What is securitisation?
Put simply, it is a means by which a bank or other mortgage lender can refinance its mortgage loans. Typically lenders will make the mortgage loans using short term facilities or on-balance sheet funding until they have a large enough pool of mortgages.
Then they are able to bundle them together, transfer them to a special purpose funding vehicle and issue either Eurobonds or mortgage backed securities secured on these loans.
This funding technique started being used in the UK in the mid 1980s by the specialist and centralised lenders such as National Home Loans (now Paragon), but it was during the last 15 years that large lenders started issuing in volume.
Why would anyone want to securitise mortgages?
The most obvious reason is to raise funding. Banks and lenders that fund mortgages exclusively on-balance sheet will have a limit to how much funding is available to them.
If you are funding mortgages from short term funding sources like retail deposits, then you run the additional risk that you are lending long and borrowing short, and this is exactly what happened with Northern Rock. It wasn’t the securitisations that were the problem – quite the reverse.
They had managed to make mortgage loans which were funded by comparatively short term bank facilities and retail funding with the intention of refinancing through the longer term mortgage backed securities markets.
But the securitisation markets disappeared overnight at the onset of the credit crisis in August 2007, leaving Northern Rock with a funding problem. Had they securitised their entire mortgage loans before the crisis, then the bank run need not have happened.
Another benefit of securitising mortgages is that you pool risk. In broad terms the securitisation structure has to be able to survive a house price collapse in the order of 50%, all happening on one day and simultaneously coping with nearly 20% of borrowers defaulting.
How many lenders run that sort of analysis and make provision for it in advance? By doing this, the mortgage backed security issue is able to obtain ratings up to an AAA level and ensure that senior (or highly rated) note holders will get their interest paid on time and in full. This has made mortgage backed securities a much sought after investment over the last few years.
So what went wrong?
The short answer is very little. The securitisation deals that have taken place in the UK have been well executed, with fewer than 10% of issues being downgraded and no losses by investors. The US on the other hand has seen in excess of 50% of their issues either being downgraded and/or defaulting.
A problem that has increased over the last 10 years is that investors in mortgage securities have been what are called leveraged investors. That is to say they have borrowed the money to be able to buy mortgage backed securities.
With the overall global shortage of liquidity that we have seen, this type of investor has withdrawn from the market leaving comparatively few investors left. That is why non bank lenders have substantially withdrawn from the market and still find it difficult to raise funding through this market today.
Looking ahead
The UK is by far the largest issuer of mortgage backed securities in Europe, accounting for about 70% of the European market. Our issues have stood the test of time and are, by and large, performing well.
Large issuers have been issuing again since September 2009 (Lloyds were first back into the market in any size) and since then the pace of issues has stepped up.
There have been some glitches with deals pulled at the last minute, but in a market dominated by Eurozone nerves that is hardly surprising.
This is a market that we all need to recover. Funding from the government and the Bank of England is all well and good but it is not available to all lenders. The Funding for Lending Scheme for example is not available to non-bank lenders or smaller banks and building societies.
But it is not external investment, which is what the country needs right now. Only by freeing up liquidity from this source of funding and getting foreign investment back into the UK mortgage market will we be truly be on the road to recovery.
Tony Ward is chief executive at Home Funding
