The U.K. mortgage market is predominantly a refinance market, with borrowers on average refinancing their loans every two to four years after the expiration of their teaser period.
As lenders limit the number of their product offerings, more of the country's borrowers could be headed for payment shock with less opportunities to refinance.
In the prime market, the decreasing number of mortgage products to choose from has been made evident when some lenders predicted that overall origination is expected to slow as certain loan offerings are scrapped altogether. For instance, mortgage originators Alliance & Leicester, Birmingham Midshires and Northern Rock pulled their 125% LTV mortgage products recently.
In the nonconforming space, it's been more a case of shutting up shop than tightening criteria, the most recent example being Morgan Stanley's discontinuation of its U.K.-based residential mortgage lending business, Advantage Home Loans.
Fitch Ratings responded that the closure will not have any impact on the bank's ResLoc U.K. 07-1 RMBS backed by Advantage mortgages. The servicing of the loans is done by a third party, Homeloan Management (a subsidiary of Skipton Building Society), with Morgan Stanley Mortgage Servicing handling the special servicing. Both of these entities are unaffected by the closure of Advantage with the special servicing unit set to remain operational.
Lehman Brothers cut 200 staff from both of its U.K. mortgage lenders, Southern Pacific Mortgages and Preferred Mortgages. According to a company statement, the businesses will refocus on the near-prime market. Lehman has a number of securitizations outstanding under its various RMBS programs, including ESAIL, Southern Pacific securitization and Preferred Mortgages PRS series.
Britannia subsidiary Platform, the originator behind the LEEK program, also announced that it will be laying off 65 of its 305 employees, citing difficult market conditions.
Meanwhile, Finance Ireland announced that it will temporarily withdraw its lifetime mortgage products from the Irish market because of ongoing difficulties in the wholesale banking and mortgage securitization markets. The company said its decision to remove the products also comes in the wake of the unavailability of reasonably priced wholesale funding.
"The above job cuts are all reflective of the current challenges in funding new nonconforming originations," Deutsche Bank analysts said. "Previously securitization has been the key plank in these lenders' funding strategy, but currently the primary market for such transactions is essentially closed." The decrease in lender activity will likely reduce the refinance options for borrowers in the nonconforming sector when their teaser rates expire, analysts said.
"If lenders continue to exit the market or withdraw product ranges, options for borrowers to refinance when they are due will be limited or may not be available," said Dipesh Mehta, manager on the securitization research team at Barclays Capital. "The borrower will attempt to remortgage with their current lender, if possible, or be forced to revert to the higher SVR of the bank. This higher rate can result in a payment shock for the borrower leading to potential delinquencies."
Phil Adams, RMBS research analyst at Royal Bank of Scotland, said the stress is likely to fall more heavily on the most vulnerable borrowers because they will find it hardest to refinance their loans.
Even prime lenders who have made moves to tighten underwriting standards have effectively shut out some borrowers from refinancing, especially those with more unpredictable income streams or interest only 100% LTV loans.
Even if borrowers manage to find an alternative product, they are likely to be paying a higher rate than their current teaser rate as a result of the funding problems of these nonconforming lenders, which would also lead to a payment shock. This risk is partially mitigated by the Bank of England lowering interest rates, although lenders, especially those suffering from funding issues, might not pass this rate discount to borrowers, Mehta said.
This is why analysts believe that deal performance is likely to deteriorate in 2008. How far this deterioration goes will largely depend on how well the economy, particularly unemployment, weathers the slowdown.
Performance deterioration, especially in nonconforming mortgages, causes prepayments to fall, impacting existing deals.
For existing securitized transactions, a slowdown in prepayment rates could result in potential extension risk as the bonds continue past their expected maturity dates, whether they are step-up dates or clean-up call options, adding a reputation risk for lenders who wish to enter this market again in the future (ASR, 2/27/08).
Chris Greener, senior analyst at Societe Generale, said that the nonconforming landscape will change significantly as many of the existing lending practices appeared poor, although these were still being priced to meet investor demand and to conform with rating agency models. This renewed focus on risk will likely limit demand in a market that already has an overhang of existing loans waiting to be securitized.
"Nonconforming lenders are heavily dependent on the capital markets for funding and are therefore suffering from funding and liquidity issues as the securitization market has largely been closed since August last year," Barclays' Mehta said. He added that if this persists, it is likely that the nonconforming market will be significantly altered with reduced product availability, especially further down the credit spectrum, unless alternative financing methods are found.
If the nonconforming market reopens and some level of normalcy returns, lenders are likely to be more cautious, especially in the next few years, as they look for additional supplemental sources of funding.
Loan margins would also have to gap out significantly to cover the massive spread widening, SocGen's Greener said, adding that even then demand for the risk transferring in single-A and triple-B-rated tranches will be extremely low - even for quality paper - and would likely lead to difficulty in executing the transfer.
"I think the market will take some time to return; even then I don't expect it to get back to the conditions of a year ago for several years at least," RBS' Adams said. "I won't say it's been permanently altered, because never' is a very long time - it's only 15 years since the last (and much more serious) housing crisis in the U.K. However, I do think that the recovery in market confidence will be measured in years, not months." - NCThe U.K. mortgage market is predominantly a refinance market, with borrowers on average refinancing their loans every two to four years after the expiration of their teaser period.
