Wanted: more frequent issuers

  • 01 Sep 1998
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The UK markets is still the most developed in Europe, with quasi-securitisations from the UK's Private Finance Initiative shoring up the staple diet of consumer asset transactions. No other European jurisdiction contains such a concentration of expertise and experience, either among originators, arrangers and investors.
But, as Charles Olivier reports, the market still lacks the stream of regular issuers necessary to achieve the critical mass of the US.

In size as in geography, the UK asset-backed market lies somewhere between the US and continental Europe. It is nearly twice as big as the French market (its nearest European competitor) but only a tenth the size of that in the US.
According to Moody's Investor Services, UK asset-backed issuance totalled $19bn last year compared to $11.3bn in France and $178bn in the US.
In terms of product development and liquidity, the UK market is at a similar half-way stage. Unlike the rest of Europe, the UK has most of the products seen in the US market such as bonds backed by student loans, corporate loans and credit card receivables.
The UK market has also mimicked the US in its structural nuances, playing host to exotic classes such as interest only (IO) strips and mortgage early redemption certificates (MERCs). But it continues to lack the regular issuance necessary to create a US-style secondary market in any of these.
Perhaps because of their natural tendency to look west rather than east, many London-based originators and investors seem frustrated by the slow pace of development in the UK.
Nevertheless, significant strides have been made, particularly in the last year. In March 1998, Greenwich NatWest launched the first ever UK securitisation of student loans - a heavily structured £1.03bn transaction.
Two months later, Stagecoach, the train and bus company, broke another record when it raised £265m of debt backed by revenues from trains which had not even been built.
June 1998 saw the first UK securitisation of consumer loans - a £300m transaction by Finance for People No 3 (the financing vehicle for UK finance house Paragon).
Crucially (given the amount of business expected to come out of this sector in the coming months) securitisation has gradually gained acceptance among PFI teams working on hospital construction contracts. Previously, the only PFI projects which used bonds were road, rail and property-related deals.
Hospitals (with their operational risks and uncertain cashflows) were deemed too complicated. But in October 1997, Greenwich NatWest and Schroders brought the first ever hospital PFI bond to market - a £75.8m 30 year deal for Carlisle Health Management. Since then it has been used on two other hospital PFI projects, the Law Hospital and the Greenwich Hospital.
In July 1998, Tyseley Waste Disposal issued the first ever bond financing backed by revenues from a local authority. The £88m 20 year deal (which is being used to refinance construction of a waste-to-energy plant in Birmingham) was 30bp cheaper than French contractor Vivendi's previous cost of funds. "Local authorities are the last frontier for the PFI," said Lee Rochford, head of UK securitisation at Paribas which arranged the deal. "This bond creates a template that the markets are happy with. It will probably be the first of many from the sector."
Asset-backed bonds have also begun to gain favour in the corporate community, particularly in the pub industry. In February 1998, Morgan Stanley arranged the first ever pub lease securitisation - a £231m bond issue for the Wellington Pub Company. The following month, Bankers Trust launched a similar £535m deal on behalf of Punch Taverns.
And Marston, Thompson and Evershed, the UK brewing company, is believed to be in talks with Nomura International to securitise revenues from its 631 pubs. The deal is expected to be around £100m in size.
At the same time, the UK market has proved that it has sufficient depth to accommodate extremely large amounts of asset-backed paper without the need for US dollar investors. In October 1997, Bradford and Bingley Building Society issued a £1.025bn mortgage-backed deal - the largest ever in sterling.
The following month the UK asset-backed record was broken by Nomura which launched and sold £3.14bn of asset-backed bonds backed by rents from the Annington Homes portfolio of Ministry of Defence property.
But such achievements have been overshadowed in recent months by the market turmoil which has swept west from Asia. Spreads on UK asset-backed debt have stayed relatively steady compared to other asset classes but they have not been immune. Triple-A rated paper (which accounts for at least 90% of the UK asset backed market) has widened by as much as 5bp.
In July, for example, paper from the UK arm of MBNA, the US credit card company, was trading at around 10bp over Libor. In August, MBNA had to offer Libor plus 14bp to find buyers for its £250m floater via Barclays Capital. Meanwhile, single-A paper such as that backed by Punch Taverns cashflows has gone out from Libor plus 75bp at the time of launch to Libor plus 90bp at the end of September.
Coming on top of the normal summer lull, that spread widening has helped depress issuance. Since the end of June, just five structured finance issues have surfaced in the UK markets - a £50m FRN for Preferred Residential Securities, the Meridian Hospital Bond on behalf of Greenwich NHS Trust, a £88m project bond for Tyseley Finance and £250m and £142.5m deals for MBNA and Kensington Mortgages respectively.
And with few signs of volatility easing, issuers remain extremely cautious with remarkably few deals in the pipeline for early autumn, normally one of the busiest periods of the year.
