Taken at face value, Europe’s residential mortgage-backed securities market is a shadow of its former self. The €36.5bn equivalent of bonds placed publicly with investors in 2016, according to JP Morgan data, pales in comparison with the €254.3bn sold at the crest of the market’s pre-crisis wave in 2006.
The decline is, to a large degree, the result of a slump in issuance from the master trust vehicles of UK banks, which have traditionally accounted for the bulk of the European RMBS market.
Today, much cheaper funding options are available for those banks, as central bank stimulus measures — such as the European Central Bank’s targeted longer-term refinancing operations (TLTRO) and the Bank of England’s Term Funding Scheme (TFS) — give institutions both direct access to funding, while historically low interest rates have made retail deposits so cheap that wholesale funding has lost some of its charm.
“Most issuers need some level of diversification, but as a result of quantitative easing, interest rates are so low that retail deposits have become a very cheap source of funding,” says Alex Maddox, capital markets director at the Northview Group, a non-bank mortgage lender owned by TPG and Blackstone.
“Cheap central bank funding is also available, and banks are using those facilities — unlike previous schemes which were considered a last resort.”
The numbers do not tell the whole story, however. Issuance might seem slim compared to the heyday of the market, but volumes have steadily been on the rise since 2013. The €36.5bn placed in 2016 was a jump from €27.5bn in 2015, €27bn in 2014, and €21.2bn in 2013.
The increase over the last year has been driven by a series of one-off legacy transactions — financing portfolios of crisis era mortgages carved out from struggling institutions.
The most significant of these have been in the UK, with Cerberus securitizing a £6.2bn book of former Northern Rock mortgages, owned by UK Asset Resolution, in April 2016. UKAR also sold off an £11.8bn pool of Bradford & Bingley buy-to-let mortgages to Blackstone and Prudential, in April this year.
Financing those hefty portfolios has been made easier by a rally in RMBS spreads. Triple-A rated, three to five year UK RMBS spreads dropped from 77bp at the end of April last year to just 28bp in May this year, according to Markit data.
PE sniffs peripheral opportunities
The contraction has also been pronounced in Europe’s periphery. Indicative spreads on three to five year Spanish RMBS fell from 150bp over three month Euribor at the end of March last year to just 66bp in May this year, according to Markit.
For private equity firms who took a bullish position on the recovery of the Spanish and Irish housing markets after the financial crisis, the bet is now paying off.
Blackstone for example has now sold two deals from its Spanish Residential Finance securitization platform, which is backed by re-performing loans from a €6.4bn portfolio the PE firm bought from Caixa Catalunya for €3.6bn in July 2014.
US firm Lone Star has also been a busy user of the capital markets in a different peripheral real estate market — Ireland. The firm has launched three deals, backed by both performing and non-performing mortgages.
Similarly, Mars Capital, an affiliate of Oaktree Capital Management, sold an Irish RMBS backed by performing mortgages in April this year.
Many of the Irish mortgages being securitized were bought from the Irish Bank Resolution Corporation, the entity created after Irish Nationwide Building Society was nationalised in 2010 after a government bail-out, before being combined with Anglo Irish Bank.
“We’re seeing increased issuance from private equity firms using RMBS to finance portfolio acquisitions, largely because they can get cost-effective financing and term funding through the RMBS route,” says Lynn Maxwell, head of group strategy in the structured finance group at HSBC in London.
Opportunities in complexity
Syndicate desks supporting issuers in this market have shifted in response to the new players in town, which often have more tailored needs than the largely homogenous “flow” deals from banks that used to drive deal volume.
“Over the past couple of years, the syndication methods for securitization have perhaps become a little more bespoke for each transaction,” says Maxwell.
“We’ve seen some very large transactions, from the Granite, Bradford & Bingley and Slate portfolios, which require slightly different strategies than a typical flow ABS deal. There are often discussions over pre-placing bonds and possibly selling the whole capital stack which do change the way syndicates go about the deal.”
Unsurprisingly, large bespoke transactions also command bigger fees for syndicate and structuring teams compared to traditional flow deals. Providing financing for those portfolio sales is also becoming a key part of banks’ efforts to secure deal mandates.
“In Europe there is less flow business, so if a syndicate is only focused on the flow market is can be very challenging to justify seats,” says Maxwell.
Large parts of the market are now moving behind closed doors, with private, sometimes bilateral transactions or warehouse facilities often being preferred to public deals, for cost or regulatory reasons.
“We have seen this across the board so at HSBC we decided to merge together our structured capital markets team with the asset financing side of the business, which we see as a much more efficient use of resources,” says Maxwell.
There is hope that despite the lack of incentives for banks to issue meaningful amounts of RMBS under current conditions, a functioning securitization market will be available for banks as and when they require it.
“The technology is very well understood by issuers, investors and dealers, and all the plumbing and pipework is there to allow the market to grow to whatever size is needed,” says Maddox.
The RMBS market could also take heart from the well received return of Royal Bank of Scotland to the sterling covered bond market in May, after a five year absence. With the Bank of England’s Term Funding Scheme window due to close early next year and funds borrowed under TLTRO soon coming up for repayment, European institutions are staring at a potential funding cliff, which is likely to boost the appeal of wholesale options.
“I’m not sure we’ll see a sudden rush of ABS issuance when TLTRO is turned off, but we could see issuance increase more gradually,” says Maxwell.
“Europe’s periphery is still relying on central bank liquidity, or just sitting on collateral because banks don’t necessarily need to raise wholesale funding, so we would expect to see more issuance from those countries.”
Growing interest in the private label RMBS market in the US, which largely disappeared after the financial crisis, is another source of optimism, according to Maddox.
In the meantime, Europe’s banks may also be interested in how they can use RMBS for capital relief purposes, particularly with one eye on potential increases to risk weightings that could come in under Basel IV regulations. Under the draft capital requirements regulation (CRR) if issuers can achieve significant risk transfer through securitization, they can get leverage ratio relief.
It might be less than a sixth of the size it was at its peak, but there can be no doubting the versatility of the RMBS product in Europe. Having weathered a storm of criticism since the financial crisis, it is well poised to become a more central part of bank, as well as private equity firm, funding plans as cheaper alternatives roll off.
