Tuesday, November 3, 2009

With JPM's boots full, what next for UK RMBS?

Posted on International Financing Review:

Now that RMBS transactions from Lloyds Banking Group's HBOS unit and Nationwide are out of the way, those in the market are starting to question where follow-through deals will come from. Lloyds itself is rumoured to be looking at issuing a deal from its Arkle programme, but even if this materialises, there is still much uncertainty over the medium term.

The two deals to have priced so far raised £4.05bn and £3.5bn respectively but both relied heavily on demand from JP Morgan, which took £2.9bn and £2.25bn (for a combination of repo and buy-and-hold) respectively. The fact that it took huge lead orders from JP Morgan to catalyse wider demand has re-focused attention on prospects for state intervention in the UK's structured finance market.

The pricing of Silverstone 2009-1 last week (see "Granite unaffected by Rock restructuring" in MBS section for details) along with the Permanent 2009-1 RMBS in late September were undoubted successes in their own right. But the confidence of JP Morgan's chief investment officer in UK RMBS stands in sharp contrast to the apparent attitude towards the asset class displayed by the Bank of England.

"The bank governor has a massive blind spot on this issue and an inability to grasp what securitisation and RMBS mean for the mortgage funding market," said one structured finance banker. This frustration is mirrored by many other industry professionals, who believe that, unless effective action is taken to revive securitisation, another crisis is in the making.

The BoE's seemingly unenthusiastic role in any attempt to revive structured finance's role in UK mortgage funding also compares poorly with efforts elsewhere in the world.

The US set up the Term Asset-Backed Securities Loan Facility to provide financing for those that want to buy structured paper, while the Australian authorities have just doubled – to nearly US$15bn-equivalent – their RMBS purchase programme.

Even the ECB has set up a covered bond purchase programme and provided ample repo financing. The powers that be in the UK, on the other hand, have provided little practical help specific to the beleaguered UK mortgage market beyond the special liquidity scheme (SLS).

The UK's ABS guarantee scheme, applauded at the time by some for its positive attempt to help, has in hindsight proved to be ill-advised. It has not yet been used and may never be.

Even the value of the SLS is set to diminish. The scheme is coming to the end of its first year, which means that haircuts will rise to 33% before escalating once again in 2011 to 66%. Estimates suggest that about 80% of the £190bn pledged to the scheme is Triple A RMBS. This inventory back-log, along with all new lending, will either need to be refinanced and placed in the public market or held on lenders' balance sheets.

"The SLS is the big elephant in the room, I don't think they have even started thinking about what will replace it," a banker who has advised the Bank of England said. "Given they have such a vested interest in getting this market working again, it beggars belief."

The banker went on to note that he did not expect follow-through issuance after the HBOS and Nationwide deals, saying: "There's just a gaping hole."

He went on to question whether the BoE thought any part of the securitisation market was valuable, adding that UK prime RMBS was among the highest quality globally.

"It was the same technology that resulted in the US sub-prime fiasco but this is a very different animal," he said. "I am still not sure they [the BoE] really understand or believe that."

Of course, for every pound of debt that cannot be refinanced in the public market, the availability of mortgage credit will contract. Since the timing and depth of the UK's economic recovery is likely to be heavily dependent on a functioning wholesale funding market, it seems inevitable that, unless the UK authorities can come up with a workable mechanism that encourages investor participation in securitisation, another crisis management solution will be forced on them.

Some bankers think that the BoE could eventually look across the pond and set up some sort of TALF-like mechanism that introduces government guaranteed leverage – so driving spreads in and bringing investors and issuers to the table.

Or it could still agree to provide guarantees on eligible mortgage loans. This would cost nothing – at least to begin with – earn it fees and help generate a new type of UK agency mortgage market.

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