Out of the darkness
The £4bn RBMS deal by Lloyds Banking Group is a green shoot of hope in a blasted landscape, but it seems the full reopening of the securitisation market is not yet in sight
Money makes the world go round, so the saying goes. And once upon a time securitisation oiled the wheels of the mortgage machine, spewing out funding for a seemingly never-ending queue of borrowers wanting mortgages.
But when the mortgage market’s equivalent of the apocalypse hit, the reputation of securitisation went down the toilet. Residential mortgage-backed securities were attacked for being the root of all evil and the slicing and dicing of assets for profit became to some observers the perfect illustration of the depths to which the global financial services sector had sunk.
While there may be something to be said for this argument, at least in the US, the fact is that without the funding options provided by securitisation the mortgage sector has ground to a halt.
Signs of a return to more normal lending levels were beginning to seem like a mirage and commentators scoured the landscape for the best part of a year in the vain hope that something would happen to free up lending.
Then last month a genuine green shoot seemed to emerge from the scorched landscape. It came in the form of the £4bn RMBS issue from Lloyds Banking Group, the first such deal since August 2008.
The mortgages backing the Permanent 2009-1 deal are loans originated by Halifax along with those originated by Bank of Scotland under the Halifax brand, both part of the Lloyds group following the creation of the super-bank this time last year.
This is the 14th issuance from the Permanent master trust programme and follows the same pattern as the last issuance from HBOS back in May 2008 - high quality AAA-rated UK residential mortgages.
“The offer was significantly oversubscribed, underlining the high asset quality and brand name of the Permanent programme,” says Robert Plehn, head of structured securitisation at Lloyds group. “The success of this issuance further expands the funding options available to the group. We believe we have taken an important step towards helping to reopen the European securitisation market.”
Since Alliance & Leicester’s £400m issuance last August the wholesale funding markets have effectively been in a state of hibernation. So understandably, when news about the Lloyds group deal surfaced the mortgage industry leapt on it as a sign that maybe, just maybe, the tide had turned.
“The success of this issuance represents a desperately needed boost to the funding options available to lenders,” says Alison Beech, business relationship director at estate agency group Spicerhaart.
“With the markets being closed for more than a year the new fund is set to open the door for further securitisation deals. This will hopefully lead to enhanced lender funding options, improved competitiveness and more affordably-priced mortgage products.”
Beech says that in the short term any deals that emerge on the back of the Lloyds issue will be restricted to AAA-rated assets but predicts that nevertheless the deal will pave the way to an improved mortgage market.
“Lenders will have to rely less on expensive wholesale funding or retail deposits,” she adds. “The transaction should facilitate a gradual increase in the number of affordable mortgage products in a starving market. This is a landmark deal that could stimulate funding and help the sector considerably.”
Michael White, chief executive of Email Mortgages, agrees. “Given that the securitisation market had all but dried up, the fact that Lloyds group has successfully managed to get a sizeable deal away means that other lenders may attempt similar moves in the next few weeks,” he says.
White says the timing of the issuance and the investor appetite for the deal is evidence that a recovery is underway in the financial services sector as a whole.
“This type of transaction represents an important source of funding for lenders, particularly specialist firms,” he adds. “Improved liquidity is vital for a recovering lending market, certainly in this country.”
Even lenders are feeling more optimistic about the use of securitisations in the future. As part of its Q3 2009 Credit Conditions Survey the Bank of England asked lenders whether they felt there had been any change in the use of securitisations associated with mortgage lending in the three months to September. A net balance of just 4.7% of lenders reported seeing an increase in the number of securitisation deals.
But when considering the prospects for the next three months the net balance jumped to 23.6%. This reading represents the most positive lender forecast for the RMBS market since June 2007 when data for the survey was first collected.
The survey was conducted before the Lloyds group issue was announced so one could argue that if lenders were positive about securitisation before the deal, now that it’s happened there should be a further surge in confidence.
But although lenders have privately confided their optimism to the Bank they are more tight-lipped in public when it comes to their intentions.
Sources tell Mortgage Strategy that a big lender is considering a similar deal to the Lloyds group transaction, with Nationwide being one of the names in the frame. A spokesman for Nationwide says the building society is unable to comment on forward funding transactions because it would create a false market in its securities.
