Market participants in UK RMBS celebrated this week as prime deals issued by Lloyds and Virgin Money landed two rare but hefty blows on sterling covered bonds, printing a few basis points inside where similar transactions in the covered bond market would have been expected.
Lloyds’ emblematic Permanent shelf received a hero’s welcome, pricing at 52bp over Sonia on Wednesday and doubling the issue size from £500m to £1bn. On Thursday, Virgin Money's subsidiary Clydesdale Bank also priced its £500m Lanark 2023-1 deal at 52bp over Sonia.
The result was particularly impressive for Virgin Money which, as a smaller issuer, usually prices its RMBS about 5bp wider than Lloyds, and matched it with a longer weighted average life.
Lloyds certainly had the order book to command tighter pricing, but since investors were understood to be resistant to this, Lloyds instead doubled the deal size to £1bn, similar to what it could have issued in the covered bond market.
A banker on the Lanark deal said the pipeline had become so busy that some investors were not making offers.
“All trades could have gone better in clear markets,” he added.
Bankers on both deals were delighted. Monica De Vries, head of securitization and capital optimisation at Lloyds, told GlobalCapital she was “very pleased with the outcome, given the £1bn size and the attractive spread”.
RMBS steals the show
The level of 52bp over Sonia is significant because covered bonds are usually expected to be priced 5bp-10bp tighter than prime RMBS.
Eight issuers have priced sterling covered bonds this year. National Australia Bank issued the most recent deal, on May 9: a £1.25bn June 2026, priced at 60bp over Sonia.
Lloyds last visited the covered bond market in November 2022, when it raised £1bn of five year funding at 65bp.
Lloyds’ covered bond and RMBS deals have similar credit enhancement of about 10%. But because of their dual recourse feature and more favourable regulatory treatment, covered bonds have historically traded somewhat tighter than RMBS.
Covered bonds attract a lower capital charge, get better treatment in liquidity coverage ratio portfolios and attract a lower valuation haircut for repo purposes, compared with RMBS.
These features are especially important for bank investors which, counterintuitively, bought 69% of Permanent, the highest allocation by investor type. The distribution was similar to Lloyds' last two RMBS.
Bank treasuries usually invest in a range of different asset classes.
“We often find there are separate buckets for RMBS and covered bonds from the same originator,” said Miray Muminoglu, managing director at Lloyds.
But unlike sterling covered bonds, Permanent was offered under 144A documentation, giving it extra appeal for onshore US bank investors and asset managers. Muminoglu said it made sense to structure deals with a view to reaching the largest investor audience.
“There is no other reason for having 144A unless they had a bid,” a rival banker concurred.
The extraordinary demand for RMBS has been driven by scarcity of sterling issuance and the fact that some major issuers, such as Kensington Mortgages, are no longer in the market.
“Over time, the outstanding stock of prime RMBS has become increasingly limited,” said John Millward, HSBC’s global co-head of covered bonds and head of ABS for EMEA. This has resulted in “a strong technical which, along with higher absolute rates, means there are a lot of investors that have cash to put to work.”
Eternal flame?
Some bankers have questioned whether tight RMBS spreads can be sustained, convinced that the market will eventually widen back to historical norms and offer a premium over covered bonds.
But in Millward’s view, it is the covered bond market that is out of synch, not RMBS.
“RMBS is trading where it should be,” he said. “Given fundamentals between the two products and a decent crossover of demand from UK bank treasury investors in both asset classes, there is arguably potential for a recalibration of covered bond spreads, which have historically traded 5bp-10bp tighter.”
As promising as the result may appear for securitization, it still faces substantial structural disadvantages compared with covered bonds.
Securitization has a far smaller investor base and suffers from bouts of volatility, leading to fears of illiquidity. This also means the market can easily become oversupplied, making it risky for issuers to be too dependent on securitization for their funding.
Nevertheless, one banker not involved in either Permanent or Lanark said bank treasuries across Europe would be keen to diversify their funding, as cheap central bank funding schemes had now ended.
“Every bank is probably looking at their different funding tools, their different capital tools and thinking: what is possible here?" he added.
Many of the most storied and prime UK RMBS shelves have been kept alive in recent years only in the name of funding diversification. But with floating rate assets back in vogue as rates continue to rise, those programmes have accelerated this month.
Indeed, De Vries said: “The aim, especially for Lloyds, this year is to diversify our sources of funding, including securitization, and hence the revival of Permanent.”
More prime issuance is expected throughout the year, with the likes of The Co-operative Group expected to return at some point too. However, landing consistently inside sterling covered bonds looks unlikely, another banker said.
At the very least, securitization teams on both Lanark and Permanent are enjoying their moment in the sun.