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European RMBS: summer brings holiday stresses

As the Covid-19 crisis seeps into the summer months, the issue of extended payment holidays among mortgage borrowers will be a continued source of tension. While investors digest data on mortgage affordability, sources say RMBS players will be looking to non-bank issuers for new deal flow as banks access cheaper central bank funds, writes Tom Brown.

As Europe eases out of Covid-imposed lockdowns, countries will have a range of decisions to make on how long mortgage moratoriums should last, skewing performance data and possibly masking the extent of delinquencies for a period. 

The advice from the UK’s Financial Conduct Authority (FCA) not to count loans with Covid-related moratoriums as being in default is distorting the picture of underlying loan performance because it obscures which borrowers can pay independent of government support and which cannot.

Once the moratoriums come to an end, borrowers who are furloughed and with jobs to return to will make up missing payments over the next few months. Different payment plans are being negotiated depending on borrower needs and lender policy.

As it stands, the market is expecting a considerable portion of borrowers under some kind of payment holiday scheme to default. Industry group UK Finance forecasts that 30%-40% of borrowers currently using the scheme will be unable to resume payments after the moratorium ends in October.

The UK has a particularly high rate of moratorium uptakes compared with other countries in Europe, with over 20% of UK mortgage borrowers on a payment holiday through May. This is because the criteria needed for borrowers to be granted a moratorium is largely self-selected, making reported levels higher than the Netherlands, for example.

“Where there are people who go on payment holidays, some will find their feet again and the payment holiday may have allowed them to stay in their homes, but equally some people won’t be able to pay at the end of their payment holiday and they may be in similarly dire straits,” says Erik Parker, executive director in ABS strategy at Nomura International. “Waiting six months has just made that loss for the vehicle a little bit larger. Also, you may end up enforcing these properties in a declining housing market, perhaps increasing the loss further.”  

The UK government is also considering extending moratoriums for up to 12 months, according to national newspapers.

Payment arrears

Other problems arise from prolonged missed payments on the assets side. Some market commentators argue the moratoriums are disguising a credit stress as a liquidity stress.

“If you take the view that a payment holiday is not an arrear in the purest sense — and consequently arrears triggers are not in breach as a result of this interpretation — transactions can continue to function as normal when otherwise they would not,” says Mandeep Lotay, partner at Freshfields Bruckhaus Deringer. 

Originators can take steps to avoid cashflow disruptions. An originator, for example, could continue to sell more loans to the securitized portfolio or any ABS transaction that uses default ratios to control portfolio risk, though a continued cashflow disruption will eventually cause problems for deals with thin liquidity, which is why the rating agencies have put certain deals on negative watch.

Unlike payment holidays, cashflow disruptions are not open for interpretation with regards to rating agencies.

Lotay says prolonged moratoriums could in some cases cause tension between investors and originators.

“Money will go out of the door to the residual noteholders, often originators at the bottom of the capital stack, in the form of excess spread,” says Lotay. “When payment moratoria end but some customers still can’t pay because, say, we are in a severe recession with high unemployment, what started as a liquidity issue has turned into a credit problem.”

This would come in the form of principal losses, which will be suffered by investors as performing loans turn into NPLs. But during the payment holiday period, the originator has been receiving principal and loss in the form of excess spread.

The path for non-banks 

Market participants predict the UK RMBS sector will be split between those lenders who have access to government support and issuers who continue to survive without.

“There is a danger that there is going to be a divide in the market between those who have access to those facilities and those who don’t,” says Sarah Porter, a partner at Baker & McKenzie. “It was just about beginning to get back to normal in terms of funding cycles, and now we will go straight back to the reliance on Bank of England schemes for those who have access to them.”

Investors and rating agencies expect the market to mirror 2012 in terms of issuance levels, forecasting a steady supply of retained deals for the bank issuers who have access to central bank funding schemes.

Syndicated RMBS issuance will depend on government support for the non-bank sector, as well as to what degree those lenders continue to see securitization as an attractive funding tool.

“[Non-banks] need banks to basically bridge the gap in their funding model, i.e. increase the warehouse available, but bank appetite to do that is likely to be limited,” says Cliff Pearce, global head of capital markets at Intertrust.

Across the continent, originators have offered varying levels of support for their RMBS transactions, with master trust or conduit issuers in particular incentivised to support noteholders.

Santander and Together Money (UK) have publicly pledged to support their RMBS transactions, the former for its Holmes Master Trust shelf and the latter for its private Charles Street Conduit deals.

Before the pandemic, S&P Global Ratings had a “positive outlook” for UK specialist lender Together. That has been downgraded to negative. Together is an example of a previously healthy non-bank business whose economic forecast has deteriorated due to a lack of government support.

RMBS syndicate bankers expect issuers to insert RMBS shelf protections only in so far as it protects senior noteholders, potentially exacerbating the tension between the originator and the equity holder over the issue of excess spread.

Some issuers are leaving the excess spread in the payment structure uncollected, say lawyers. Other lenders are exploring similar options to Santander, but without knowing the full extent of the government-led moratorium measures it is difficult for issuers to plan for shortfalls. 

There is also the concern of rating assumptions being put to the test in the following months, as many models assume that foreclosures are enforceable and courts are active. 

“With lockdown and what’s been happening, there’s been a moratorium on enforcement. Once that ends it is going to take longer to go through enforcement policies,” says Baker McKenzie’s Porter. “That would probably test some of the assumptions that the rating agencies have made when they run their credit analysis. That is one to keep an eye on.”

In the rest of Europe, the mortgage market trajectory will differ by country. The RMBS market is set to recover quickly in Ireland, for instance, largely due to the its financial diversification since the last crisis compared to southern European countries such as Spain, Italy and Greece.

“What we’re seeing in the Irish market, like everywhere else in Europe, is a very active government and state response to various loan markets including SME, residential, and consumer,” says Callaghan Kennedy, partner at Maples and Calder in Dublin.

Moody’s predicts southern European RMBS will weather a short, sharp recession followed by a lower recovery, though the trajectory will differ by country. Spanish transactions have a higher probability of credit quality deterioration compared to Portuguese and Italian deals, for instance, as Spanish deals have pro rata structures which do not build as much credit enhancement for senior tranches as they delever.   

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