“Any mechanism that improves the ability of UK financial institutions to raise cost-effective financing in the capital markets will be supported by Nationwide,” he says.
The Council of Mortgage Lenders says it welcomes the Lloyds group issuance as well as the results of the Credit Conditions Survey. But the trade body does not believe these factors herald the return of the widespread use of securitisation markets.
“There have been some encouraging signs involving the reopening of the wholesale funding markets and we hope this trend continues,” says a CML spokesman. “But any future deals of this nature are likely to be focussed on the highest quality mortgage assets because at the moment this is still essentially an exercise in rebuilding confidence.”
The spokesman says the process of restoring RMBS issues as a common source of funding is likely to be slow but adds that any deals that come to light in the near future will undoubtedly widen the funding options for those lenders able to get them through. He says the speed of progress depends to a large extent on how quickly the wholesale markets recover.
“We have a long way to go, not only to return to anything like the levels of lending seen before the crisis but also to deliver adequate funding to meet demand,” he adds.
And it’s not just the CML that is cautious. The Financial Services Authority, having fallen asleep at the wheel in the years leading up to the financial crisis, now needs to be seen to be taking an aggressive stance on anything it failed to clamp down on previously.
Securitisation is one such element. Jon Pain, managing director of retail markets at the FSA, made his feelings on the subject clear at the regulator’s mortgage conference back in May, long before the prospect of securitisation making a comeback entered the industry’s consciousness.
“While we acknowledge the limitation of retail funding and the continuing importance of the wholesale markets in future we will consider the extent that securitisation in certain sectors of the market has encouraged excessive risk-taking and created an unsustainable and poorly performing market,” Pain said at the time.
He referred to the disproportionate number of specialist mortgages with balances outstanding - 32% at the market’s peak - which had produced significantly higher arrears.
Pain went on to describe how specialist lenders had been cut off from funding, leaving them with limited scope to offer struggling borrowers lower repayment rates. This in turn forced wholesale lenders that were unable to manage their arrears to sell off distressed mortgage books.
“Our primary concern is consumer protection and what happens when books are sold on,” Pain concluded. “We will look at what needs to change to avoid this happening again and prevent securitisation being used as a vehicle to allow lenders to take on unacceptable levels of risk.”
And it seems the regulator has been true to its word. Fast forward five months and lo and behold tighter restrictions on the use of securitisation are being phased in. Last week the FSA published a policy statement on strengthening liquidity requirements - the final rules on liquidity standards that firms will have to adhere to. The inherent risk associated with securitisation is a theme that runs through the 319-page document, with a total of 13 references to the subject.
In its statement the regulator argues that in the past firms were subject to an “over-reliance on short-term credit-sensitive wholesale funding markets” as well as an “over-reliance for funding on securitisation markets”. Under the new rules the FSA expects lenders and financial services firms to work out how cash flows coming in from securitisations could change when liquidity becomes a problem so that they have a grip on the extent of the off-balance sheet risk they face.
Firms considering using securitisation that have limited experience of the market have been cautioned by the regulator to pay particular attention to the risks involved.
“The assessment of this risk is particularly important for a company which ordinarily does not raise funding from its non-marketable assets in this way and places proportionately greater reliance on securitisation programmes compared with other funding strategies to generate liquidity,” the document states.
And all the while lenders are expected to maintain a diversified funding model. They will also have to report to the regulator the level of high quality asset-backed securities they are trading, as well as the number of high quality covered bonds.
So the spectre of regulation seems destined to haunt the RMBS market even before it has fully got off the ground again. And that is before lenders learn of any further regulatory initiatives that could be un- veiled as part of the FSA’s review of the mortgage market, expected this week.
Oliver Hughes, head of capital markets at Hometrack, says that although the use of securitisation as a funding technique will eventually make a comeback the market will in no way resemble what it used to be.
“Securitisation has to come back to the market to enable banks to lend and fill the funding gap that has been in evidence on lenders’ balance sheets,” says Hughes. “It also allows better matched funding for banks.”
But he says that new liquidity rules mean any future funding based on securitised assets will not resemble the model that existed before.