"It is a waiting game," says Andy Clapham, head of UK securitisation at Greenwich NatWest. "There is a lot of turbulence in the markets and you do not want to launch into a market where spreads are widening."
However, Clapham remains confident that once spreads stabilise, dealflow will bounce back. "I think the recent volatility could be good news for the asset-backed market," he says. "It increases the need of companies to securitise assets, it lowers valuations on stockmarkets, making acquisitions more likely, and it encourages investors to stick with high quality paper."
So if and when the markets find their feet, what kinds of issuance can the UK asset-backed market expect in the coming year? Some borrowers are more predictable than others. The UK arm of MBNA is likely to issue around £500m in 1999 according to Vernon Wright, the company's treasurer. Meanwhile, Piers Williamson, treasurer of HFC of the UK, the second most frequent issuer of debt backed by credit card receivables, expects to securitise between £300m and £400m of assets.
According to John Shinton, director of structured finance at Hambros, housing associations such as Haven Funding 32 and the North British Housing Association (both of which completed deals earlier this year) are unlikely to increase significantly in 1999.
"Because they don't have balance sheets, they don't have any real need for securitisation," he says. "But we should see around £500m of issues in the next 18 months."
On the mortgage-backed side, Kensington Mortgages is likely to issue around £350m of debt in 1999, as is Ocwen Financial (which took over City Mortgages last year).
At the same time, Bill Cherry, managing director of Southern Pacific, is expecting to do a £60m deal in October 1998 but is unsure about issuance in 1999. "I would expect to do more next year than we did this year [£120m including the deal expected in October]," he says.
The old school mortgage-backed market has been sluggish for some time despite modest growth in the underlying mortgage sector. But bankers see some signs of hope.
In February 1998, Abbey National issued a £235m mortgage-backed bond, a move that marked the UK lender's switch from the buy side to the sell side. Describing the deal as a pilot issue, Abbey National treasurer Brian Morrison said the bank launched the deal even though it was more expensive than its standard sources of finance.
"But the all-in cost came below where we expected," continued Morrison. "And we have gained the comfort that our systems are adequate to securitise when we want. The technique will give us the flexibility to manage our balance sheet in our core activity - mortgages - if we should need it at some time in the future."
PFI dealflow during 1999 is extremely difficult to estimate. The Department of Health is keen to complete contracts on the six uncompleted first wave hospital projects so that it can progress onto the second wave.
The Ministry of Defence OD, meanwhile, is under no immediate pressure to sign contracts, but with over £2.5bn worth of deals already at the bidding stage some transactions will certainly be completed by the end of 1999.
Principal finance companies (such as Nomura Principal Finance) still have significant amounts of capital to spend and may view the current market as a buying opportunity.
Earlier this year, Nikko Principal Finance paid £169m for RoadChef, the UK's third largest motorway service station group. Bankers say that a securitisation of its revenues, along the lines of the Welcome Break financing last year, is likely.
Looming large on traders' radar screens will be the second student loan package valued at around £1bn.
According to NM Rothschild which is managing the sale, 17 institutions expressed an interest in the deal. Indicative bids are due in October 1998 which would suggest completion in the first quarter of 1999.
But while the list of upcoming deals may be impressive in terms of variety, it also graphically demonstrates the way in which the UK market is chronically dependent on large one-off transactions to boost dealflow.
Take away PFI deals and the student loan transaction, and future issuance begins to look rather meagre. At the same time, the UK lacks any £1bn a year issuers of debt backed by mortgages, loans and credit card receivables.
"There is not a huge incentive for high street banks to do them," says Clapham at Greenwich Nat West. "They are well capitalised and can borrow very cheaply elsewhere."
Taken together, these two factors have made it hard for financiers to create bond structures which can be used on a repeat basis, or so-called cookie cutting.
This not only keeps borrowing costs unnecessarily high but also reduces the incentive for local investors to hire asset-backed specialists.
Nevertheless, there are signs that some borrowers are getting close to the creation of cookie-cut templates. Most of MBNA's bonds, for example, are very similar in structure.
"We like to have consistent terms on our deals," says Vernon Wright. Meanwhile, HFC's Piers Williamson reports that he too is "getting close to a template structure".
Unlike markets such as Italy and Germany where securitisation is only just starting to take off, the UK asset-backed market may not see many records broken over the next 12 months.
"Most of the benchmarks have already been done," says Guy Fletcher, head of UK securitisation at Barclays Capital. Nevertheless, there is still room for further structural development such as the use of step-up and inflation-linked coupons.
"Securitisation is an emerging business area where we will see increasing activity and the evolution of new ideas," says Fletcher. EW

