Tuesday, March 9, 2010

Santander deal heralds growing confidence

Original posted in the Financial Times by Jennifer Hughes

What bankers have nicknamed the “brain damage premium” is slowly disappearing in the securitisation markets, potentially opening up a source of funding for banks that could help ease tight lending conditions.

The belief comes after a £1.4bn deal for Santander became the first since the crisis without a “put” option, or redemption guarantee, indicating greater investor confidence.

Securitisation, where lenders package bundles of loans into new securities, was tarred with the “toxic asset” label during the financial crisis, even though European deals in fact suffered little of the havoc wreaked on their US counterparts by the widespread inclusion of low-quality subprime loans.

The resulting market freeze sent borrowing costs soaring and made it too expensive to issue new deals, cutting off an important source of loan funding for banks, which had used the process to free their own balance sheets for fresh lending.

This led to the “brain damage” label since, logically, bonds backed by specific, high-quality assets should carry lower borrowing costs than unsecured lending, which leaves bondholders in a queue should the borrower go bust.

The Santander deal, which consisted of loans originated through its Alliance & Leicester subsidiary, was sold in three parts on Friday.

The UK securitisation market was by far the largest in Europe before the crisis and attracted interest from investors across the region. Of the Santander deal, two-fifths went to investors outside the UK.

The pricing meant the deal was cheaper than current market quotes for similar bonds issued by Lloyds in January, but was still slightly higher than Santander’s unsecured paper, suggesting the costs of the toxic asset label are still present, but shrinking.

“The maths is beginning to work again in some countries for securitisations,” said Miray Muminoglu of the London syndicate team at Barclays Capital, which worked on the deal. “The market is on track to move away from these puts and rebuild itself in the way it used to exist.”‪‬‪

Since September, there have been a few deals from lenders such as Lloyds, Nationwide and Co-operative Bank, but each has included a guarantee that the sponsoring bank would buy the notes back after a set period.

This made them more like covered bonds, a form of bank funding where investors have recourse to the bank balance sheet if the deal sours. This in effect exposes bondholders to the credit risk of the bank instead of simply the danger that something goes wrong with the pool of loans.

Chris Tuffey of Credit Suisse said: “Without the put, this was about investors being prepared to fund the mortgage portfolio, as opposed to the credit of the bank – this is about diversifying funding sources for bank lending. Given the appetite and interest we saw, I think more banks will go the securitisation route to fund their lending.”

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