What is securitisation?
Put simply, securitisation is the process used by some lenders to convert the value of the debts they hold (the mortgages they have sold) into bonds, which can then be sold onto institutional investors. These investors do not own the assets, but they do own the securities, which then offer returns based upon the performance of the assets. By securitising, the lender can free up funds and continue to make mortgage loans.
The term securitisation is derived from the word ‘securities’ which is used to describe bonds that can be traded on the securities market.
The technique of securitisation originated in the US and moved to the UK in the late 1980s. It is now the dominant practice in the US and is used significantly in the sub-prime market in the UK. In fact, the Council of Mortgage Lenders has said: ‘The UK is likely to remain the biggest ‘mortgage-backed securities’ market in Europe.’ Around 6% of the total UK mortgage book is currently securitised and this is the largest single group of such assets in Europe.
It is not just mortgage assets that can be securitised ‘ in theory anything that has an identifiable income stream over a given time, where risks can be estimated, can be securitised. For example, Southampton Football Club’s newly-built St Mary’s stadium was financed by securitisation with the future revenue of season ticket sales being used as security against the loan.
What are the other methods of funding available to lenders?
The traditional source of funds for mortgage loans, and the one which the general public is most familiar with, is the funding of new loans from retail deposits. Here, savers put money into a bank or building society, which it then lends to borrowers as mortgage loans secured against property.
The second method open to lenders is to borrow funds on the international money markets. This method has an effect on the sort of rates that a lender can then offer to borrowers. When rates have been falling, lenders have been able to offer competitive fixed and capped rates. However, in times of rising rates, new borrowers are expected to repay loans at the standard variable rate (SVR), so international money markets cannot be guaranteed to fund new mortgage products which give borrowers the benefit of more competitive terms.
Why do lenders securitise their assets?
The main reason why lenders securitise their assets is to remove the assets from their balance sheet. This is known as ‘off balance sheet lending.’ This means the debt does not form part of the lender’s assets. Securitisation also enables the lender to reduce their exposure to certain types of higher risk lending and it can provide an alternative source of mortgage funding.
Having securitised, a lender will continue administering mortgages on behalf of the investor, for which income is earned.
The funds released by securitisation are not tied to fixed interest rates. This allows lenders to design new, competitively-priced mortgage products to offer the borrowing public.
Why is it important for brokers to understand how securitisation works?
It is not essential brokers know the full details about the process of securitisation, as it is complicated. What they should be aware of is the implications it has for the lenders they deal with.
Many mainstream lenders, such as Abbey National and Northern Rock, have been using the securitisation technique for a number of years and it has now crossed over to the non-conforming lender market. For example, Mortgages plc recently announced its fourth securitisation for £250m, bringing the total amount of assets securitised over the £1bn mark since the lender began trading in 1998.
A lender who has recently securitised is demonstrating to the market it is an expanding business which is successfully marketing and selling its products.
With the advent of the requirement for all mortgage advisers to pass professional exams, mortgage brokers are progressively becoming more of a true ‘consultant’ to their clients. In addition to their knowledge about product terms and conditions, it is important that brokers also have a good working knowledge of the way lenders are funded. This enables the broker to satisfy the possible demand from borrowers to know more about the non-conforming lenders they are being advised to take products with.
What are the implications for borrowers from securitisation?
Essentially, there is little direct impact on borrowers who have mortgages with lenders who have securitised some of their loan book. This has been demonstrated in the US where approximately 60% of US mortgages continue to be funded through securitisation with no visible price differential.
What it does mean is that there is a healthy mortgage market and lenders are keen to raise capital funds to offer new competitively priced products. Ultimately the borrower will benefit from the number of products available on the market.