“There is an inevitability about the securitisation market coming back but when it does it will be in a much more basic form,” he adds.
Of course, as with everything else the debate on a future model for the securitisation market may be reshaped by a change of government. This is a shame as it seems that the present administration is just beginning to realise how crucial RMBS deals are in securing a normalised mortgage market.
“While the immediate future for the RMBS market remains uncertain there is evidence from sources close to the government that it appreciates that the funding gap in the mortgage market will have to be closed through the revival of securitisation,” says industry consultant Mehrdad Yousefi.
“It is not feasible to finance this from retail savings flows and short-term funding from wholesale money markets. The recent deal by Lloyds group is a welcome development and I’m optimistic that more deals will be forthcoming in the next six months.”
But with the Conservative Party’s attention firmly focussed on spending cuts in a bid to shrink the budget deficit, you have to wonder how much of a priority securitisation is for it. And with proposals directed at house builders rather than the mortgage market it seems as though freeing up mortgages isn’t something a future Tory government would be too bothered about.
The last word has to go to the rating agencies that always seem to be able to squash any hope of recovery - as the mutual sector can testify.
Moody’s Investors Services produced a report last week damning assets backed by UK sub-prime loans and predicting that losses on these securities are set to continue into 2011. The report, Is International Securitisation On The Road To Recovery?, answered its own question with a resounding no, blaming low house prices and the high rate of unemployment.
“It’s too early to speak of signs of recovery,” says Frederic Drevon, head of securitisation for Europe, Middle East and Africa at Moody’s.
“When the securitisation market recovers it is not certain what the volumes involved will be.”
So between the regulators and the ratings agencies it’s unlikely this green shoot will be blossoming any time soon.”
Deal will have limited effect
intermediary mortgage lenders association
The recent Lloyds Banking Group residential mortgage-backed securities issuance is a welcome sign that serious efforts are being made to restart the RMBS securitisation market. It is also an indication that the government’s Asset Protection Scheme is not working - even though the Lloyds group issuance was expensive it still preferred to issue without a guarantee.
It was a complicated transaction with a number of features that differed from previous ones so it doesn’t provide many clues as to what the RMBS market might look like in future. Three tranches of bonds, all AAA-rated and backed by low LTV mortgages, were offered to the market with a total value of around £4bn, split into £1,650m, £1,650m and €750m. There is an expected maturity date of October 2014 and at an interest, or coupon, rate of three-month LIBOR plus 1.8%.
Lloyds group purchased £1,565m of the first tranche, perhaps for subsequent sale or use with the Bank of England scheme, and investment bank JP Morgan bought £1,250m of the second tranche, some of which has now been sold at a profit. The remaining £485m and €750m were bought directly by investors.
The interest rate paid on the tranches was higher than the payments due from the underlying mortgage pool and Lloyds group has put in place a yield reserve fund to support the transaction along with what is known as a put option - a built-in right for investors to sell them back to the originator in five years.
It seems direct investors were keen to buy the £1.2bn available but this was no surprise given that the return was much higher than in 2007, the income stream was guaranteed and there was a buy-back option. The fact that Lloyds group needed to put all these features in place plus build demand shows what a task it was to restart primary issuance after the turbulence of the past two years. The put option ensures the liability will remain on Lloyds group’s balance sheet. This was not done to seek capital relief but rather to raise new funds and reopen a market.
The UK mortgage sector is facing a shortage of funds. We all know that the issuance of the past five years has to be repaid along with more than £300bn of government-supported funding. If the RMBS market remains closed it will add to the pressure. Lloyds group was trying to address this and well done to it. Shortly afterwards Barclays came to market with a €2bn 10-year bond which was oversubscribed. And rumours abound that another lender will soon make a similar move.
Is this the beginning of a new age? Well, big players are offering top assets on good terms so it has a limited bearing on the market as a whole. We are some way from the market fully reopening, particularly for specialist lenders.
Reopening of the RMBS market should facilitate more competition
senior technical manager
Since the wholesale markets closed banks and building societies have been trying to increase the proportion of funds obtained from savers but this will never make up for the shortfall in wholesale funding. Pre-credit crunch, around 20% of total mortgage funding came from residential mortgage-backed securities and an even higher proportion supported new lending.
