Securitisation backing could fuel UK mortgage trading
* Funds need leverage to meet bank price demands
* More mortgage portfolios to trade to funds
* Securitisation can clean up the mess it created
By Owen Sanderson
LONDON, Aug 2 (IFR) - The re-emergence of cheap securitisation funding should allow funds to help clean up UK banks' balance sheets, allowing them to bid more aggressively for legacy assets.
UK banks have wanted to sell legacy mortgage assets, and funds to buy them, for at least two years, but the funds need to be able to get cheap leverage to pay the prices banks demand for the assets. For a bank with mortgages marked at 100, any sale below that level is a direct capital hit.
This means banks are incentivised to hang onto assets, and because they have abundant cheap liquidity, can easily do so. Using securitisation rather than bank leverage cuts the cost of leverage, and allows funds to bid closer to the levels banks want to sell at.
"I'd expect to see a pickup in portfolio trades using securitisation financing - there are still huge volumes of mortgages in non-core books in the UK," said Alex Maddox, business origination and development director at Acenden, an independent servicer, and former head of European mortgage trading at Deutsche Bank.
The gains in generic UK non-conforming spreads, which have rallied from 265bp to 175bp in the last year, according to analysts from JP Morgan, have created the opportunity.
"More efficient senior financing levels the playing field between vendors' cost of capital and funds' cost of capital," said Matt Gilmour, managing director at Mars Capital. "The biggest competitor on any trade is always the vendor themselves."
GAME OF THRONES
Three recent deals underline this trend. This week, Citi underwrote the GBP117.74m Thrones 2013-1, which funds a portfolio for Mars Capital. The deal carries a coupon of three-month Libor plus 150bp for a 4.41-year average life. However, it may be sold at a tighter spread than that - it is on Citi's balance sheet and will be placed at variable prices in the secondary market, rather than through primary syndication.
"We do think will put some reinvigorated interest back into whole loan trading, and we might see more assets come up as vendors think they can sell closer to where they have assets marked," said Gilmour. "But it won't be to the tune of billions or a flood of issues in the short term."
Thrones follows the GBP117.7m Virgil Mortgage No. 1, which finances a book of re-performing loans held by Fortress Investment Group, and the GBP220.2m Alba 2013-1, which financed a book for Pamplona Capital Management.
These deals are tiny compared to the outstanding volume of mortgages in non-core books, but the economics are at least compelling.
"Securitisation takeouts at 150bp should give confidence to funds looking for mortgages that they can finance the portfolios cheaply, and encourage banks to offer cost-effective bridge finance," said Maddox.
Having securitisation available is important because bank leverage is much more expensive. The precise numbers are always kept very private, but it is a substantial spread. Even when a bank is planning to bridge the fund to a capital markets exit, such as through securitisation, it has to price the facility as though it is term debt, in case the capital markets deal fails.
While securitisation is now helping to transfer assets away from unwilling holders, it also helped create the overhang. Pre-crisis, lending to non-traditional borrowers with poor documentation, adverse credit or high LTVs was heavily reliant on securitisation markets.
When the market shut, this left huge volumes of mortgages remaining in the hands of institutions that do not want them - creating an opportunity where hedge funds and private equity thought there should be bargains. GE Capital has around GBP10bn of unsecuritised UK mortgages which it has said are non-core, while UK Asset Resolution, the holding company for the UK nationalised banks, has GBP40bn outside its securitisations holdings.
Investment banks such as Lehman Brothers directly owned "non-conforming" lenders - in Lehman's case, Southern Pacific Mortgages, Preferred Mortgages and the London Mortgage Company. But Merrill Lynch, Bear Stearns, Morgan Stanley and Deutsche all owned UK non-conforming originators.
Some of these holders have reasons not to sell - UKAR has zero or close to zero cost of capital, noted Gilmour, and should be demanding top dollar for assets on behalf of the tax payer, rather than dumping them quickly.
But plenty do. Thrones 2013-1 finances a portfolio from Heritable Bank, a subsidiary of failed Icelandic institution Landsbanki. It has been in administration since October 2008. Administrators Ernst & Young opened the tender for this portfolio in 2012, with Mars winning the bids and completing in May 2013.
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