Sub-prime finds fertile ground

SUB-PRIME (lending to people who cannot typically get loans from banks or building societies) has become one of the fastest-growing areas of the UK asset-backed market. Two years ago there were only two sub-prime companies - City Mortgages and Kensington Mortgages. Now there are over 10, including the Money Store, Southern Pacific, Future Mortgages and Mortgages Plc. "Sub-prime lending is still a fairly recent development," says Bill Cherry, managing director of Southern Pacific. "There are plenty of potential borrowers who still have to learn about it."

Just how fast the sub prime market will grow over the next few years is a matter of some debate. According to a recent report by the Council of Mortgage Lenders, the potential (or untapped) size of the market is £2bn a year. But some industry experts believe that the UK market could eventually mirror that in the US, where one in five mortgages are made to sub-prime borrowers. If this market share is achieved, sub prime companies such as Kensington Mortgages, Southern Pacific and City Mortgages (now Ocwen) could be making (and possibly securitising) more than £12bn of loans a year.
This would come as a welcome boost to a UK mortgage-backed market which has been starved of supply in recent years as interest in securitisation among mainstream lenders has remained low. While most use loans to warehouse mortgages, all of the sub-prime lenders use securitisation as their main form of end-finance.
"Securitisation is the norm for us," says Martin Finegold, chief executive of Kensington Mortgages. "We do not want to sell the loans because we want to hold onto the customer."
Kensington has issued more than £660 million of sterling asset-backed paper since January 1997.
According to Finegold, Kensington will issue an estimated £400m over the next 18 months.
Sales of whole loan portfolios has been one of the avenues for growth for sub-prime lenders in the US, but has rarely been tried in the UK. Southern Pacific sold a loan portfolio to the Money Store in 1997. "We look at both loan sales and loan securitisation," says Cherry at Southern Pacific.
"It is a trade off between getting rid of prepayment risk or getting more cash upfront. But Cherry says that present market conditions favour securitisation over loan sales.
Given their US provenance, sub-prime issuers have been particularly willing to experiment with deal structures from across the Atlantic. Kensington Mortgages, for example, was the first UK borrower to launch sterling bonds with interest-only (IO) strips.
In June 1998, it went one step further and issued the first ever sterling tranche of mortgage early redemption certificates (MERCs) as part of its £111.4m bond via Deutsche Bank.
MERCs (which represent prepayment penalties incurred by borrowers redeeming their loans early) are normally sold together with IO strips because they offer a natural hedge against pre-payment.
The deal also included another groundbreaking 'C' Class tranche which is backed by all the residual cash in the structure - excess spread and the originator's original deposit."
Demand for the paper was such that Kensington was able to launch a £142.5m tap issue in September 1998.
So far, other sub-prime issuers have shied away from MERCs. Cherry, for example, is not planning to offer them on Southern Pacific's forthcoming £60 million transaction due later this year. "The transaction will look fairly similar to previous deals," he says. "It is a question of time and effort."
But Finegold is keen to press ahead with new structures.
"We are constantly looking to evolve our structures and will continue to do so," he says, adding that although none of the MERC or IO tranches has been sold, he has received several enquires. "We have had investors wanting to buy our IO and MERC strips but it suits us to hold them which is a polite way of saying we did not like the price."
Kensington is reluctant to spell out exactly what kind of structural innovations it is considering but bankers believe that the next stage is likely to involve more complicated channelling of cashflows rather than the introduction of wholly new asset classes.
But one of the key issues facing the sub prime market is the maintenance of loan quality. According to Fitch IBCA, the rating agency, sub prime companies (and by extension investors in their bonds) are more vulnerable to a housing recession because the quality of their borrowers is lower.
At the same time, as Cherry admits, companies are having to ease up on lending criteria in the face of increased competition from new entrants.
"A few years ago you never saw anything with an LTV (loan to value) ratio of over 75%," he says. "Now you see it all the time and some lenders are doing business on a 100% basis."
Another area of concern is the lack of loan classification on many sub prime bond issues. In the US, loans are labelled A,B,C or D according to the quality of the borrowers. The UK market has yet to reach this level of sophistication, although at least one leading issuer is believed to be readying that classification soon.
These are minor challenges, however, compared to the difficulty of pricing sub-prime issues in the coming months.
Spreads at the end of September are 5bp to 10bp wider than they were three months ago. Some borrowers such as Kensington, which offered 18bp over Libor on the A tranche of its recent £145.2m tap issue - seem prepared to accept the new conditions. But bankers warn that other companies with smaller loan books may prefer to wait until the spreads come back in before launching further issues. EW

  • 01 Sep 1998

All International Bonds

Rank Lead Manager Amount $m No of issues Share %
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1 Citi 35,106.76 122 7.85%
2 JPMorgan 30,256.65 110 6.77%
3 Barclays 29,969.05 73 6.70%
4 Goldman Sachs 28,948.54 58 6.48%
5 Deutsche Bank 24,623.55 77 5.51%

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Rank Lead Manager Amount $m No of issues Share %
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2 ING 1,140.87 4 6.84%
2 BNP Paribas 1,140.87 4 6.84%
4 Citi 841.02 3 5.04%
5 Mitsubishi UFJ Financial Group 811.02 2 4.86%

Bookrunners of all EMEA ECM Issuance

Rank Lead Manager Amount $m No of issues Share %
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1 Goldman Sachs 1,607.28 5 19.42%
2 Credit Suisse 1,301.65 4 15.73%
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4 BNP Paribas 522.35 4 6.31%
5 SG Corporate & Investment Banking 444.17 3 5.37%