So the news that Nationwide, Barclays and Lloyds Banking Group raised funds by issuing sterling senior unsecured medium-term floating rate notes in the past few weeks is encouraging. Nationwide raised £700m for 10 years but had to pay 1.85% above three-month LIBOR compared with 0.1% over LIBOR last time it raised money this way in 2005 This demonstrates how the market has changed despite LIBOR returning to pre-crunch levels. Barclays was able to borrow at a narrower margin than Nationwide but Lloyds group had to pay more.
Shortly after these moves the group raised £4bn at three-month LIBOR plus 1.8% in the first European or US RMBS issuance since Lehman Brothers went bust. Lenders have been waiting for investor sentiment to improve sufficiently to allow a new RMBS issue and full marks to Lloyds group for dipping its toe in, despite having to concede onerous terms.
It is paying 1.8% over three-month LIBOR and retains the first 8% of risk on these assets compared with what would typically have been only 1.5% before the credit crunch.
The issuance does not have a government guarantee but although these are long-term securities they have an effective five-year put option. This should improve liquidity because it gives investors the option of selling their bonds back to Lloyds group after five years, thus preventing the lender from counting the bonds as long-term borrowing on its balance sheet.
Despite the stiff terms, at least Lloyds group has succeeded in reopening the RMBS market. The first issue was always going to be tricky but the market can now build on it. I have no doubt that plenty of other lenders will be interested in issuing RMBS but the key question is whether they can find buyers on terms they are prepared to accept, although as market conditions continue to stabilise I would expect the terms of future issuances to slowly improve.
Recent issues make sense for the lenders concerned despite the high margins involved because they still provide funds more cheaply than in the instant access retail savings market.
The reopening of the RMBS market is an encouraging sign for a mortgage sector starved of funding. It should bring more competition which suggests that margins above the cost of funds are close to peak. But the Basle capital adequacy rules mean that the spread between the pricing of high and low LTV mortgages will continue to be much wider than prior to January 1 2008 when they came into force.
Hooray for this effort to rekindle an important element of funding
The Lloyds Banking Group deal is a step towards repairing the securitisation market. So is that it then? Has the market reopened? I’m afraid not. But this securitisation is important in reminding us that to have a healthy mortgage market we need these types of transactions. It has saddened me in the past two years to read so much about how the securitisation market contributed to the crunch. In the UK it did not and many commentators should know better than to say it did.
Securitisation has provided a significant proportion of all mortgage funding - some 27% in 2006 - so nobody can deny its importance. It is excellent funding for at least three reasons - it matches funds to maturity of mortgage portfolios, it has undergone a stress test by ratings agencies to ensure it can survive the sort of downturn we have experienced and it is subject to continuing oversight.
This sort of funding is good and if more had been done we would not be in this mess now. The problems that have tainted the market have come from the US in esoteric classes of instruments such as repackaged sub-prime collateral debt obligations or deals in which sponsors extracted all value and risk at the outset. This is not what mainstream issuers in the UK have done.
If anyone doubts this they should look at prime residential mortgage-backed securities issuance from 2003 to 2005 and they will see that the structuring of issues was broadly sound and the performance of assets has been maintained. Investors have not lost a penny.
The Lloyds group deal was oversubscribed which is good but let’s not be in any doubt about the reasons for this. It was sponsored by Lloyds group and the pricing of the notes was high. The assets were prime and most significantly the group offered a put option at year five, when it can buy the bonds back from investors. With low prepayment rates on mortgages and lack of secondary market demand the deal would have been a dud without this feature.
So why did the lending giant do it, given that this must represent relatively expensive five-year funding for the group with no capital relief as the put option places the deal on its balance sheet? Because it had to. The secondary markets are still not working properly and investors have lost confidence in the mortgage-backed sector given the lack of secondary market liquidity. But at least investors are focussed on the sector and in time it should be possible to remove put options from deals.
So this deal isn’t going to suddenly free up large amounts of funding. Any subsequent issues will be from named sponsors and wider access to the securitisation market is still some way off but hooray for Lloyds group and its managers Barclays Capital and JP Morgan for having the courage to try to rekindle this vital element of mortgage funding