The winddown of the Bank of England’s Term Funding Scheme (TFS) this month means UK lenders are more likely to consider replacement sources of funding.
In a report published on Monday, analysts at BAML argued that UK borrowers would probably fight for deposits, but would also consider a wider range of other funding sources.
But, in contrast to regulators in the eurozone, UK regulators “are loath to allow massive asset encumbrance”. Accordingly, UK regulators have set up asset encumbrance limits which give a chance for “securitization to come to the rescue”. The primary UK securitization market is likely to be active in 2018 and 2019, in both sterling and dollars.
As with the UK, eurozone banks have also drawn heavily on cheap central bank funding offered by the term long term refinancing operation (TLTRO) with the last large draw taking place in March 2017.
However, in addition to this, the European Central Bank (ECB) expanded its balance sheet by €2.3tr via its asset purchase programme which has benefited covered bonds, and cut its deposit rate to minus 0.4%.
These measures mean that, aside from an excess of deposits, eurozone banks also have a favourable covered bond market that gives access to long and ultralong duration issuance, said BAML.
No encumbrance limit in Eurozone
More pointedly — and in contrast to the UK — the eurozone “does not impose any particular limit on covered bond use and related asset encumbrance”.
“Securitization funding costs and regulatory overload cannot compete with covered bond funding costs,” said BAML.
Eurozone banks’ funding needs are likely to remain subdued in the medium term “even with the repayment of the TLTRO funds and the withdrawal of easy liquidity”, said BAML. That is unless something changes. For example, the ECB has signalled that it will not buy a conditional pass through (CPT) covered bonds from non-investment grade issuers.
Investment grade issuers in the Netherlands, are theoretically untouched by this change. However, Dutch bankers told GlobalCapital that they are nervous the ECB’s decision will send a negative signal to the CPT market as a whole.
This could potentially raise CPT funding costs and ultimately tilt the balance back towards RMBS issuance.
Another potential change, which the BAML analysts believe is not likely, is the introduction of a eurozone asset encumbrance limit for covered bonds.
The Belgian regulator’s decision to set a covered bond encumbrance limit “prompted the return of RMBS” the analysts observed.