Sub-prime motivation

Demand for riskier mortgage debt seems to be on the rise, offering hope of increased funding and an increase in mortgage lending.

Both in the UK and in the US, investors are starting to look at investing in sub-prime debt in a way the market has not seen since the financial crisis, albeit in far lower volumes.

Following the crisis, the wholesale markets, which offer a vital source of funding to lenders, all but closed as investors shied away from bonds backed by mortgages.

It was not until September 2009 that the first post-crisis transaction was launched, when Lloyds Banking Group issued a £2.82bn bond backed by prime Halifax mortgages.

But even though there have been numerous transactions since then, they have tended to be prime transactions offering AAA notes, with the originators of these bonds holding on to the riskier tranches.

In the US, the ABX index, which tracks the performance of sub-prime debt, has risen by 22 per cent in the past year. These have tended to be trades of existing securities rather than new issues but demonstrates a pick-up in appetite.

The picture is also improving in the UK. Last July, Credit Suisse launched a £482m non-conforming RMBS backed by sub-prime loans.

In November, Kensington Mortgages’ parent company Investec looked to publicly place a £204m pool of loans, called Gemgarto 2011-1, which contained a full capital structure, meaning it is not solely made up of AAA notes. Investec eventually pulled the deal but said this was due to pricing issues and not a lack of demand.

Banks are going through a deleveraging process and are required to build capital reserves under the Basel III rules but Cicero Consulting director Iain Anderson says the likelihood of bond issuance becoming an avenue for increased lending is getting closer.

He says: “There is no doubt that sentiment has improved massively. When we see more origination in this area, I think this will be used more to bolster capital but I think the likelihood of this leading to increased funding is more likely than we have seen for a very long time.”

But Home Funding chief executive Tony Ward believes funding will not increase in the short to medium term.

He says: “It is positive that we are seeing a return of investors in riskier assets. We might see wider investment in RMBS asset classes but I do not expect this to give rise to more mortgage lending as banks still need to deleverage.”

Although investor appetite for riskier asset classes has increased, we have not yet seen prolonged demand.

Citigroup Global Markets head of European securitised products research Gordon Kerr says it will take a while before the increased appetite results in new issuance of non-conforming RMBS transactions.

He says: “We have seen a fair amount of trading in this product but it will not necessarily lead to new issuance of these bonds. It will take some time for this to happen.

“The market is healthy at the moment and there are lots of deals happening but it takes time to pull a deal together and people are worried they will not be able to get it away, so it will take a continued rally in investor appetite for that to happen.”