Safe as houses

28 November 2011 | By Samuel Dale

The uncertainty sweeping global markets is palpable as the eurozone crisis threatens to cripple massive economies. Greece, Portugal and Ireland have succumbed to bailouts after public borrowing costs hit unsustainable levels, while Italy stands on the brink and Spain and France are threatened with contagion.

Massive deleveraging across the western world is threatening growth and its ability to repay debts, while governments and the European Central Bank are refusing to intervene in a meaningful way.

European and UK banks are being threatened by their exposure to sovereign debt and faith in inter-bank lending is being undermined. In response, LIBOR has rocketed in the last few months - at the time of writing it had hit 1.03%, up from 0.83% in July. On top of this the unsecured markets have seen confidence plummet.

But there is a silver lining as the lack of faith in unsecured lending is leading to a flight of investors into secured bonds. The impression of investors is that governments would not bail out banks again and that regulatory changes will affect them.

Rob Thomas, senior policy manager at the Council of Mortgage Lenders, says the unsecured market is suffering because of a perception that the government will not act in a crisis.

“We live in strange times and some of the interest in RMBS is being driven by regulatory changes and shifts in the government’s desire to bail out banks,” he says. “It is an area of relative safety in a world of uncertainty. RMBS have rarely looked as relatively attractive as they do today. The cost of the senior unsecured debt market has increased rapidly over the last two or three months.

“So if you are looking to buy paper then any bond issue secured against an asset is relatively more attractive now. I don’t see what would reverse the trend for the time being as it is being driven by a perception of when the government would act and regulatory changes.”

Emma Matebalavu, partner at Clifford Chance, says the economic uncertainty caused by the European sovereign crisis is making the capital markets volatile and discouraging issuances.

“But the asset-backed and secured bonds appear to be more resilient than other types of unsecured corporate bonds,” she says. “On this basis, I would agree that bonds backed by high quality mortgage collateral do look appealing, although this will vary by jurisdiction, so investors will not be attracted by southern European RMBS.”

Tony Ward, chief executive of Home Funding, says the eurozone crisis and bank deleveraging means markets will remain jittery for some time to come.

“With banks contracting their balance sheets to bolster capital you might think this is bad news for mortgage lending and banks investing in RMBS,” he says.

But it isn’t - mortgages are secured loans and benefit from lower risk weightings. So do RMBS and covered bond AAA tranches when held as investments by banks, hence they are relatively attractive to banks.

“Solvency II, the insurers’ equivalent of bankers’ Basel concordat, also benefits insurers that invest in property-related assets. In a world of volatile markets and risks, UK residential mortgage lending and their risks, once repackaged into AAA RMBS/covered bond programmes, look attractive and high yielding. Good news for us all, maybe.”

Another factor has been the solid performance of UK RMBS, especially prime bonds, which made cumulative losses of just 0.21% in August, according to Moody’s recent Credit Insight report. The number has actually increased by 50% on last year and explains why the door to funding markets for the big banks has been ajar since 2009.

The cumulative losses of buy-to-let were just 0.45% out of €36.9bn of outstanding balances.

This autumn has seen a flurry of securitisations that began to gather pace earlier in 2011 - a clear sign that the appetite for deals is growing. Lloyds Banking Group, Santander, Nationwide and the Royal Bank of Scotland have all issued multi-billion pound bonds in the last few months totalling more than £10bn.

But they have been active since 2010, occasionally issuing prime deals but, significantly, Barclays has launched its first deal since the crunch.

Building societies are getting in on the act as well, with Principality launching its first ever deal in August worth £668m. Yorkshire launched its first RMBS deal in June worth £750m, followed by the Co-operative Group’s second deal valued at £871.5m.

And just last month, Paragon Mortgages issued the first solely buy-to-let securitisation since 2007, albeit only £150m.

Clydesdale and Yorkshire banks also issued an £829m securitisation backed by some buy-to-let deals while Kensington issued another specialist securitisation of £204m. This is a major increase on the number of deals launched over the same period in 2010 and there were even fewer in 2009.

Matebalavu believes the issuance from specialist lenders is a significant step in the right direction for securitisation.
“The recent issuances from specialist mortgage lenders are definitely a positive sign as it indicates that wholesale markets are now open to lenders outside the main large commercial banks and building societies,” she says.

“I am not aware of any sizeable market for lower rated tranches below AAA, although the AA class has been publicly placed on some deals.”
Thomas believes the specialist deals are important and sees no problem with solely buy-to-let deals.

“The Paragon deal is significant because it is the first solely buy-to-let deal since before the crunch,” he says. “I can’t see why investors would have any difficulty investing in it because the quality of the loans is high with low arrears.”

Thomas says that despite the regulator and the government adopting an anti-securitisation stance in the wake of the crisis, the government’s reluctance to bail out banks and increased regulation have thrust many investors into the arms of RMBS.

“It is one of the great ironies that regulators and government, who were so opposed to securitisation, are now encouraging it through their actions,” says Thomas. “It is an example of unintended consequences.”

But the shift doesn’t necessarily spell good news for mortgage funding as the overall picture of bank funding remains gloomy.

“The big difference is the difficulty banks have in funding themselves in the unsecured funding markets,” he says. “The RMBS market hasn’t got cheaper but unsecured funding has gone up in price. The average funding costs of banks haven’t improved so it is not good news for the mortgage market.

“The costs are still high, though, with Paragon’s recent deal 2.75% above LIBOR, whereas pre-crunch levels could be just 0.5% above. But it suggests the market is open to players that were not open in the last few years. For the bigger issuers they have been back in the market since 2009 so the current situation is just a continuation of what they have been doing.”

Gary Styles, director of Hometrack, agrees that the overall funding position remains the same so the impact on mortgage funding could be small.

“I wouldn’t necessarily see it as a welcome sign for mortgage funding,” he says. “The ideal scenario is to have a diverse source of funding that includes retail deposits with long and short-term wholesale funding. It has always been the case that being limited in one or two sources of funding has been tough.”

This is as true for those smaller societies that are solely reliant on retail deposits as it is for those banks that pre-crisis were wholly dependent on the wholesale funding markets.

But Styles adds that there have been more securitisations recently and improved retail deposits in the last few months.

Thomas says the situation is better than 2008 when markets closed - at least some areas remain open for business now.

It is clear, however, that the banking sector is going through a period of tremendous readjustment. Massive regulation, the decoupling of state intervention and a profound debt crisis are undermining confidence.

In such a tumultuous environment for the sector and investors generally, bonds with assets as collateral are proving valuable. With the UK already a safe haven for gilts, its property market is looking attractive compared to southern Europe and the US.

It has meant UK RMBS have become a safe haven driving an increase in issuances in the last few months.

For the mortgage market the funding position remains weak and there is no change to gross lending but a vote of confidence in property is a good sign.

After years of reliance on unsecured lending followed by government bailouts, investors relying on bonds backed by real assets seems a more sensible, sustainable position.

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