The funding of UK residential mortgages has greatly diversified over the past few years. It’s not average savers with their nest eggs in local building societies who are funding the boom in mortgage lending and nor do lenders only look to the capital markets. Increasingly, funding is achieved through the securitisation market and the issuing of residential mortgage-backed securities.
These bonds are sold across the world but investors are fickle and rely on rating agencies to assess the credit rating of each issue.
If they think there is a higher risk in the UK than the rest of Europe, the cost of funding will rise or the liquidity in the market will decline, meaning serious repercussions for the UK mortgage market.
The most profitable area in the industry in recent times has been sub-prime, which offers borrowers with arrears the ability to remortgage and start afresh. This is the area of the market that has been identified by a number of lenders as having the most potential for increased volume this year and substantial profits too as long as funding can be obtained at reasonable spreads.
This sector has also been the focus of most activity in terms of the issuing of RMBS. The structure is off balance sheet for originating lenders with the risk of default being taken by the bondholder which could be a European pension fund or an international bank.
But if institutions lose confidence in RBMS, either funding will become increasingly difficult for this class of mortgage or the cost of funding will rise. This would have an adverse effect on what may be the fastest growth area in the UK mortgage marketplace.
There is no need to worry yet but the residential property market in the UK has a question mark hanging over it as a result of high house prices and rising interest rates.
A rapid increase in residential property prices generally provides analysts with comfort because there are plenty of well seasoned deals for which LTVs have fallen. But considering new transactions raises concerns about the potential effects of a house price correction.
In the UK, the national press earlier this year featured articles on the trend among lenders to offer loans at 5 x salary and even more in some instances. Many house buyers are stretched to the limit.
And with many aspiring first time buyers unable to afford to purchase houses, buy-to-let investors have stepped in to fill the gap, adding to the overall level of perceived risk in the market.
A major correction in the UK would represent a serious challenge for the securitisation market which has enjoyed benign conditions for several years.
But the only asset class which experienced problems during 2006 was credit cards and as long as the economy remains strong there won’t be too many worries about funding. The US investment banks that control this market remain confident that funding will not be a problem, but how the spreads work out remains to be seen.