By Structured Credit Investor, 4th October 2017
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The European securitisation market faces what is expected to be an “interesting” year ahead, as low-cost central bank liquidity dries up and banks adopt new funding strategies. Together with boosting primary ABS issuance, Bank of England and ECB tapering will likely impact the volume of paper being retained.
In the UK, the drawdown periods for the Funding for Lending Scheme (FLS) and Term Funding Scheme (TFS) are respectively set to close at the end of January and February 2018, ending a cheap source of funding for the country’s banks. As at 30 June 2017, 43 institutions had participated in the TFS and 13 in the FLS, withdrawing a total of £123.3bn, according to DBRS figures.
UK bank and building society RMBS outstandings are estimated to have fallen by about 70% since the beginning of 2016, as issuers allowed existing deals to run off and replaced them with TFS funding. Similarly, UK prime RMBS volumes are constrained by the fact that transactions have largely been brought by smaller issuers since the FLS was extended in 2014.
However, Prytania Asset Management CEO Mark Hale is optimistic that a combination of the end of FLS and TFS, plus a hike in base rates, will encourage more issuers to tap the UK RMBS market. “All these elements should drive a sustained pick-up in issuance, assuming government policies remain unchanged and barring any shocks. We expect the diversity of funding channels to remain: securitisation is one, but many issuers will continue to weigh the relative costs of retail and wholesale deposits, issuing covered bonds and straight debt as well,” he observes.
Gordon Kerr, head of European structured finance research at DBRS, concurs: “We expect to see the return of prime issuers on a regular basis, with increasing volumes as central bank funding tapers. But securitisation isn’t the only answer – some cash will likely find a home in covered bonds as well.”
With the TFS and FLS beginning to roll off, he anticipates that volumes will pick up gradually in 2018 and 2019, until there is a sizeable funding roll-off in 2020 and 2021 – which will need to find an alternative source of funding. Termination of the Bank of England schemes doesn’t represent a cliff edge, however, as the cash is out with banks for four years.
Consequently, if these banks have alternative sources of funding, there isn’t an immediate need for them to securitise. At the same time, non-banks are becoming banks – as exemplified by Paragon Group recently rebranding as Paragon Banking Group, in order to optimise its funding and capital position – and diversification of funding sources is increasingly common to both types of institution.
JPMorgan figures show that Virgin Money utilised close to 80% of its total borrowing allowance under TFS, as of 2Q17, which anecdotally supports its return to the primary RMBS market last month with Gosforth 2017-1 – the first print from the issuer since April 2016. Previously, Clydesdale Bank returned to the primary market in June, having utilised 83% of its TFS borrowing allowance by end-1Q17.
Hale suggests that the Gosforth and more recently the Holmes deals can be seen as an early sign that 2018 should see more prime RMBS issuance. “Central bank tapering and a withdrawal of the extraordinary measures put in place by the official sector as a whole in the credit crisis implies more bond supply and a portion of it will come to the securitisation market. At present, demand is sufficient to pick up the slack, but that appetite is vulnerable to volatility. This means the market could reach a new equilibrium, with more supply but lower demand, which could reverse the long-standing trend of spread tightening – especially for ECB-eligible bonds.”
Kerr adds that further factors driving increased sterling issuance ahead of Brexit are avoiding the need to include swaps in structures and the desire to bring foreign money back into the sterling market.
Indeed, if supply were to rise, the importance of diversifying investors by type and by geography becomes more significant. “Issuers would be wise to cultivate overseas investors in order to maintain the demand for sterling bonds. If the UK markets begin underperforming in general, issuers can’t afford to be blasé about overseas buyers. A specific trigger for volatility is hard to discern right now, but it’s impossible to rule out,” Hale warns.
As such, more UK lenders are expected to issue in euros and dollars, following the inclusion of a US$421m senior tranche in the recent Gosforth deal (see SCI’s primary market database). Yen bonds are a trickier proposition, given that the FX rate is painful for Japanese buyers, although some CLO arrangers are overcoming this with structural solutions.
Nevertheless, Kerr says that it is an open question whether the entrance of new investors into the market and Japanese investors returning is driven by genuine interest in secured products or simply by the search for yield. “These trends will take a while to be realised,” he comments.
Meanwhile, in Europe, the expiration of some of the TLTROs in 2018 represents a further €450bn of cash rolling off. However, Kerr suggests that a large portion of recent TLTROs were undertaken less for liquidity reasons and more for the opportunity to access cheap funding for margin, so much of it will probably disappear back onto bank balance sheets and the rest could be funded by covered bonds and securitisations.
As of 1 September 2017, the ECB reported €769bn of outstanding lending volume to euro-area credit institutions under the LTRO/TLTRO programmes. As at end-2Q17, JPMorgan international ABS strategists estimate that €629bn of retained European ABS (ex-UK) is outstanding, of which circa €450bn is RMBS and €75bn is SME ABS. Approximately 70% of outstanding retained European ABS is senior bonds, which is a high-level criterion for ECB collateral eligibility.
Similarly, €79bn of retained UK securitisations are outstanding, a portion of which has potentially been used as collateral with the BoE instead of being distributed in the primary market. The JPMorgan strategists estimate that about 61% of outstanding retained UK ABS are senior bonds.
Despite a backdrop of tight spreads and an unslaked thirst for secondary paper, it appears to be too much effort and cost for some retainers of securitised bonds to re-offer the paper. Nonetheless, Hale notes that “a fair amount” of previously retained paper is hitting the market and there is potential for more, especially if the current rally continues and tapering progresses.
Looking ahead, market participants are focusing on the ECB’s monetary policy meeting later this month. The Bank of America Merrill Lynch house view is that the ECB’s tapering from €60bn to €40bn monthly purchases in 1H18 will be gradually scaled down to zero by end-2018, followed by a deposit rate hike some time in 1H19.
In terms of the future of its ABS purchase programme – which owns less than €25bn of collateral – Rabobank credit analysts deem a ‘hard exit’ by the ECB from the European securitisation market as very unlikely. Rather, a ‘soft exit’ may be an alternative to an overall tapering scenario.
“A soft exit would likely result in some spread widening over time and some distortion of the relative value across the debt capital stack,” they observe.
Overall European new issue volume stood at about €135bn year-to-September, of which around €60bn was publicly placed. Given that Q4 is usually the busiest quarter of the year for retained deals, Bank of America Merrill Lynch European securitisation analysts expect total issuance volume in 2017 to reach the €200bn mark.
By Structured Credit Investor, 4th October 2017
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