U.S. dollar funding is gaining traction among U.K. issuers of RMBS and credit card ABS.
What they have been tapping are mostly U.S. investors with an appetite for yield that is difficult to satisfy in today's environment. What they get in return is a cost of funding that is better than what euro tranches can offer them.
Whether this equation will hold and keep raising the absolute and relative weighting of dollar tranches within U.K. issuers' deals depends on several factors. At the same time, if U.S. investors stay hungry, arrangers across the pond may push other asset classes, such as Dutch RMBS, as well.
THE TRACK RECORD
U.S. investors are by no means new to U.K. transactions. Money market funds, for instance, had for years been purchasing RMBS deals from such names as Northern Rock, under its Granite program, and Bank of Scotland, under its Permanent program, according to Steve Curry, founding partner at Bishopsfield Capital Partners. "Even buy-to-let RMBS was being sold to 2a-7 investors in the U.S.," he said.
According to a London-based market source, about $67 billion of U.K. RMBS tranches were denominated in dollars in 2007. That figure collapsed to zero in 2009, rebounded to $14 billion in 2010 and as of press time had reached approximately $27 billion so far in 2011.
Robert Plehn, the head of asset-backed solutions at Lloyds Bank Corporate Markets, said the relative weight of dollar tranches is growing as well, offering compelling evidence that the U.S. investor is more vital than ever to U.K. issuers of RMBS and credit card deals.
In 2006 dollar tranches made up half of RMBS volume issued through the four master trusts set up by Lloyds and HBOS - before Lloyds acquired HBOS in January 2009. Some 30% was in euros and the remaining 20% in pounds. Two of those trusts, Mound and Pendeford, have not undertaken any public issuance since the credit crisis. Permanent and Arkle, meanwhile, remain active.
Putting the 2006 figures for these four trusts against more recent percentages from the wider market, while not a perfect comparison, shows how the weighting of dollar funding for U.K. issuers of both RMBS and credit card deals was well below the pre-crisis peak in the period when they first began to reissue in 2009, only to recover in earnest and now potentially surpass where it was in the boom years. (See table below.) In the second half of 2011 to November 21, dollar tranches have taken up 71% of the volume of U.K. RMBS and credit card deals.
In some recent deals it has gone further. There were sizable U.S. dollar portions in RMBS Gracechurch Mortgage Financing 2011-1, with Barclays Bank collateral, and RMBS Holmes 2011-3, a Santander U.K.-originated transaction. Closed Nov. 15 via arrangers Barclays Capital and Lloyds, Gracechurch featured dollar notes for a total of $2.9 billion, or about 77% of the entire transaction. Meanwhile, the Holmes deal had $3.25 billion in U.S. dollar tranches, or about 86% of the total volume. Arranged by Bank of America Merrill Lynch, Citigroup and JPMorgan, that deal closed September 21.
Overall, U.K. credit card deals might be even more dollar-heavy. "If you actually broke it down, credit cards probably have an even higher U.S. dollar tranche component given the high U.S. appetite for the asset class and the lack of domestic U.S. supply," said Plehn. "In addition, there are certain investors in the U.S. who prefer credit card risk to RMBS."
Recent credit card deals with dollar tranches include HSBC Holdings via its Turquoise program (92% in greenbacks), and Lloyds under its Penarth program (100%).
For its part, U.K. RMBS in dollars is not only increasing in importance for U.K. issuers, but the sector is also a leading asset class sold in the American marketplace. For this year, it currently stands as the second-largest securitized product sold in the country, behind only auto ABS, according to the market source.
The class of investor buying U.K. ABS has changed since before the crisis. Where once money market funds and SIVs provided demand, now it comes from real money managers, insurance companies and bank treasuries. Curry said that currently U.S. investors are focusing mainly on tranches with expected maturities of up to two years.
THE PRICING EDGE
For U.K. issuers, swapping into dollars makes abundant sense right now, sources said.
By one account, a basis swap from pounds into euros has over a negative basis of 50 basis points for issuers, while pounds-into-dollars has a positive impact in terms of absolute funding costs.
For U.S. investors, there is the spread pickup compared to other products whose risk is perceived similarly.
"Ultimately it comes down to risk-adjusted returns for investors," said Colin Fleury, head of ABS investment at Henderson Global Investors. "The institutions look at the value in terms of credit spreads on new issuance, relative to other technical considerations."
There is also a dearth of private-label issuance. "A number of U.S. investors have gotten comfortable that prime U.K. mortgage-backed deals have some important distinctions from the U.S. deals that have faced well-publicized performance issues," Fleury said. "That's why they're prepared to invest at, say, Libor plus one and a half percent - a relatively attractive return when you look at where spreads are in the U.S. for comparable ABS risks."
Sources said that what it boils down to for some U.S. holders of U.K. deals is that an investment backed by prime assets in a strong jurisdiction is a good bet in this acutely uncertain investment climate, where placing funds with even a reputable bank might carry a certain degree of risk.
