Bank of England’s Funding for Lending Scheme (FLS), which provides cheap funding for banks and building societies, may not eat into ABS and MBS issuance from U.K. originators as much as first thought.

In a report this week, Bank of America Merrill Lynch analysts have injected some nuance into their initial view that the program would hinder primary securitization supply.

“Ironically, the scheme which was meant to stimulate lending to the real economy lead to the contraction of spreads of bank funding instruments...by fostering expectations of low supply in the future, and consequently making market funding more attractive due to expectations for constraint supply, ” analysts said in their most recent report.

They cited the recent placement of a €650 million ($817 million) RMBS by Santander U.K. as an example of a leading originator that had not let the FLS deter it from tapping the market. While reportedly only a single investor bought the deal, it was understood to have accepted a wafer-thin spread of 75 basis points over 3-month Euribor. The transaction's weight-average life was 2.3 years.  

Indeed, BofAML analysts believe that any further spread tightening in ABS and MBS in the U.K. could wipe out the pricing advantage of FLS over securitization by banks that are, in the market’s view, the highest quality originators.

But this advantage does not accrue to every issuer or collateral type, and if markets turn south even slightly, the balance could tip decidedly in the FLS's favor.

One potential outcome of the FLS is that banks may be more prone to post commercial real estate collateral, which has less of a market right now, for their FLS funding and securitize residential mortgage and consumer loan collateral, which has been easier to place with market investors in recent months. Basically it would be riskier collateral for the BoE and safer stuff for market investors.

Launched by the BoE in mid-July, the FLS allows banks and building societies in the U.K. to use certain pools of loans as collateral against borrowing Treasurys from the BoE with a maturity of up to four years. Originators can borrow up to 5% of their loan book, plus any next expansion of lending from July 2012 to the end of this year.

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