RMBS will benefit major banks looking for new funding, while insurance companies eye up lending opportunities. Lynn Strongin Dodds reports
Royal Bank of Scotland’s recent £4.6bn (€5.2bn) residential mortgage backed securitisation (RMBS) definitely put a spring back into the market, but the general consensus among banking analysts is that it will not open the floodgates. Any recovery will be slow and not always steady.
The RBS deal, though, stands apart from its predecessors on several fronts. As with many European securitisations since September 2009, the RBS Arran Mortgage Funding Series 2010-11 was underpinned by a large order from JP Morgan, which bought about £1.94bn (€2.22bn) of the deal across three tranches. However, a large slug - about £2.76bn of paper - was sold in the wider market, including to US investors. There had been a concern that past transactions were reliant on too small an investor base, which some market participants had criticised for causing price distortions.
The RBS RMBS also stood out in that it reflected the increasing risk appetite of institutional investors. The £163m equivalent subordinated notes that were included is a far cry from the double B tranches that marked the pre-crisis glory days but it is a sign of a more confident marketplace. Patrick Janssen, fund manager of M&G’s Lion Credit Opportunity Fund, notes: “The market for prime RMBS opened for business about a year ago with German, Dutch and UK issuance, but the main difference between those and the RBS deal is that this is the first time since the crisis that we are seeing double-A rated notes. Previous deals were triple-A.”
Overall, the structure of European ABS deals, which are sliced into different tranches, has indelibly changed and has become much more conservative. The junior segments are exposed to the initial losses in the underlying loans, protecting the senior tranches, which enjoy a higher credit rating as a result. In some post-crisis deals, the cushion that the junior bonds provide - known as credit enhancement - has been significantly larger than before the crisis.
Janssen points out: “Of main importance is the fact that banks need RMBS to diversify their funding base. They need the funding, as other funding tools such as the European Central Bank and repo funding will start disappearing, and so their focus in structured credit has shifted from ‘risk-tool’ to ‘funding-tool’.”
The flipside to this though is that having too small a senior tranche makes ABS issuance a less efficient funding tool. It is not only more costly for the banks but there are no guarantees that the senior layer of debt is risk free.
Analysts believe that Europe is at least six months behind the US, with the market being split between strong investor demand for UK and Dutch mortgage backed issues and no interest being shown for Irish, Spanish and Greek transactions. In fact, the UK accounted for the bulk of Europe’s €60bn of securitisation issuance over the past year - and this is expected to continue into 2011, according to industry estimates.
Although the pipeline is not overflowing, there is a steady stream, with Nationwide Building Society recently launching a triple-A rated issue denominated in euros and dollars worth £1.5bn. Santander, meanwhile, announced plans to offer triple-A rated RMBS denominated in euros, sterling, and dollars. Dutch insurance giant Aegon is gearing up to bring a $1.3bn (€0.9bn) of prime RMBS deal to the market. These banks, along with Lloyds and to a lesser extent the Cooperative Bank and Rabobank in the Netherlands, are expected to remain the most active.
As for the CMBS market, “the door to the European market is closed,” says Simon Dunne, director of Savills Capital Advisors. A recent survey conducted by the international property adviser firm revealed that German banks continue to dominate the European commercial lending scene mainly because of a healthy Pfandbrief market. Investors are drawn to the market because of its strict requirements, comprehensive protection and the ability in case of bankruptcy to have a priority claim to the collateral listed in the cover funds.
According to Savills, over the past six months German banks have been the most active in UK commercial property deals exceeding £20m, comprising nine of the 12 banks also willing to finance larger deals. The main participants include Aareal Bank, Deutsche Bank, Deutsche Pfandbrief, Deutsche Postbank, DG Hyp, Eurohypo, Helaba, Bayern and West Immo. UK-based Barclays, RBS/Coutts and Santander comprised the rest.
Natale Giostra, head of UK & EMEA debt advisory at CB Richard Ellis, says: “We do not see the CMBS market coming back in its previous form, but gradually in more simplified strucutures. We believe that the German banks will continue to be the most active for prime properties because they are able to offer cheaper finance thanks to the Pfandbrief market. This makes it more difficult for other banks to compete.”
The Savills review predicts that German property lenders will continue to dominate lending for at least another year in spite of imminent sector consolidation. This is largely because funding costs are less than half those of their regional rivals. There have, though, been new entrants over the past year including, France’s Société Générale and BNP Paribas, Sweden’s SEB and Dutch group ING.
Giostra also believes that large insurance and life companies, for example Aviva, AXA, Canada Life, Allianz, M&G and Pramerica and MetLife, will be a force to be reckoned with over the next year. Giostra says: “We expect insurance companies to play a larger role in the market over the next 12 months and they are currently developing their infrastructure to build a more diversified offer. We believe they will compete across a wider spectrum of commercial property in areas where German banks are less active because of the strict requirements of the Pfandbrief market. There is currently a funding gap here, which insurance companies could help to plug.”