Traditional mortgage backed deals and more innovative transactions from the likes of Canary Wharf have put sterling's structured finance market on the map. UK banks and corporates have endorsed the flexible and innovative funding options that securitisation offers - and most have chosen to bring their deals in the local currency. But as supply in the asset backed market looks set to break new records, some concerns have been noted
UK companies are embracing securitisation with gusto. In 2000, they raised some £28bn in the asset backed market, itself a record, and in the first half of 2001 they raised a further £19bn - not all of which was in sterling, although the UK currency accounted for the lion's share of issuance. That seems certain to have laid the foundations for another record year in the asset backed market. "We are going to see much more in the way of mortgage backed issuance, project bonds and other structured transactions," says Martin Hibbert, head of sterling syndicate at Deutsche Bank in London, "simply because the sterling investor base is in need of more supply and more yield."
Bank of Scotland set the tone in January with its blowout £750m securitisation of UK residential mortgages using the master trust structure it originally launched in April 2000.
Mound Financing, led by Schroder Salomon Smith Barney, was tranched in dollars and sterling and all pieces were reportedly very healthily oversubscribed.
Among bank issuers, Abbey National provided a variation of the theme with its Holmes No 3 securitisation, led in May by Credit Suisse First Boston and Salomon Smith Barney, which raised £2.2bn (equivalent) in dollar and euro tranches, with a sterling portion conspicuous in this transaction by its absence. That was a reflection of Abbey's continued drive to broaden the geographical reach of its investor base, an exercise that by all accounts was highly successful.
While in sheer volume terms it may still be difficult for UK securitisations to trump programmes such as Holmes, in terms of innovation the spotlight this year has fallen on corporate asset backed deals, the supply of which has been gathering pace in recent years. To some, that expansion in supply has been a source of concern, with a Moody's report on the performance of the Madame Tussaud's £230m securitisation launched in May 1999, for example, assessing the risks that can affect even businesses with cashflows that appear stable. In the first nine months of 2000, visitor numbers to the waxworks museum were down by 80%.
In the case of the Wightlink securitisation, however, arranged by Barclays Capital in July 1999, the company - which runs three ferries between the UK mainland and the Isle of Wight - has been subjected to a stress case that virtually nobody could have predicted and, according to its chief executive Mike Aiken, has passed the test with flying colours. The unforeseen and brutal outbreak of foot and mouth disease in the UK ravaged the tourism industry and was therefore potentially a highly disruptive force as far as Wightlink's cashflows were concerned. Although the Isle of Wight kept foot and mouth disease away from its shores, Aiken says that it led to a drop in traffic of 10% in March and 5% in April. Since then, traffic levels have recovered and Aiken says that there will be no overall impact on the company's annual revenues. That is a reflection first of the defensive nature of the traffic passing between the mainland and the island, which Aiken says is divided roughly equally between business and commuting travellers, tourists and individuals visiting friends and relations; and second of the fact that ferries provide the only way of reaching the island. As Aiken puts it, unless you're a very strong swimmer there is no other alternative.
Among the corporate securitisations in the sterling market this year, the retail sector has been an especially fertile source of innovative transactions. Here, J Sainsbury plc alone has been at the forefront, although Marks & Spencer and other UK retailers are expected to come to the market shortly.
In June, British Land's £575m securitisation backed by the 35 supermarkets that it leases to Sainsbury's - Werretown Supermarkets Securitisations plc - was described by bankers as a landmark transaction in the history of the UK asset backed market. But so too was Sainsbury's first securitisation this year, Store Finance, which was an innovative means of financing the retailer's outsourcing of its information technology functions. Barclays Capital led the £300m Store transaction, and arranged a parallel £240m syndicated loan for its sister company, Swan Infrastructure.
