Although the market for private sector residential-mortgage-backed securities is frozen in the U.S., it has recently shown signs of life in the U.K. and the Netherlands, where there is no competition from government-backed lending agencies like Fannie Mae and Freddie Mac. Surprisingly, the primary investors snapping up these securities are U.S. banks hunting for higher yields.
The biggest recent deal was a £4.7 billion ($7.4 billion) issue in September by Royal Bank of Scotland Group, which originated the loans with National Westminster Home Loans. A week later, Dutch insurer Aegon completed the sale of €842 million ($1.17 billion) worth of mortgages in the Netherlands. In total, for the first nine months of this year, European mortgage-backed issuance reached $50 billion, up from $9 billion for all of last year. Of course, that’s still well below the $300 billion in RMBSs issued in 2006.
Jean-David Cirotteau, senior asset-backed securities analyst at Société Générale in Paris, says the principal ABS markets in Europe, particularly in Germany, are for U.K. and Dutch mortgages and auto loans. Spain and Ireland used to be major issuers of securitized debt, but those markets dried up with the housing bust.
The European Central Bank tried to support the asset-backed market by allowing the use of ABSs as collateral for refinancing operations during the financial crisis, so that banks could fund ABSs even when investors fled the market. Beginning in January of this year, a steady trickle of German auto loan issuance showed that the ABS market was slowly returning to life, but it is still restricted to a handful of countries. Credit terms are much stricter, with investors demanding that the cushions for losses, known as credit enhancements, be much larger than in past transactions.
Cirotteau says the recent issue of U.K. and Dutch bonds was helped by the fact that they are paying 120 to 170 basis points over LIBOR, compared with only 25 basis points for ABSs in the U.S. That helps explain why U.S. investors were among the biggest players in the deals.
“JPMorgan bought huge amounts of U.K. and Dutch RMBS for its own purposes, and there were other large U.S. banks participating in the market,” Cirotteau says.
U.K. and Dutch financial institutions have been under pressure to sell their loans because they have no funding alternatives such as covered bonds, which are the primary financing vehicle for housing loans in Germany and Scandinavia and were a big factor recently in Spain. Stephen Hynes, head of securitization, group treasury, at RBS, says the September transaction was his bank’s first mortgage securitization sold to investors since June 2007, although other major U.K. banks have done large deals earlier this year.
Hynes says one of the attractions of the U.K. securitization market is that none of the prime mortgage bonds issued in the past few years has been downgraded. The RBS deal involved only prime mortgages with an average loan-to-value ratio of 75 percent. “It’s very strict credit criteria, and there are no impairments allowed,” he says. “It doesn’t fall into the category of near-prime or Alt-A or even further down the credit curve.”
Now that spreads for RMBSs are in the triple digits, it’s an extremely attractive asset class for fixed-income investors. “There’s a significant amount of interest from U.S. investors, which has helped us to build momentum,” Hynes adds.
RBS sold only the triple-A and double-A tranches of the deal and retained the rest. There is an ongoing discussion in the U.K., similar to one taking place in Washington, about whether to force banks to keep a 5 percent piece of the credit risk of securitized transactions, to make sure they have “skin in the game” and don’t sell poorly performing loans to unwitting investors.
Hynes notes that because of new capital rules, banks have to keep securitized transactions on their balance sheets: “In the last decade securitization was more about capital relief as much as funding, but there’s no doubt that the pendulum has swung in the direction of funding.”
