Should U.K. home prices head south, U.K. non-conforming securitization structures could theoretically weather the storm, given the credit enhancement and structural mitigants of these deals. But at the moment, it's a notion not likely to play out, say lenders who see housing fundamentals stabilizing and more good times ahead for this sector.
Home prices have slowed, but most lenders in the market remain positive that an all-out collapse is not in the cards. "Our view is that house prices will continue to slow but the press headlines that we see at the moment are misleading," said one market source. "What we are seeing is not a general slowdown but a slowdown, or a reduction in the increase of house prices."
The latest beliefs suggest a reversal to the slowing trend, with some even expecting up to 6% home price appreciation this year. It's certainly a more optimistic view that supports the benign market condition that, at the moment, has driven non-conforming MBS pricing in.
The spread differential between prime and non-conforming U.K. MBS is around four to five basis points at the triple-A level, according to Morgan Stanley analysts. Strong demand for this paper could drive spreads tighter on both the prime and non-conforming levels. "I think that even a slight widening would still be considered good value for lenders looking to do a deal in the current market," added the market source.
The Royal Bank of Scotland recently held a specialty lender summit where some of the concerns of the market were discussed and investors complained that spread compression removed relative value from the market. "One participant observed that a premium is required to buy notes with long legal finals and structures to understand - when compared to bank paper this premium is somewhat light," reported analysts. "The panel accepted that cash requiring investment was the predominant factor behind spread tightening and lower corporate volumes in 2005 will likely exacerbate this spread pressure."
For issuers, slowing loan originations pose as a concern at the moment. U.K. mortgage lending fell from to GBP7.1 million in December 2004 from GBP9.1 million in the previous December, suggesting a slowdown has been underway, reported analysts at RBS. "A likely cause of this decline is a reluctance to accept flat or modestly lower offer prices," said analysts.
The Council of Mortgage Lenders released data last month suggesting that mortgage lending in the buy-to-let sector slowed to a greater extent than overall mortgage lending during the second half of 2004. "Applications have been down but loan size is up 10%, and we haven't increased the LTV for these borrowers," said one lender. With first-time lending declining to a 12-year low, lenders in the buy-to-let sector are hoping the rented accommodation could provide an answer for this market segment, thus increasing appetite in the buy-to-let sector.
The relative affordability of U.K. housing makes if difficult for buyers to get onto the property ladder and has prompted some lenders to raise LTVs to 100% - or in rare instances up to 130% - said one market source. But despite the move on behalf of some lenders to service this portion of the market, the trend for a number of non-conforming mortgage lenders has been to move away from the mid-to-heavy end of the subprime market, and into the less risky side of lending with the average first-time buyer LTV at 87%.
"I think what we have seen of late is a lot of the subprime lenders actually tightening lending criteria and a number of lenders have migrated into the prime end of subprime end, opening up the lower end of this market to new lenders - we have seen a widening of the segment," said one market source. "And we are currently seeing interest from prime lenders who actually want to acquire some of the more prime aspects of this subprime product."
"I think there has been a recognition that the market is very complicated and requires some work. The motto at the moment is: stick to what you know best," the market source added.
For the more traditional lenders looking for some alleviation from the even tighter spreads seen for prime mortgages, the relative benign market conditions of the non-conforming market have made it worth while for some players to consider entering the market. Lenders at the RBS summit said that this competitive threat could lead to a reduction in loan margins leading to a reduction in excess spread. On the mid-to-heavy side of the lending field, new entrants looking to tap into this segment of subprime lending could damage the market by dragging loan margins tighter and loosening loan standards beyond levels viewed as breakeven for existing players.
"I think that for the near-term its safe to bet that stability will continue in this market," said one market source. "There has been a lot of pent up demand over the Christmas period that still needs to be serviced and we are starting to see the Spring applications come in, there is a massive amount of [refinancing], along with more first-time buyers coming through."
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