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Northview Group ¦ UK Mortgage & Property Research Report ¦ Spring 2018 PDF Print E-mail
Monday, 09 April 2018
Mortgage lenders rely on a range of short and long term funding sources, generally either retail deposits, warehouse funding lines, securitisation or other debt issuance, or in many cases – some combination thereof. When the financial crisis hit, access to the latter two was effectively cut off. Government liquidity schemes became an important boost to funding availability, although access to these was generally (and remains) restricted to deposit-taking banks and building societies. Almost a decade on from the crisis, wholesale funding markets have largely recovered and RMBS issuance is once again an important funding tool. During this time however, the UK mortgage lender landscape has changed significantly, with many specialist lenders who were active pre-crisis and reliant on securitisation for funding exiting the market entirely. A group of new lenders has emerged, first through the forceful entrance of the so-called “challenger banks” and in more recent years a number of new specialist lenders and online lending platforms. The timeline in Figure 1 summarizes the cycle the market has been through in the last decade. In this issue, we examine the various funding options available to lenders today, and review the historical market conditions which have led to this more closely. 

The RMBS market, which was very active and well-developed just before the crisis hit, has made a recovery from the complete absence of issuances in the years following it, but as can be seen in Figure 2, has not returned to its pre-crisis peak.

Many of the lenders who relied on it as their main source of funding collapsed and exited the market. The financial institutions that did continue to issue securitisations in the following years did so almost exclusively through retained structures, which were very rare previously. The significant increase in these in 2007-2011 is apparent in Figure 2. In addition to being used to refinance existing debt, these structures are evidence of the importance of central bank funding schemes at the time, as they became a key way post-crisis for banks to access various liquidity schemes through repo transactions.

Distributed RMBS began to be issued again by lenders for whom it was the key source of funding around 2013/14, when specialists such as Paragon and Precise started accessing the market on a regular basis, followed by the Northview Group (known as Kensington at the time) in 2015. By then, the cost of RMBS funding had reached more stable levels following the extreme spike from 2008-12, and AAA spreads for specialist issuers hovered around 80-110bps over Libor. By the time these increased again in mid-2015, both Paragon and Precise had acquired banking licences. Paragon has not issued any RMBS since, and Precise has become a much less frequent issuer, with both firms opting for retail deposits or central bank funding instead.

They were not alone in going down this route. Many of the new entrants who moved into the lending market right after the crisis have received or applied for banking licenses and are funding their lending with deposits. The importance of deposits as a source of funding for lenders is evident when looking at UK Finance’s (formerly Council of Mortgage Lenders) list of the biggest UK mortgage lenders. Of the top 20 from the 2016 list1, there is not a single one without a banking license. In fact, the Northview Group (NVG) is the largest UK mortgage lender without one. It comes as no surprise that NVG is also the most active RMBS issuer, with 7 new origination issuances since re-entering the RMBS market in 2015. This reliance on RMBS does have benefits however, as it allows the group’s assets to be almost fully match-funded, and this reduction in asset-liability mismatches is one of the key advantages of funding through securitisation. Another benefit for originators is the risk reduction offered by the fact that once the assets are sold into an SPV and securitised, bondholders do not have recourse to the originator and the risk is shared by the institutional investors in the notes. As can be seen in Figure 4, the wave of new lenders who entered the market around 2015 have opted to fund their lending through securitisation, which became a viable and attractive option once again, both for the reasons discussed above as well as the decrease in funding cost at the time.

Besides cost of funding, the increase in lenders opting to become banks can also be attributed to the fact that in 2013 the PRA and FCA simplified the authorisation process for being granted a banking licence and made changes to the regulatory requirements for start-up banks in order to reduce barriers to entry. The application process was changed to include an optional “mobilisation” phase which allows banks to become authorised more quickly, with the assessment phase taking as a little as 6 months so long as the firm has adequately prepared its application. This step allows a firm to begin operating as a bank (albeit with some restrictions) so that they can invest in the build out of the bank and expand their operational capabilities while awaiting full authorisation.

The new process also introduced reduced capital requirements at authorisation (to reflect the fact that new banks are not of systemic importance) and reduced liquidity requirements for new banks (through removal of the new bank premium). Following the changes, in its first 12 months of operation a new bank is expected to hold as a minimum sufficient capital to meet Pillar 1 (8% against RWA) and Pillar 2A (scalar to Pillar 1 for additional risks) requirements for at least the next 12 months based on the projected business plan, plus the Capital Planning Buffer, which in the new process is calculated as the wind down cost rather than the 12-months operating cost2. The liquidity requirements were also reduced to fall in line with incumbent banks.

Paragon was one of the first banks to be granted a licence through the new process, making use of the mobilisation option. Precise, which was historically a big issuer of RMBS, followed suit several years later through their Charter Savings Bank (CSB) entity. In the 3 years since launching in March 2015, CSB has raised c. £5Bn of retail deposits3, vs c. £1.3Bn in placed RMBS. While the cost of raising retail deposits for “challengers” such as CSB and Paragon is still higher than that of incumbent high street banks (as seen in Figure 6), having a banking licence provides these firms with a significant source of funding diversification, and also makes them eligible for government funding schemes such as TFS which have been an important boost to funding.

The Term Funding Scheme (TFS) was introduced in August 2016 and was made available to banks and building societies to encourage them to pass on the 25bps BoE base rate cut made in the same month to consumers by lowering the banks’ cost of debt. This worked by allowing them to borrow up to 5% of their existing stock of lending (as of 30/06/2016), as well as additional funds equivalent to net new lending at the bank base rate so long as they maintained or increased their total lending level. The scheme closed on 28 February 2018, with more than £127bn in drawdowns made.

As can be seen in Figure 7, many of the mid-size high street banks and building societies and challenger banks who issued RMBS prior to the launch of the scheme and who tapped into TFS-funding have issued no, or much less, RMBS since the programme’s launch. Master Trust issuances also decreased significantly, with only a handful of issuances in total across the market between the launch and end of TFS. Despite being restricted to deposit-takers, the scheme created favourable funding conditions beyond the lenders eligible for drawdowns, as the resulting decrease of RMBS issuances from deposit-takers, coupled with a number of redemptions of large legacy Master Trusts, led to an imbalance in supply and demand which helped drive funding spreads tighter for non-bank issuers whose issuances became increasingly coveted in a supply-light market. Funding cost across the capital structure for all types of UK RMBS collateral reached levels that had not been seen since before the crisis. Figure 8 demonstrates the extent to which Non-TFS eligible lenders took advantage of this and dominated issuances after August 2016.

As can be seen, the cost of and availability of the different types of funding is subject to significant fluctuations, and these are not always easy to anticipate. For example, in the summer of 2016, few RMBS-reliant lenders would have predicted that the Brexit vote would have led to better funding conditions for them via the base rate cut and subsequent TFS-driven decrease in RMBS issuances. Such volatility is of course not always favourable for lenders, and is an argument for funding diversification, which is one of the advantages of having a banking licence. Nonetheless, wholesale funding remains an attractive and important source of funding for lenders, and access to it also increases competition in mortgage lending as it enables new lenders to enter the market more easily than if they had to go through the banking licence authorisation process. Most of the more recent specialist lenders who have entered the market have opted for the wholesale funding route. In the immediate future, the end of TFS is generally predicted to lead to an increase in RMBS issuances from eligible lenders who will look to supplement their current funding options and re-finance their existing drawdowns. There has already been an increase in issuances from high street lenders in recent months, and this renewed activity could lead to spread widening after many months of tightening. As in any market, cost will ultimately come down to a balance of supply and demand.

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