As lenders limit the number of their product offerings, more of the country's borrowers could be headed for payment shock with less opportunities to refinance.
In the prime market, the decreasing number of mortgage products to choose from has been made evident when some lenders predicted that overall origination is expected to slow as certain loan offerings are scrapped altogether. For instance, mortgage originators Alliance & Leicester, Birmingham Midshires and Northern Rock pulled their 125% LTV mortgage products recently.
In the nonconforming space, it's been more a case of shutting up shop than tightening criteria, the most recent example being Morgan Stanley's discontinuation of its U.K.-based residential mortgage lending business, Advantage Home Loans.
Fitch Ratings responded that the closure will not have any impact on the bank's ResLoc U.K. 07-1 RMBS backed by Advantage mortgages. The servicing of the loans is done by a third party, Homeloan Management (a subsidiary of Skipton Building Society), with Morgan Stanley Mortgage Servicing handling the special servicing. Both of these entities are unaffected by the closure of Advantage with the special servicing unit set to remain operational.
Lehman Brothers cut 200 staff from both of its U.K. mortgage lenders, Southern Pacific Mortgages and Preferred Mortgages. According to a company statement, the businesses will refocus on the near-prime market. Lehman has a number of securitizations outstanding under its various RMBS programs, including ESAIL, Southern Pacific securitization and Preferred Mortgages PRS series.
Britannia subsidiary Platform, the originator behind the LEEK program, also announced that it will be laying off 65 of its 305 employees, citing difficult market conditions.
Meanwhile, Finance Ireland announced that it will temporarily withdraw its lifetime mortgage products from the Irish market because of ongoing difficulties in the wholesale banking and mortgage securitization markets. The company said its decision to remove the products also comes in the wake of the unavailability of reasonably priced wholesale funding.
"The above job cuts are all reflective of the current challenges in funding new nonconforming originations," Deutsche Bank analysts said. "Previously securitization has been the key plank in these lenders' funding strategy, but currently the primary market for such transactions is essentially closed." The decrease in lender activity will likely reduce the refinance options for borrowers in the nonconforming sector when their teaser rates expire, analysts said.
"If lenders continue to exit the market or withdraw product ranges, options for borrowers to refinance when they are due will be limited or may not be available," said Dipesh Mehta, manager on the securitization research team at Barclays Capital. "The borrower will attempt to remortgage with their current lender, if possible, or be forced to revert to the higher SVR of the bank. This higher rate can result in a payment shock for the borrower leading to potential delinquencies."
Phil Adams, RMBS research analyst at Royal Bank of Scotland, said the stress is likely to fall more heavily on the most vulnerable borrowers because they will find it hardest to refinance their loans.
Even prime lenders who have made moves to tighten underwriting standards have effectively shut out some borrowers from refinancing, especially those with more unpredictable income streams or interest only 100% LTV loans.
Even if borrowers manage to find an alternative product, they are likely to be paying a higher rate than their current teaser rate as a result of the funding problems of these nonconforming lenders, which would also lead to a payment shock. This risk is partially mitigated by the Bank of England lowering interest rates, although lenders, especially those suffering from funding issues, might not pass this rate discount to borrowers, Mehta said.
This is why analysts believe that deal performance is likely to deteriorate in 2008. How far this deterioration goes will largely depend on how well the economy, particularly unemployment, weathers the slowdown.
Performance deterioration, especially in nonconforming mortgages, causes prepayments to fall, impacting existing deals.
For existing securitized transactions, a slowdown in prepayment rates could result in potential extension risk as the bonds continue past their expected maturity dates, whether they are step-up dates or clean-up call options, adding a reputation risk for lenders who wish to enter this market again in the future (ASR, 2/27/08).
Chris Greener, senior analyst at Societe Generale, said that the nonconforming landscape will change significantly as many of the existing lending practices appeared poor, although these were still being priced to meet investor demand and to conform with rating agency models. This renewed focus on risk will likely limit demand in a market that already has an overhang of existing loans waiting to be securitized.
"Nonconforming lenders are heavily dependent on the capital markets for funding and are therefore suffering from funding and liquidity issues as the securitization market has largely been closed since August last year," Barclays' Mehta said. He added that if this persists, it is likely that the nonconforming market will be significantly altered with reduced product availability, especially further down the credit spectrum, unless alternative financing methods are found.
If the nonconforming market reopens and some level of normalcy returns, lenders are likely to be more cautious, especially in the next few years, as they look for additional supplemental sources of funding.
Loan margins would also have to gap out significantly to cover the massive spread widening, SocGen's Greener said, adding that even then demand for the risk transferring in single-A and triple-B-rated tranches will be extremely low - even for quality paper - and would likely lead to difficulty in executing the transfer.
"I think the market will take some time to return; even then I don't expect it to get back to the conditions of a year ago for several years at least," RBS' Adams said. "I won't say it's been permanently altered, because never' is a very long time - it's only 15 years since the last (and much more serious) housing crisis in the U.K. However, I do think that the recovery in market confidence will be measured in years, not months."
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