The Bank of England threw another lifeline to banks last week, unveiling a new GBP50 billion ($99.3 billion) special liquidity scheme (SLS)
The new scheme will allow banks to temporarily swap their high quality, triple-A rated MBS and other securities for U.K. Treasury Bills.
The Bank of England has already stepped up its normal liquidity operation since the credit crisis began. It has also offered a number of expanded and exceptional three-month lending facilities since December 2007, which have also accepted ABS and RMBS as collateral.
However, unlike the bank's open market operations, the SLS necessitates an expansion of the Bank of England's balance sheet via the use of T-Bills issued specifically by the government's debt management office for the purposes of this program.
The new scheme will include primarily U.K. and European triple-A cash RMBS and covered bonds. Senior triple-A credit card ABS is also accepted, a category that allows U.S. collateral-backed bonds to be swapped.
Banks participating in the program will be charged a fee, reflecting half the difference between three-month Libor and the Gilt repo rate.
"Any bank using the scheme would effectively be required to provide capital or subordinated funding for anything it swaps under the scheme at a significant multiple of its regulatory capital requirements for the same assets and considerably higher than that required for a AAA' rating," Fitch Ratings analysts said.
The haircuts will vary, with a maximum of 30% for master trusts where collateral might include loans originated after December 2007, 100% of the value of the securities/loans at the end of December will be eligible for the first year, falling to two-thirds in year two, and to one-third in year three. RMBS, ABS and covered bond haircuts start at 12% for maturities under three years.
According to Fitch, the 12% haircut for floating-rate securities compares to a 2% haircut applied by the European Central Bank (ECB) to its valuation of floating-rate securities for use as collateral for its repo funding facilities.
The haircuts are based on observable market prices, with extra cuts of 3% for non-sterling securities, 5% for own group collateral, and 5% for not having an observable market price, giving a possible haircut of 35%.
Banks will be able to enter into new long-term asset swaps at any point during a six-month window starting April 21. Each swap will be for a period of one-year and might be renewed for a total of up to three years. After that, the scheme will close. During the lifetime of an asset swap, banks will be required to pay a fee based on the three-month Libor.
Only securities held on balance sheet at the end of December 2007 or securities backed by loans held on balance sheet at this date will be eligible for the swap arrangement and participating banks will be required to replace the loans if they suffer higher-than-expected defaults.
Analysts said that it's likely that banks will turn to the scheme as a tool to manage balance sheet liquidity and it's unlikely that U.K. banks will immediately use the facility to finance new loan origination.
"Under the SLS, banks can avoid crystallizing mark-to-market, capital depleting losses from accelerated asset sales while reducing their short-term vulnerability to wholesale market technicals," Deutsche Bank analysts said. "Socializing the costs of liquidity in the U.K. mortgage lending bank market (and effectively subsidizing the weakest players) should also mean that the risk of another Northern Rock debacle is reduced, at least."
What the Bank of England has essentially done is to create a program that gives banks the time needed to work out the kinks that have erupted in the credit crisis.
The new liquidity scheme provides U.K. banks with backstop liquidity, guaranteeing amounts that are likely to be inaccessible in the wholesale markets currently.
"The Bank of England has been cautious to minimize the credit risk that is absorbed, but ensuring that liquidity is improved. Reduced access to capital markets both for funding via lower tier 2 debt and risk transfer via securitization is severely restricting many institutions," Societe Generale analysts said. "We expect that many institutions will be aided by the facility, allowing them to benefit from hold-to-maturity."
Rick Watson, managing director and head of the European Securitization Forum (ESF), said that while the new scheme is not securitization related, it does provide a significant amount of cash liquidity to lenders over a sufficiently long three-year window while the securitization market heals.
"Securitization investors need time to evaluate a number of issues - supply overhang, rating agency consultations, and subprime resolution," Watson said. "Everyone wants the market to come back. What this scheme does is provide a lot of liquidity for until the market does come back - hopefully much sooner than three years. I think most of us would think that if the securitization market isn't back by the three year mark - then we have an even bigger problem than we already have."
But Watson said that the Bank of England's new program isn't designed to be a substitute for the long-term securitization market.
Deutsche Bank estimates that the "back-book" of unsecuritized U.K. mortgages is around the GBP975 billion mark and said that the new scheme will likely drive a rise in securitizations of these assets in the near-term.
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