Policy makers would be wise to examine the history of Davidson Kempner’s Stratton Mortgage Funding 2021-2, which is being refinanced this week in a Bank of America led trade. The story of the collateral provides lessons in the trade offs that regulators have to make, and comes at a timely moment considering the current continuous stream of PRA and FCA consultations.
The mortgages backing the Stratton deal came from Northen Rock and Bradford & Bingley, both UK lenders that failed in 2008. When the two entities were later nationalised, the UK government was left with the problem of what to do with the mortgages they held. In 2010 the UK Asset Resolution (UKAR) was established to tackle the roughly £100bn of debt newly owned by the taxpayer.
By 2021, the process was complete, with the final sale resulting in the deal that is now up for refinancing. It could not have been achieved without the RMBS market. It is perhaps even fair to say that had there been more depth in the RMBS market it could have been achieved quicker still.
Rather than ignore the the past, or write off securitization for its role in the subprime mortgage crisis, as many are so quick to do, the entire process should offer two lessons for the UK regulators as they look to rewrite the rules that govern the sector.
First, RMBS is an extremely elegant way to deal with a portfolio of mortgages and should be encouraged. Even a thorny, legacy, non conforming pool, with a mix of interest only loans, buy-to-let loans and all kinds of arrears can be transformed into a series of tranches with different levels of risk attached.
Sophisticated investors are still required to make sense of all that, but the labour can be divided and the ticket sizes can be slashed dramatically. Doing this means that collateral that might only have had a couple of buyers in a portfolio sale is suddenly opened up to the dozens of RMBS investors.
But the UK's current securitization regulation is restricting the investor base, limiting the good that securitization can do. It took 11 years for UKAR to complete its work, not surprising considering distributed UK RMBS issuance has been around the £25bn mark annually in recent years. That number would be much higher if there were more investors to absorb the supply — but there simply aren't.
The second point, however, is that regulators must remember how the Stratton pool came into the hands of the UK taxpayer in the first place. There is no doubt that obfuscating actors within securitization compounded the shock waves from the US subprime crisis that toppled the fragile UK lenders.
The performance of European securitization was very strong during that period, but the regulatory treatment that followed was harsh nonetheless. Popular opinion deemed the market confusing and risky and the government acted as such. Reforming regulation of securitization is sometimes cast as increasing the risk in the economy in exchange for growth. To do that democratically, a public debate and an electoral mandate would be best.
But that isn’t necessary for significant securitization reforms. Indeed if regulation was fairer more private deals would come into the public sphere and they would have ratings and disclosures. Greater transparency is almost surely less risky. If opaqueness is the enemy, then securitization can be a tool to fight it.
In this context, regulatory reform is almost common sense, with the bonus of extra growth.