THE TROUBLE WITH EURO INVESTORS
Meanwhile, European investors have not been the most welcoming this year, obviously in part because of the sovereign crisis affecting their risk appetite in credits related to financial institutions. But there are other, fundamental concerns as well that have particular relevance for the ABS market. "Most investors acknowledge that the performance of prime European asset-backeds has been good, but still some are not purchasing these deals anymore because their generic asset allocation preferences shifted away from the asset-backed product," said Mike Nawas, founding partner at Bishopsfield.
Aside from the subprime albatross still hanging around the neck of the ABS industry, a stronger regulatory hand is pushing or will push away some investors.
"When Basel III and Solvency II are introduced in their current drafted form, they will make securitization paper less attractive to investors," said Bishopsfield's Curry. This is on top of eurozone turbulence.
But a return to stability could mitigate some of regulatory effects, sources said.
One London syndicate official noted that there's been enough indigenous demand in Europe for auto loan paper to deter originators and arrangers of those deals from seeking outside investors. "Auto ABS is very short and self-amortizing, [and] there's a group of people very happy to buy those," he said.
In addition, continental European issuers of ABS have not nurtured longstanding relationships with U.S. investors to the same degree as their U.K. counterparts.
"It's really only the U.K. issuers who've set up programs to sell paper into the U.S., whether it's RMBS or credit cards," said Lloyds' Plehn. "Pre-crisis, many European issuers were concerned about liability and other issues with selling on a 144a basis, whereas the U.K. guys always felt that it was an important market."
Still, many players in the European ABS realm are keen to tap the U.S. market - or, more broadly, sell to all kinds of foreign buyers of U.S. dollar product.
DUTCH RMBS: NEXT UP?
One area that has lately been bandied about as a good candidate is Dutch RMBS, which has also recently been one of the most active corners of continental European ABS. While there are a few instances of Dutch RMBS tranches being sold to U.S. investors before the crisis, there do not appear to have been any in the last three years, sources said.
Originators such as Obvion and Delta Lloyd were on hand at the most recent ABS East conference to at least in part talk up their product to a U.S. crowd, although as it turned out investors were an endangered species at the gathering.
Volumes in the Dutch sector are not insignificant."After the U.K., the Netherlands is the largest country in Europe in terms of RMBS issuance volume," said Nawas. "And U.S. investors need to see a pipeline with deal flow in order to warrant the effort of doing the research and getting the credit lines in place."
But there are certainly obstacles for Dutch originators to reel in the U.S. investors. Nawas noted that American buy-siders would need time to get used to some peculiarities of Dutch RMBS.
LTVs that would give pause in other markets are among these peculiarities. Due to the tax-deductible nature of interest payments, Dutch borrowers tend to push up the LTVs of their mortgages, with figures of 100% or higher a common feature.
"[The Dutch tax] regime provides borrowers with a strong incentive to maximize the outstanding principal balance on their mortgage for as long as possible, thereby increasing the tax benefits over the life of the loan," Standard & Poor's said in a recent report on the sector. For the same reason, the Dutch will often go for interest-only loans, a product that elsewhere might raise red flags.
S&P said that these characteristics need to be seen within the context of other variables - such as generally favorable loan-to-income ratios - in order to paint a more complete picture of a Dutch borrower's credit profile.
Still, in wooing U.S. and other overseas buyers, lenders from the Netherlands would still have to find ways to assuage the uneasiness surrounding the eurozone. Dutch mortgages, after all, are denominated in a currency whose contours - in terms of participating countries, for instance - are being increasingly called into question. "Dutch issuers have been out a number of times to the U.S.," said Plehn. "But given the euro problem, issuing Dutch RMBS there would be tough to do right now." He added, however, that once Europe gets sorted out, Dutch issuers may be able to tap the U.S. market.
Dutch RMBS issuance reached â‚¬9 billion ($12 billion) in the first nine months of the year, making up about a quarter of all publicly issued European ABS deals. Solid collateral performance throughout 2008-2009 has made Dutch RMBS a touted bright spot in European ABS.
Factors helping to buoy the market have included a relatively low jobless rate and the predominance of fixed-rate products, which account for more than 80% of outstanding loans. The most important originators of Dutch RMBS are Fortis and ABN AMRO. The chart to the left shows the share of the market - at least in the S&P-rated portion - by originator up to Q2 2011.
While delinquencies rose 40% between 2007 and 2010, they remained low, at below 2%. This compares favorably to the 4% posted by prime U.K. RMBS in mid-2011. Dutch RMBS issuance should continue pick up, underpinned by economic fundamentals that are more solid than in most other European countries, S&P said.
While some participants are trying to peddle Dutch RMBS deals to U.S. investors, there are arrangers looking to expand the buy-side base beyond the U.S. for securitizations that are already being issued in dollars.
The goal is to entice Asian investors, but the messy euro drama is spoiling their appetite for anything in the neighborhood, and that might include U.K. deals. "They're simply not keen to look at big investments in European credit," said Nawas, who added that equities, for instance, were a different story.
If U.K. mortgage originators keep cranking out the volumes we have been seeing then they may feel increasing pressure to push into Asia, said the syndicate official. "It's the holy grail."