The truth is: the Mortgage market NEEDS securitisation

 

Over the past 18 months the word ‘securitisation’ has become synonymous with the credit crunch and has been demonised to such an extent that rational discussion of its future role in funding the mortgage market has become virtually impossible.

 

Whilst it is undeniably true that some of the deals issued, particularly the ones that relied heavily on ’financial black arts’ and (a)  had a great deal of complexity/lack of transparency and (b) were responsible for much of the financial fear and contagion that went around the financial sector, the truth is that securitisation, used in the right way and context, still has an essential role to play in the funding of mortgage products in the future.

 

 

Putting securitisation in perspective  

 

So much has already been said about securitisation and the global credit crunch that I won’t go into any detailed analysis here. A very short précis would be that what started off as a relatively simple funding and risk transference mechanism became in many instances far too complex, with many of the underlying assumptions (particularly from the rating agencies in the US), flawed. So complex in fact that in some deals became impossible to properly assess in terms of risk.

 

Cheap credit and the ‘carry’ trade between borrowing ‘short’ and buying ‘long’ meant that demand continued to grow from the SIVs and conduits encouraging/allowing lenders to package up more and more assets into ever more complex details, many of which in the light of day now, were entirely inappropriate.  In short, securitisation ended up being used for assets and in ways for which it was never originally designed.

 

So in the ‘demonising’ of securitisation it is important to get the perspective right. Whilst some deals have ‘blown up’, most notably US non-conforming/Alt A mortgage deals and the CDOs, UK residential mortgage deals, the immediate area that concerns us, continue in the main to perform within expectations. Senior notes (AAA/AA) are not under threat and the biggest concern for most investors is not whether the capital is ultimately safe but the timing around when the notes will be pre-paid given the slowing redemptions of mortgage loans. In short this is more a timing and liquidity issue for most investors in UK RMBS rather than a collateral performance issue.      

 

 

Will there again be a market for new mortgage issuance?

 

For a market to return there has to be demand/need from both sides - the issuer and investor. From the issuer’s side, there is still a clear funding issue with most of the banks. Whilst immediate cash/liquidity issues have been addressed, access to longer term funding remains problematic. This is evidenced in all aspects of lending but particularly mortgages where not only has the price of funding increased dramatically, but the level of funding  has significantly reduced.

 

The figures from the CML clearly show this with gross mortgage lending falling from circa £360Bn in 2007 to circa £160Bn this year. Whilst the £360Bn figure may be an aberration at the height of the market, clearly lending at today’s levels does not go anywhere near satisfying demand which we estimate around the £250Bn level per annum. Without the ability to generate funding from external investors, the mortgage market is going to be left short of funding for the long term..

 

On the investor side demand will always exist for quality, transparent assets with high returns. The question is how far new deals can go towards satisfying these requirements.   

 

 

‘Back to basics’ for new issuance   

 

It is accepted by all sides that for the securitisation market to return, significant changes are required. However we believe that securitisation, used in the right way still offers both issuers and funders a good way, of generating funding/good returns with minimal risk.

 

Whilst in the past securitisation was used by issuers as both a means of funding and risk transference, it is accepted now that new issues will not be able to transfer all the risk without the issuers themselves retaining a significant piece. Securitisation will therefore become much more about funding rather than risk transference. In addition all of the factors, which in hindsight made securitisation of mortgage assets a higher than often appreciated risk, have been addressed. By this I am referring to the assumptions made by the UK ratings agencies, (which are now clearly being tested and from a UK perspective are actually, believe it or not, not too far off the mark), but most importantly the quality of the underlying collateral.

 

Assets generated post credit crunch have all the advantages and none of the dis-advantages of pre-crunch legacy assets. Assets being generated now have higher margins, tighter criteria (built on post credit crunch learnings) but most importantly the underlying collateral, the houses, are at the or near the bottom of the price cycle. Losing money at the bottom of the property cycle is going to be very difficult to achieve!

 

With more conservative structured deals, a ‘sharing’ of the risk between issuers and investors, a complete re-setting of the bar in terms of the underlying collateral, and much greater investor returns than were ever previously available, it is perfectly feasible that investors will once again look at high quality, transparent securitisation paper.   

 

 

Market timing

 

With a clear imbalance on the mortgage funding side, we are very much of a view that that securitisation will return. The only thing that is a little unclear at present is the timing.

 

With the SIVs and the conduits purchasing over half the securitisation paper pre-crunch, clearly their subsequent closure combined with the slowing pre-pay speed of mortgage assets has meant a glut of paper in the market. This can be seen in the very wide spreads in the secondary markets which is more a reflection of liquidity than of underlying performance concerns. However, excess paper is clearly a timing issue. As house prices level and existing mortgage paper continues to redeem, confidence starts to return and over-supply diminishes.  

 

One of the biggest problems in the market is the lack of issuance to test new demand and pricing. As outlined above, new deals would be so superior to existing deals that they would hardly bear comparison. Our view is that within the next 12 months we will see the first of several new deals coming to market as some lenders look to release some cash. Whilst the price may be wide and the demand limited, it will represent the start.     

 

 

Ultimately markets themselves find solutions to funding issues and clearly securitisation, with the right structure and right price will address the requirements from both sides. The mortgage market needs funding and securitisation is ultimately a long term part of the solution rather than the underlying problem.