It’s been quite some time since we have seen a new public issue in the UK RMBS market. In fact, it’s probably been closed for new deals since the beginning of the crisis. As property prices plummeted, and as everyone fled risk assets for cash and gilts, RMBS bonds saw large price falls. Liquidity in these bonds actually suffered almost as much as subordinated bank bonds, because unlike corporate bonds where you generally know the company you are buying into and the terms on which you are agreeing to invest in them, with RMBS you have to know about all the structural idiosyncrasies of the bond, including its ranking, which assets it is secured against, what the triggers of the structure are (that can sometimes protect you as an investor, and sometimes impede you), and so on. Given these additional layers of complexity in contrast to a traditional corporate bond, and given that they are largely secured upon financial assets, which everyone hated during the onset of the crisis, liquidity fell off a cliff.
Last week, though, we saw the issue of Permanent Master Trust 2009-1, the RMBS issuing platform of Halifax Bank of Scotland (now owned by Lloyds TSB). The government, having provided all the support it has to prop up the entire banking system (including capital injections, debt guarantees, liquidity facilities, and asset purchase schemes (almost!)), was keen that the banks in return offer to make new loans to its voters. So banks on the one hand had to de-lever urgently, but on the other now owed their very existence to the government who were telling them to keep lending. In fact, even, to increase lending over 2007 levels!
Whilst banks have not been able, let alone willing, to originate many new loans of any type, even secured, they have clearly made some, and have built up meaningful balances of mortgages and other loans that are sitting on balance sheet, or being financed on repurchase agreements with the Bank of England or the European Central Bank. It felt that the old master trust system had well and truly broken. Until Wednesday.
In order to get the investment community interested once more in the UK RMBS space, the Permanent deal had to come with an array of structural concessions in favour of the buyer. Whilst there are too many protections built in to mention here, there are a couple that are worth mentioning. The first was that traditionally you bought a master trust RMBS bond that had two maturity dates, the first being an expected maturity date, and the later being a legal final maturity date. The difference between these was that in the event that everything was working fine, your bond would pay out at expected maturity as cash flows from all the mortgages started to be trapped to build up your expected principal. But if there was some kind of problem with the market, the master trust, or the bank, and the principal couldn’t be built up within the master trust, then you knew you had the risk of extension of your bond to legal final maturity date. This new bond, though, came with a new put option at the expected maturity date, which means that after 5 years if the master trust hasn’t been able to trap the cash to pay our principal out (at expected final), we as investors can put the bonds to Lloyds and get our principal back. So the new RMBS deal has eradicated extension risk, and is now essentially a bullet bond. The other new feature of this issue was that Lloyds-HBOS replenished the master trust’s reserve fund, which is the most subordinated part of the trust, from c.2% to c.8%. In other words, the issuing banks felt they needed to improve the credit enhancement of the trust to get a new deal done.
Well, these improvements to the old structures worked. The deal was upsized (ie they issued more than planned) given the high interest, and even after increasing the size of the deal, the books were 2 times oversubscribed (orders for 2 bonds for every one being issued). Lloyds-HBOS issued euro and sterling denominated tranches, both coming at around Libor + 1.8%. The deals have performed extremely well in the last couple of days, and are now quoted at spreads of around Libor +1.3%, meaning the bond is priced almost 2 points higher in only 2 days!
Our feeling is that at this level of funding for new mortgages (somewhere close to 1.5% over Libor), the banks are once more, and after a considerable period of time, economically able to finance mortgage loans. We thus anticipate more deals to come from other master trust issuers in the coming weeks. Ultimately, if this genuinely represents the reopening of the RMBS market, and doesn’t turn out to be just a fillip, then mortgage availability to all of us is about to improve dramatically, and that just can’t be a bad thing.