In marketing the Store offering, Barclays needed to emphasise that the securitisation differed from previous Sainsbury's offerings (principally the Highbury and Dragon structures) inasmuch as there was no element of removing property assets from the balance sheet. David Wells, director of structured finance at Barclays Capital, stresses that this was an important point in the Store Finance transaction, where no such sale and leaseback took place, either of property assets or of the IT which was the subject matter involved. The transaction came about following a strategic decision by Sainsbury's to outsource its IT functions to Accenture (formerly Andersen Consulting) via a special purpose vehicle (Swan Infrastructure) which in turn is funded from the proceeds of the securitised bond issued by Store Finance.
"The only reason why the bond is not issued directly by the entity to which the banks are lending, Swan Infrastructure, is ratings driven," explains Melanie McLean, director of structured capital markets at Barclays Capital. "The agencies wanted to see an insolvency remote entity such as Store Finance issuing the bond."
For its part, the only asset Store Finance has is the right to repayment of the loan made to Swan Infrastructure. Store Finance lends the proceeds of the securitised bond to its sister company, Swan, whose only source of income comes from carrying out all Sainsbury's IT functions, including stock control, invoicing and warehousing, services which are outsourced by Accenture for a fee. "The transaction differs from other securitisations in that generally the originator would transfer assets to a vehicle and in return would receive the debt proceeds", says McLean.
"In this instance, Sainsbury did not receive the cash proceeds. Instead this money stayed within Swan Infrastructure and was used to provide the IT services to Sainsbury". The bond that emerged as a result is for a principle amount of £300m maturing in 2007 and was rated A and A2 by Standard & Poor's and Moody's, respectively, mirroring the Sainsbury's rating. It was sold as passthrough Sainsbury risk because the sole business of Swan Infrastructure is providing IT services to the retailer. Sainsbury is contractually obliged to pay Swan for its services on a monthly basis over a seven year contract and has minimum payment obligations if Swan fails to deliver.
The significance of the transaction over the longer term, says McLean, is that its basic components are capable of replication for other entities wanting to outsource IT or indeed any other function - which is especially germane at a time when the corporate sector's pursuit of shareholder value is leading to a renewed focus throughout industry on companies' core competencies.
Elsewhere within the corporate securitisation world in the UK, other important transactions this year have included the £650m whole company transaction by Rank Hovis McDougall, arranged by JP Morgan, which explored new territory by using flour mills and revenues from household name products such as Mr Kipling's cakes to back its bonds. Canary Wharf, meanwhile, raised £875m at the end of May in the first property company transaction backed by revenues from buildings still under construction.
"The investor base is clearly hungry for securitised product at the moment," says Clive Davies of the securitisation department at the Royal Bank of Scotland Financial Markets in London, adding that there is also plenty of potential for new issuance in the UK asset backed sector, especially for deals backed by the more conventional forms of collateral. "I think we have only just scratched the surface in terms of residential mortgages," he says. "The proportion of mortgages in the UK that have been securitised is still in single percentage figures. When you consider that banks like Lloyds TSB and HSBC have yet to do any residential mortgage issues and that RBS combined with NatWest has only done £300m versus a residential mortgage book in very substantial multiples of that, it is clear that there is a great deal of potential for more issuance."
Over and above these potential issuers, Halifax reported recently that by September it will have a structure in place to allow it to access the securitisation market for the first time, appearing to have opened the way for the UK's largest mortgage lender to make use of a master trust structure similar to the one that has served Abbey National and Bank of Scotland so well.
The problem, Davies says, is that to date few of the main mortgage lenders in the UK have had much of an incentive to securitise given their historical strong cash positions. But as he points out, a further wave of globalisation and consolidation within the industry and an increasingly competitive market place for retail deposits is likely to trigger a fresh hunt for capital funding, in which case the merits of securitisation could once again come to the fore among the leading UK clearing banks.
