Written off as a busted flush by some, can the bruised securitisation model make a comeback? This is the question being asked by many with a vested interest in the health of the UK mortgage industry.
And with good reason, because securitisation has been at the heart of the past decade’s spectacular expansion in lending and innovation.
The reasons for securitisation’s fall from grace derive from the turmoil created by the implosion of the US non-conforming market.
This has led to investors turning their backs on mortgage-backed assets, and funders – many of whom have been directly affected by massive write-downs on their non-conforming investments – to hoard cash.
Urgent action is being taken by governments and agencies around the world to help correct the problems in the global financial system – a clear recognition of its seriousness.
The US has been most visible in this regard with its central bank, the Federal Reserve, recently slashing Base Rate by 125 basis points (1.25 percent).
Further steps include a moratorium on interest charges for vulnerable borrowers and help for monoline insurers, a little-known group that provides vital confidence to the bond investment sector.
Meanwhile, a number of the institutions that have suffered high-profile write-downs have turned to the markets for help in repairing their damaged balance sheets.
Hence the emergence of the Sovereign Wealth Funds – pools of cash set up by governments, principally from the Middle East and Asia, to make overseas investments.
Despite this, the money markets remain largely frozen, and UK lenders who are reliant on them for their funding – whether front-end via wholesale lines or back-end via securitisations – have become effectively disenfranchised.
Balance sheet lenders are also affected as many rely on the markets for a significant part of their funding. The result is product rationalisation, a tightening of lending criteria, price hikes and frustrated lenders, intermediaries and borrowers.
A fully functioning securisition market will help reverse this scenario. But before considering how this might happen, it is worth examining the securitisation process in more detail.
Origins and development
Securitisation originated in the US non-conforming market in the1960s as part of a public policy initiative to increase the funds available for residential mortgages.
It first came to Europe in the 1980s, and was adopted in the UK in the mid-1990s by the new generation of specialist lenders. It has since proved instrumental in fuelling the growth of the non-conforming market, and has been adopted by specialist and mainstream lenders alike.
Securitisation is the commoditising of revenues or assets so they can be sold as interest-yielding structured investment bonds. Put simply, assets are bundled together and sold to a special purpose vehicle (SPV), a company set up for this purpose.
The bundle of assets within the SPV is rated by specialist rating agencies to assess their quality and the expected cashflow over time. The bonds are then sold to investors on which they receive interest.
Many different types of asset are suitable for securitisation. In the context of mortgage securitisation, a quantity of mortgages are grouped together in a SPV and repackaged as tradable securities in the form of bonds. These are known as residential mortgage-backed securities. The SPV takes on the risk attached to the mortgages, and the lender receives cash from the sale of the bonds.
The benefit to the lender is that the cash can be used to pay off the loans from the bankers that funded the mortgages in the first place. Coupled with the transfer of risk to the SPV, the injection of cash puts the lender in a better position to negotiate new funding lines and to develop new products.
In most cases, the lender also continues to earn benefit from the mortgages in the SPV as the interest paid to investors is lower than that charged to the mortgage borrowers.
Securitisation also provides lenders with long-term funding by matching the term of the mortgages in the SPV. By contrast, funding lines negotiated through banks are short term – less than 365 days in most cases – more expensive, and more difficult to obtain and keep.
