLTV  ↑  ↑  ↑  ↑  ↑  ↑ 
DTI  ↑  ↑  ↑  ↑  n.a.  ↑ 
Interest only  ↑  ↑  ↑  n.a. n.a.  ↑ 
Remortgage  ↑  ↑  n.a. n.a.  ↑  n.a.
Buy‐to‐let  ↑  ↑  n.a. n.a. n.a.  ↑ 
Second home  ↑  ↑  n.a. n.a. n.a.
Self‐employed n.a. n.s.  ↑  ↑  ↑  ↑ 
Self‐certified  ↑  ↑  n.a. n.a. n.a. n.a.
Variable‐rate n.s.  ↑  ↑  ↑  n.a. (all loans n.a.
loans variable rate)
Fixed‐rate loans n.s. (very few ↓  ↓  ↓  n.a.  ↓ 
long‐term fixed‐
rate loans) 
Adverse credit  ↑  ↑  n.a. n.a. n.a. n.a.
Flat  ↑  ↓ (condominium) n.a. n.s. n.s.  ↓ 
n.a. Data not available or the field was not relevant to the particular country
n.s. Variable was not statistically significant at 10% or below 
↑ Where the variable increases the probability of default 
↓ Where the variable decreases the probability of default
Source: Fitch

Default Drivers Among UK Residential Mortgage Loans

February 2010 11 
 Structured Finance

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Default Drivers Among UK Residential Mortgage Loans

February 2010  12