HBOS, the UK's largest residential mortgage lender, this week launched the biggest ever European mortgage securitisation (MBS) with a £3.5bn equivalent blowout deal that set new pricing benchmarks for European MBS. As bankers across Europe hurried to complete transactions before next week's ABS conference in Barcelona, joint bookrunners Barclays Capital, JP Morgan and Citigroup/SSSB catapulted the jumbo MBS into the market, the first issue from a new master trust.
While the banks involved were unable to comment on the deal as they awaited SEC confirmation, the consensus among market participants was that it was a success: some tranches were as much as five times oversubscribed. Pricing was tight for a new issuer in the market, but the HBOS name is well regarded and investors are still turning towards the relative safety of MBS.
With outstanding residential loans of £110.1bn, Halifax is the largest UK mortgage lender. In September 2001, Halifax and Bank of Scotland merged to create HBOS plc, but the two names are being separately maintained. Only Halifax mortgage products are included in this first transaction.
Bank of Scotland has its own master trust, which issued Mound Financing (No 2) plc in January 2001. The £750m deal was a blowout for bookrunner Citigroup/SSSB and was launched at spreads well inside those of other prime MBS at the time.
This week's dramatic debut gives the booming European MBS market another major issuer alongside Abbey National and its Holmes Financing master trust. The two banks are expected to be fierce competitors.
Last year Abbey brought three transactions from its Holmes series totalling almost £7.5bn for the year, culminating in Holmes Financing (No 5) plc in November. It tapped the US money market funds for the first time under Rule 2a7 and launched $1bn into this market.
Despite the volume issued by Abbey over the year, the deal was again 1.5 to two times oversubscribed across all tranches. Barclays Capital and JP Morgan are also expected to lead the next Holmes transaction this year.
"It is healthy for the market to have a new strong benchmark that creates a more competitive environment and helps to push pricing for other issuers," said one banker. "Halifax is opening up the way for others - maybe we'll see Barclays Capital bringing Woolwich or RBS coming to the market."
Market players this week compared the new MBS environment to the rivalry between Citibank and MBNA, benchmark borrowers in the US credit card ABS market. The major players in the UK MBS market represent the most liquid areas of European structured finance and spreads have been coming in rapidly as investors become increasingly comfortable with the sector.
HBOS entered the market with 13 tranches of bullet notes sold via Permanent Financing (No 1) plc. Nine were offered in dollars, with one euro tranche and three sterling layers completing the jumbo issue.
A $750m one year tranche was priced at 2bp under one month Libor to sell to the US money market funds. Two further short dated tranches were offered in this series.
Pricing was particularly tight on a $1.1bn triple-A 3.5 year tranche which came at 12.5bp over three month Libor.
That spread blows a hole through the previous benchmark transactions in the market. Recent deals from Northern Rock, Westpac and St George Bank were all priced at 16bp over Libor.
But UK and Australian MBS are still no nearer to catching up with the ABS market's benchmark US credit card paper. After September 11 that market widened to about 13bp over Libor in three years, but since then the flight to quality has compressed spreads by about 1bp a month. Three year credit card floaters now trade at 5bp over Libor, while fixed rate deals are at 4bp over swaps.
The Halifax transaction was a blowout, with a high level of oversubscription across all tranches, bar possibly the two fixed rate tranches.
The strongest interest was shown in the subordinated notes, explained by investors becoming increasingly attracted to the high yields available further down the MBS credit curve.
Sterling MBS spreads have been tightening increasingly this year and the £1bn triple-A tranche from Permanent Financing was priced under the magic 20bp over Libor mark, at 18bp over with a five year average life.
Inevitably some experienced investors in Europe found the pricing across the transaction too tight. "At that pricing it doesn't even pay the lighting bill," said a portfolio manager at a German bank. A fund manager in London said: "It was a bunfight - it has sold on the name, but we maxed out on MBS earlier this year when the spreads were wider."
But most investors also recognised the high quality of the portfolio and regard Halifax as a conservative institution.
One banker estimated that taking into account swap costs, the weighted average cost of funds for the entire deal on day one was 18bp-19bp over Libor. Taking into account the different average lives of the various tranches, which gives a truer picture of the funding costs, the weighted average margin over time would be slightly higher.
The costs of funds on these transactions have come in markedly. A close comparison is not possible without more detail of the swap costs, but the first master trust mortgage deal, Bank of Scotland's Mound Financing (No 1) plc in April 2000, had a weighted average margin over time of 32bp.
The notes are backed by a pool of loans from England and Wales that totals around £12bn. All were originated by Halifax and the provisional pool included variable rate loans, discount rate, fixed rate and tracker rate loans. When the fixed, discount or tracker periods expire, usually within five years, the loans revert to variable rate.
According to Fitch, the average loan-to-value ratio (LTV) of the provisional portfolio was 72.7% with good geographical diversification and 33 month average seasoning. Standard & Poor's reported a current LTV of 69.72% and a current indexed LTV of 55.7%.
Not every investor was enthusiastic about the collateral. One said: "The lack of spread on the mortgages jumped out at me and on the day it priced there was a negative story in the press about two-tier mortgage pricing."
The UK financial ombudsman has ruled against several UK mortgage banks for introducing a lower standard variable rate (SVR) to attract new customers. Borrowers with capped and discounted loans remained pegged to the old, higher SVR.
The Financial Times reported that Halifax, unlike other banks, had not written off a sum to compensate disgruntled borrowers, but is dealing with complaints on a case-by-case basis.
Fitch reported that any compensation required for loans of this kind in the securitisation would be paid by Halifax. The agency added: "Any residual risks associated with this issue which remain outstanding have been adequately addressed."
Realistically, the deal is very unlikely to lose money from this issue, but it is the kind of point for which a hawk-eyed investor might demand a higher spread.
