Tapping the market for £2 billion ($3.2 billion) in the middle of August is something that most bank treasurers would have probably done a great deal to avoid. Not so Lloyds Bank, which did just that via an RMBS trade backed by mortgages from its Cheltenham & Gloucester subsidiary.
The deal was swiftly followed by a £2 billion-equivalent deal from Santander UK in September and £2.5 billion from building society Nationwide. RBS priced a £3.6 billion RMBS deal in October and at the end of last month Lloyds had just announced a similarly sized deal, backed by HBOS mortgages, which is expected to raise £3.5 billion. In late October, Barclays Capital was also poised to roadshow its first RMBS deal since 2007.
While other banks in Europe face a growing funding squeeze, these UK mortgage banks are benefiting from a perfect storm of low ABS spreads in the US and an abnormally expensive euro-sterling swap. The result has been strong dollar demand for securitized assets that are seen as of high quality but paying much more than their US equivalents, together with a strong disincentive for UK issuers to issue in euros.
The consequences are striking: the July Lloyds deal raised $3 billion in dollars, Santander UK’s dollar component was $3.25 billion, Nationwide’s $2.75 billion and RBS’s $3.8 billion. The latest Lloyds deal will raise $2.95 billion in dollars.
Pricing lure
The reappearance of Barclays Capital is important, as the UK bank has been an active covered bond issuer. It raised €2 billion in the covered bond market in August at 52 basis points over mid-swaps. The lure of RMBS pricing seems to have now caught its attention.
"Covered bonds used to be cheaper than securitization but the recent RMBS deals have achieved very good pricing from the US," observes one covered bond specialist. "UK banks are in a fortuitous position because they can issue where the demand is."
And that demand is in dollars.
"Large US dollar investors have always been a significant part of the UK RMBS market," says Damon Mahon, head of European ABS syndicate at RBS. But the nature of their involvement has changed. Before 2007, dollar tranches were targeted at 2a7 funds and were thus overwhelmingly of 12-month duration. But this issuance is highly collateral inefficient, as it is structured as a one-year hard bullet.
Several of the recent deals have included natural 2a7 one-year tranches but they don’t tend to be larger than $500 million to $750 million. They are cheap – Santander paid 13bp over Libor on its 12-month Holmes tranche. As UK banks also now have to hold liquidity against funding of 12 months or less, they are concentrating issuance at around the three-year maturity mark. Nationwide even incorporated a $500 million nine-year fixed-rate tranche in its deal – an unprecedented maturity for a UK master trust that was the result of a reverse enquiry from a high-quality real-money buyer.
Dollar buyers
Dollar buyers that have moved in include the treasury departments of several large banks along with supranational buyers and large money managers. JPMorgan CIO has been the single largest buyer for some time but other North American bank treasuries, in particular Citi and Wells Fargo, have been building up their presence.
"Although the number of buyers is increasing, six to seven large buyers take more than half of the US dollar books in these deals," says Miray Muminoglu, director on the London syndicate team at Barclays Capital. "There are also a few new names looking to get involved in large size."
When Santander did its first 144a tranche after the crisis, it attracted 12 accounts – the dollar tranches it issued in May this year attracted 120 accounts.
This surge in demand is driven primarily by the spread differential.
| "A small number of investors are sitting on their hands over concerns about contagion from the eurozone but a larger number of new investors are looking to come in" |
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"US investors looking for secured financing have the option of US credit cards or autos at around 15bp to 20bp over Libor or UK prime RMBS at around 150bp over Libor," explains David Wallis, treasurer at Nationwide. "A small number of investors are sitting on their hands over concerns about contagion from the eurozone but a larger number of new investors are looking to come in." And UK RMBS is to some extent benefiting from being seen as distinct from eurozone risk. "Although UK banks might be benefiting from some marginal eurozone aversion, we expect dollar funding will remain significant for issuers," says Mahon. "But as and when the basis swap normalizes, euro issuance will again become more attractive."
Another driver is the arbitrage available to the US banks, which can use ABS in their liquidity buckets. European banks cannot.
But it is not just US institutions that are buying. "Just because these are dollar buyers does not mean that they are based in the US," explains Tom Ranger, head of structured funding at Santander UK. He reveals that the 2.7-year $3 billion A2 tranche in the May Fosse transaction was only 35% sold into the US. "These tranches are attractive to currency-neutral buyers wherever they are." The net result has been a huge reliance by UK banks on the dollar bid for their RMBS funding. Some of these deals have been 90% sold in dollars. "US buyers are buying the paper in yards but interest from euro buyers is more muted," says Muminoglu. "If you want to get large deals done, you need to call in the cavalry and that is US dollar investors."
Headache
At some point, however, the imbalance in the funding market will become a headache for the UK banks if they become too reliant on the dollar bid. Indeed, some have included small euro tranches in their deals – presumably to maintain relationships. The Santander deal in September incorporated a €200 million tranche at 140bp over Euribor for 3.5 years. "We will always try to offer a euro tranche where possible," Ranger tells Euromoney. "It is important for us to issue in euro and maintain those relationships." He describes the swap cost on the recent Holmes tranche as "horrendous" but says that there was a degree of cost sharing with investors in the tranche. The three-year euro-swap spread is running at between 35bp and 50bp.
There is a clear desire for more of a balance. "It looks like the market is distorted towards dollar issuance but if the euro basis improves, people will move back into euro – but no one is prepared to pay the 70bp cost to swap back to sterling currently," says Wallis. "The euro basis is obscuring the demand in euro." That demand does seem to be fairly muted at present. The Holmes deal could have gone to €250 million on the euro tranche but only went to €200 million. RMBS issuance from eurozone banks has also been scarce – apart from Dutch issuers. Rabobank launched a €700 million trade in October – but is understood to be considering establishing a US dollar programme as well.
The run of jumbo issuance from the UK banks has been a fillip for the RMBS market, which was such a stalwart of UK bank funding before 2007. "The percentage of new issuance being issued in dollars is not a million miles away from where it was before the crisis," says Ranger. "We have been issuing dollar tranches since 2000 so this is not new – it was just a case of getting investors to reconnect with the product."
