Government aid is holding back the RMBS sector

11 January 2010

With the dawn of a new decade this is a good time to take a step back and look at the state of the wholesale mortgage funding markets and the outlook for this important sector.

After all, it is the closure of these markets that started the credit crunch which ultimately led to the nationalisation or semi-nationalisation of much of the UK banking sector.

It will only be when these markets get back to some semblance of normality that lenders will be able to shake off the shackles of government support schemes along with their associated problems.

The wholesale mortgage funding sector comprises two distinct markets with different investor bases - the securitisation market and the covered bond market. Both these provide sources of funding to banks by ring-fencing a pool of mortgage receivables to use as security.

Of the two,the securitisation market was the first to close and is also proving to be the slowest to rehabilitate.

But 2009 saw one of the biggest ever short-term rallies in stock prices. The FTSE 100 is up 53% since the lows of early March so it is unsurprising that the securitisation market is showing signs of life.

The last quarter of 2009 saw Lloyds Banking Group and Nationwide issue large deals. And the European market has shown signs of life, with a Dutch issuance from the Arena programme brought to market.

RMBS can be used for central bank funding at lower rates than those required by investors

AAA classes of UK residential mortgage-backed securities are costing issuers around 1.5% per year more than they did at the peak of the market.

This sounds expensive but mortgage rates have also increased dramatically during this period, partially offsetting the additional cost of funding.
For example, if we look at the two-year fixed mortgage rate published by the Bank of England, this was on average lower than the two-year swap rate during 2007 at 5.77% compared with 5.85%. This shows how dislocated the market had become.

During 2009 the two-year fixed mortgage rate averaged 2.25% more than the two-year swap rate - 4.3% compared with 2.06%. On this measure the increased cost of funding has been more than covered.

This is true across many European mortgage markets so why aren’t we seeing mortgage lenders racing to the securitisation market to help
fund an aggressive expansion of market share?

The truth is that lenders are using securitisation structures and retaining RMBS rather than selling to investors. The reason for this is that the RMBS they create through securitisations can be used for central bank funding programmes at far lower rates than those required by investors -mortgage lenders do not want to pay more than they have to.

So until the central bank drip is removed the RMBS market will continue to languish. And sadly, the days of non-conforming issuances remain a long way off.

The views and opinions expressed above reflect those of the author and do not necessarily reflect the views and opinions of Citadel Investment Group, L.L.C. or its affiliates.

 

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