RMBS Maintains Allure Amid UK Economic Uncertainty

While uncertainty continues to cloud the United Kingdom (“UK”) economic outlook and the housing market ponders the potential impact of Brexit, investors still have appetite for UK Residential Mortgage Backed Securities (“RMBS”) and the inherent characteristics which have seen such assets perform well in previous downturns.

Despite a degree of hesitancy in structured markets at the start of 2019, with the new Simple, Transparent and Standardised (“STS”) Securitisation regime not initially fully embraced by issuers, alongside some trepidation ahead of the original 29 March Brexit deadline, new deal issuance stepped up in the second half of the year.

Peering past the political noise and volatility pervading financial markets in the UK is the conviction among seasoned observers of the historic strength  and solidity of the collateral within UK RMBS as an attractive investment.  Furthermore, as the year has progressed, some of the uncertainties around STS have now faded and with this greater comfort we have seen more RMBS transactions electing to qualify for the designation, despite the additional regulatory hurdles.

A recent report from Fitch Ratings highlighted the dominance of RMBS in the UK securitisation market.  According to Natwest Markets data (4 October 2019), there have been 44 securitisations that have taken place in the UK in the year to date, representing £24.1 billion of issuance. Of that number £18.4 billion was RMBS, accounting for over 76 percent of total UK issuance this year.  Breaking down the numbers, prime RMBS made up just over half of total RMBS this year at £9.4 billion, with £3.7 billion of non-conforming, £3.6 billion buy-to-let and £1.7 billion non-standard.

Underlying Attraction

One of the main attractions of UK RMBS and what differentiates it from US RMBS in  particular is that these transactions, used to fund sterling mortgages, are full recourse mortgages and have displayed a lower default rate compared to other markets.  Analysis by TwentyFour Asset Management shows that the UK’s worst default rate of recent times (in 2009 just after the financial crisis), was only 0.43%, while the United States default rate was still 2.23% in 2010.  Also, compared with some other jurisdictions there is greater certainty around enforcement  of security under the laws of Britain and Northern Ireland, notwithstanding that recent regulatory changes have put additional obligations on lenders to ensure that customers are treated fairly.

Interest rates remain low, with global growth concerns compounded by the uncertainty around Brexit and increased barriers to trade. The OECD has said that it expects a disorderly Brexit would cut close to 3 percent off UK growth over the next three years, with a recession predicted in 2020. Notably within the alternative lending sector, we have seen a reduction in growth of peer to peer lending and lending standards being tightened generally as a result of the uncertain economic environment.

If the economy were to fall into a recession, there is always the possibility that the Bank of England may respond with another Term Funding Scheme (“TFS”) or equivalent, providing risk free finance to market participants and restricting ABS and RMBS supply.  Such a move, which is not currently anticipated by the industry, would clearly have a dampening effect on overall issuance- but the relative scarcity of supply may reward those issuers who do tap the market.

Despite the fragility of the housing market, the UK mortgage market has remained relatively robust. New loans are being made and non-banks have continued to use securitisation as an effective funding tool. The Bank of England announced that UK mortgage approvals hit a two year high in July and then rebounded strongly in September from an August lull, indicating the return of some stability since the result of the Brexit referendum in 2016 sparked the current political crisis.

As margins continue to be compressed in the competitive business of UK consumer lending, RMBS remains an important source of funding, particularly for non-banks.  It’s also true that banks will continue to tap the market intermittently to prove their diversification of funding sources.

Political uncertainty and sterling’s volatility means that pricing can be tricky and the window of opportunity for getting a deal away can sometimes be quite narrow.  A highly responsive  and client-focused corporate services provider helps with speed to market.  At Maples Group, we take pride in our high touch and client focused approach.