At Barclays Capital, Wells identifies at least two further trends in the UK securitisation market that suggest the market is becoming broader and deeper. The first of these is that investors in the UK are increasingly pushing into shorter dated floating rate securitisations. "In the old days large institutions tended to pump their liquidity into short Gilts and Treasuries which of course were very low yielding," says Wells. "We are now seeing them trying to be more efficient at the shorter floating end of the market. Many UK investors are allocating much of their short term liquidity reserves to liquid, triple-A rated RMBS and credit card backed deals, which is a radical change from what we were seeing as recently as two years ago. They are comfortable with the technology behind the market and these sorts of asset backed issues are relatively immune from the event risk which characterises the corporate bond market."
The second trend spotlighted by Wells is the increased use of monoline guarantees in the sterling securitisation market. A recent example of this in the UK was the £975m securitisation for General Healthcare Group (GHG) led by Morgan Stanley, just over half of which was wrapped by Ambac. The increased use of triple-A wraps, says Wells, is allowing much larger tranches of asset backed deals to be sold, although he also questions whether, over the longer term, AAA is the opitimum rating for securitisation deals in the UK. In light of the Myners report, Wells thinks that AA may be a more suitable rating for investors. "We anticipate taking securitised issues to AA and paying a little bit more rather than looking for the over-collateralisation and credit enhancement that would take them to AAA," he says.
So much for the good news about securitisation in the sterling market. The more gloomy news is that it still appears to be an asset class that is not as broadly understood as it should be, perhaps in part because of the information flows provided to the market by the issuers themselves. At Scottish Widows in Edinburgh, fixed income investment manager Gareth Quantrill describes bondholder relations among UK issuers in general as being "patchy", with relationships with the regular issuers typically much better than those with the one-off borrowers. "In the case of some of the securitisation deals, getting information beyond that which is in the covenants has sometimes been especially difficult," he says.
Davies at RBS appears to agree, although he also thinks things are improving in this respect. "There is a yearning for more information from investors about individual issues, but I think we are seeing a lot more of the borrowers and the bank intermediaries making more of an effort to provide that information," he says.
"That is especially important for those investors who are chasing yield on lower rated, subordinated transactions."
Another alarming characteristic of the asset backed market in the UK was uncovered earlier this year when PricewaterhouseCoopers conducted a survey among equity analysts with the aim of learning more about "the perception of this important funding and balance sheet management tool amongst UK equity analysts". Extraordinarily, this survey found that more than one in four equity analysts reported that they were unaware of what securitisation was. It also found that when prompted, only 39% of equity analysts felt that they had a good awareness of securitisation techniques, with those in the banking and insurance sector significantly more likely to be fully aware of these techniques.
Aside from securitisation issues as an avenue towards added yield for investors, bank capital transactions in the sterling market have continued to be an attractive source of enhanced returns.
One of the most strikingly successful bank capital transactions of 2001 to date was the £300m tier one preferred perpetual deal launched by Standard Chartered Bank via Lehman Brothers and UBS Warburg at the start of May. Very resilient demand for this deal saw its size increased from an originally planned £200m and its pricing pared from an expected 290bp-300bp spread to the 2015 Gilt to 285bp.
Guy Cornelius, executive director of credit fixed income at UBS Warburg in London, says that the book for the Standard Chartered deal was worth close to £800m.
"It was quite ironic that one of the lowest rated tier one deals of the year should have attracted one of the largest order books," he says, "and it shows the degree to which investors are keen to buy at the most subordinated level possible if they like the credit, which they did in the case of Standard Chartered."
Insurance companies have also been regular suppliers of higher yielding subordinated paper over recent months in the sterling market. A highlight in July was a debut £200m transaction for Scottish Mutual Assurance via Barclays Capital paying 220bp over the 2021 Gilt.
As Barclays commented at the time, following on from a number of subordinated offerings from other European insurers, "this trend reflects an increasing recognition of the need for efficient capital management by insurance companies and also of their ability, from both a regulatory and rating agency perspective, to issue such subordinated bonds." *