Could a falling property market destroy these two banks?

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.