-- Neil Unmack is a Reuters columnist. The opinions expressed are his own --
By Neil Unmack
LONDON Oct 27 (Reuters) - Is mortgage securitisation making a comeback? Nationwide Building Society (POB_p.L) has just sold 3.5 billion pounds of mortgage-backed bonds, just the second deal this year after a similar transaction by Lloyds (LLOY.L) last month.
The fact that two large transactions have happened is a good sign, but the market is still some way from recovery.
Nationwide and Lloyds have shown how much the market has improved since the collapse of Lehman Brothers last year, which effectively killed off demand for asset-backed securities (ABS) in Europe.
A functioning market is needed to help finance mortgage borrowing and wean Europe's banks off government support taken on during the credit crisis.
Low interest rates have brought new funds into the market, making it cheaper for banks to issue. However, asset-backed debt is still expensive compared to other forms of bank funding, and the investor base for these securities is a fraction of what it was.
Nationwide must pay at least 145 basis points over Libor on its new MBS. But the UK mutual's covered bonds, another kind of secured debt, are trading somewhere around 85 basis points over Libor, while its senior unsecured debt for 10 years is about 130 basis points over swaps.
Interest costs alone aren't the only factor, however. Asset-backed debt requires less collateral than covered bonds, reducing the total cost. Then there's the benefit of diversification. Regulators are encouraging banks to increase their longer-dated funding, meaning they need to consider all kinds of secured borrowing, including ABS.
Nationwide has clearly decided these benefits are worth the cost of paying up a little more. Other lenders may well follow suit. But for larger UK banks securitisation is still an expensive funding option compared to unsecured debt, which benefits from implicit government support.
Moreover, the new investor base remains untested. The boom years were fuelled by leveraged funds such as structured investment vehicles. But these have disappeared, and new investors need to earn an adequate return without borrowing.
Indeed, demand has been so uncertain that both Nationwide and Lloyds sold a large chunk of their transactions to JPMorgan (JPM.N) before offering the remainder to other investors.
Nationwide and Lloyds are effectively betting that investor confidence will recover, lowering borrowing costs and making the market for mortgage-backed securities viable again.
So far this has worked well for JPMorgan, which bought 1.25 billion pounds of Lloyds' deal in September, and is sitting on a paper profit of at least a percentage point after the bonds rallied in recent weeks. But some new investors may prove fickle if yields rise in other bond markets, or if defaults start to climb again.
Nationwide may have helped to restore confidence to the market for mortgage-backed securities. However, the changes in the investor base means the market will inevitably be smaller, and more expensive for issuers, than it was during the boom. -- For previous columns, Reuters customers can click on [UNMACK/] (Editing by David Evans)