Could a falling property market destroy these two banks?

Barclays Bank branch

The housing market has held steady since Brexit but at today's inflated prices, property still remains vulnerable to a correction.

The latest Halifax house price index shows prices fell 0.1% in the three months to 30 September. This could be a seasonal blip but it could be a warning sign of trouble ahead. If it's the latter, UK banks such as Barclays(LSE: BARC) and Royal Bank of Scotland(LSE: RBS) could take yet another hit.

On the slide

The housing market has actually been on a steady downward trend over the past six months, says Halifax housing economist Martin Ellis, with activity softening and house-price inflation easing. Annual house price growth peaked at 10% in March, but six months later has fallen to 5.8%.

The referendum isn't the only culprit here. Ellis says a lengthy period where house prices have risen more rapidly than earnings has put pressure on affordability and hit demand, although he adds that the property shortage and low rates should help support prices.

Wobbles ahead

However, mortgage rates can't go much lower, and buyers are reluctant to take on large amounts of debt even if money is cheap. If business investment falls and job losses rise after Prime Minister Theresa May triggers Article 50, we could see more intense market wobbles.

Low interest rates are bad news for Barclays and Royal Bank of Scotland because it squeezes their net interest margins, (the difference between the rate at which banks borrow and lend money). Bank of England governor Mark Carney is reportedly ready to cut base rates to 0.1% this year but I fear it will do more harm than good. What the UK doesn't need is more debt and even higher house prices, which would worsen the fallout when the crash ultimately comes.

The big squeeze

This morning Barclays reduced rates across its residential, large loan and buy-to-let mortgage products, in a belated response to August's rate cut. The mortgage price war, like the grocery price war, is likely to prove a further drain on bank balances. With savings rates at rock bottom lows, and some cash ISAs paying as little as 0.01%, banks have little scope to boost profits by further squeezing interest rates on deposits.

Falling UK retail profits will become a relatively bigger problem for Barclays as chief executive Jes Staley continues with his task of shrinking the bank to just two operations: UK retail and small business; and international, investment banking and cards. That's especially problematic since much of Barclays' lending is focused on London and the South East, which may be most vulnerable to a post-Brexit correction.

Poor health

A house price correction is also the last thing that RBS needs after posting a quarterly loss of £695m and facing a host of other problems, including a potential multibillion dollar US fine, the delayed sale of Williams & Glyn, and now new allegations that it deliberately destroyed businesses in order to boost its own revenues. Again, RBS is looking to focus primarily on the UK domestic market, so it needs that market to be healthy.

Negative equity, rising arrears and repossessions could all follow a housing market dip. Even a fall in transaction levels will cause some pain, reducing demand for mortgages and cross selling opportunities such as insurance. As if Barclays and RBS don't already have enough problems.

Brexit has been fantastic news for the FTSE 100 so far, with the index flying high since the referendum. Still, it's early days and if Britain does slide into recession the turbulence will return with a vengeance.

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Harvey Jones has no position in any shares mentioned. The Motley Fool UK has recommended Barclays. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

10 property hotspots
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10 property hotspots

In Scotland, Edinburgh is seen as a city with huge growth potential. In 2014, prices in Edinburgh were up 10% in a post referendum boom that shows little sign of slowing down.

Local agents are not expecting quite such stellar growth for the next 12 months, but they think price rises will be well above the average predicted for the whole country.

Rightmove named this as the area where it expects house prices to grow the most over the next five years. It says that over this period there will be a huge number of people moving out of London in order to afford to get onto the property ladder. They want a reasonable commute combined with plenty of attractions in the local area, and Southampton offers all this. With relatively affordable housing stock, it's a prime candidate for growth.

Luton was Rightmove's candidate for the second biggest house price rises over the next five years. It emphasised that this isn't a mater of opinion, it is the result of crunching the data.

Luton is another major beneficiary of the move out of London, and while it is arguably not as attractive a place to live as Southampton, it's only 23 minutes into central London - which rivals some of inner London's commuter times. With average prices of £179,368, it's clearly a far more affordable option, and the area has already started to show signs of a boom.

This was the third area suggested by Rightmove. As with Southampton, it is well positioned for London commuters, and also has huge local attractions.

A survey last year asked young professionals to name the place they would most like to live, and Brighton and Hove were the only areas that appeared on the list outside London.

One of the reasons it's not higher up the list is that houses are already on the pricey side, with an average cost of £338,956 - up 13% in the past year alone.

There may be few people who grow up with the dream of living in Swindon, but the electrification of the rail line to London will bring travel times down across the West Country, so Swindon becomes part of the outer commuter area.

Given that the average property costs £168, 968, it's easy to see why Swindon will be a popular option for commuters on a tight budget.

Bath is also going to benefit from electrification of the line, because the commute to London will fall to a manageable 70 minutes. The beauty of the city - along with a vibrant social and cultural life - makes it a clear choice for more long-distance commuters.

Of course, with an average asking price of £374,617, it's not a tremendously cheap place to buy, but the geography of the city restricts development, so these prices are expected to rise still further.

Property Frontiers says that the booming house prices in Oxford are set to get even higher. At the moment, travel to London takes 60 minutes, but this will reduce even further in 2016 when the line is electrified. Prices in the most desirable parts of the centre aren't much cheaper than London.

However, further out there are pockets of affordability, and when the Water Eaton station opens in 2015 it will open up areas to the north of the city too.

Manchester has seen enormous property price rises over the last couple of years, and Property Frontiers expects this to continue into 2015.

Other commentators are expecting the growth to slow over the next few years, especially given the gains made since 2012. However, demand for properties remains buoyant, and with the growth of the local economy, price rises seem inevitable.

Rising prices in London have pushed buyers further and further out of the centre, so estate agents are now claiming zone three as 'the new zone 2'.

Savills believes that the biggest gains over the next five years will be the less glamorous districts - putting the South and East in the frame. Gritty areas that could benefit include Ladywell, Streatham and Catford in the south, and Leytonstone, Forest Gate and Walthamstow in the east.

Cambridge could also perform well. It has already had house prices lifted by the growth of tech companies to the north of the city, and the arrival of pharmaceutical headquarters will help push prices up further.

In 2016 a new rail service from the city to the science park will keep prices rising, and beyond the opportunities presented by the local economy, Cambridge is also part of the 'outer commute' area of London, which Savills expects to shoot up in value over the next five years.


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