Thanks to the expansion of the Bank of England’s Funding for Lending Scheme (FLS) by one year to January 2015, there will likely be few securitization deals placed with investors in the foreseeable future, according to Barclays analysts.
RMBS in particular stands to keep getting hit.
During the extension period, lenders will be able to borrow £10 under the scheme for every £1 of net lending to small and medium enterprises (SMEs) in quarter two through four of 2013, and £5 for every £1 of net SME lending in 2014, according to Standard & Poor’s. Lenders will also be able to access FLS funding against net lending to financial leasing corporations and factoring companies.
The Bank of England launched the FLS in mid-2012. It 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. It was originally set to terminate in Feb 2014.
Under the scheme, funding rates are lower, in most cases, than what the real market can offer. As a result, securitization issuance from banks has suffered, and it is expected to continue to suffer.
In an April 24 report, analysts at Barclays said that they revised their issuance estimates for U.K. RMBS this year based on the extension: They now expected the market to fall far short of their start-of-year forecast of £12.5 billion ($19.4 billion). The bank’s new figure is £5.0 billion. That would translate to a 73% drop from 2012’s volume of publicly placed U.K. RMBS.
“The extension of the FLS scheme, while expected, will add to the lack of supply, for longer, for RMBS investors,” said the Barclays analysts. Since FLS was launched, only two deals— BRASS 2012-1 A1 in September 2012 and GFUND 2012 2 A1A in November 2012— have been publicly placed. The former deal came from the Yorkshire Building Society, the latter from Virgin Money.
The disincentive for U.K. issuers to come to market with RMBS is strong enough to trump the yield-driven appetite from U.S. investors. Dollar tranches had been part of the market as buysiders from across the pond sought higher returns. But Barclays said it has not seen a single dollar tranche this year, even outside the U.K. RMBS sector.
What is more, RMBS is not the only asset class with something to lose from the FLS. The analysts added, “Other forms of U.K. ABS issuance (as well as wider bank funding options, eg, covered bonds and bank securities) may also suffer as lenders are able to receive a larger multiple of funding for lending to SMEs, which will therefore assist them in their overall funding profile.”
There are a few silver linings. In Barclays’ view, spreads are likely to remain tight if not tighten more in some instances. These compressed spreads will, in turn, make issuance more attractive in the future and therefore erode some of the FLS’s appeal vis-à-vis securitization.
The analysts have said that this would make mezzanine and subordinated tranches more economical to issue as well, potentially breathing new life into a sector that has been quiet since the crisis.
“But RMBS would still need to tighten significantly, when comparing a four year funding term the FLS provides,” the analysts said. “[And] if banks decide to hold their treasury bills that they receive under the FLS (e.g., use it for their liquidity buffers), the all-in cost for the FLS is simply 25 basis points if they increase net lending.”
At any rate, the bank does expect some fresh RMBS this year. Barclays said it will come from two camps: second-tier building societies that may not be able to capitalize on the FLS because of restrictions on boosting their net lending, and large master-trust issuers looking to keep their securitization programs alive.