After 2022 was marked by relentless bouts of volatility, issuers across the European securitization market were bracing for a similarly difficult 2023. But financing teams have largely been able to resist continued higher rates and slowing economies so far this year, with both consumers and originators showing plenty of resilience.
Indeed, thanks to issuers having greater prudence with their lending and being proactive in their investor relations, there are reasons for cautious optimism about the securitization market as a whole. Expectations for securitization issuance volume in Europe were low at the start of the year, but activity has picked up gradually throughout the year, and has been sustained since a mini-interruption caused by the collapse of Silicon Valley Bank in the US in March.
Indeed, by deal count, May was the busiest month for the European market since the war in Ukraine began in February 2022, while well-known issuers are continuing to access the market, with the likes of Volkswagen, Tesco and Mercedes all having completed transactions.
In RMBS, the pick-up was particularly notable. Some 16 deals were priced in the asset class across April and May. Moreover, there’s been a resurgence in prime UK RMBS, with deals from Lloyds and Virgin Money.
Prudent but positive
John Rowan, CFO at UK specialist mortgage lender Belmont Green, says investors are keen to understand how underwriting standards have been adapted, whether that be with refreshed modelling, ad hoc adjustments, or debt service coverage ratios.
As a result, originations are falling. Indeed, although mortgage approval rates in the UK rose from 44,100 in February to 52,000 in March, this is still well below the 65,600 from September 2022 — just before the crisis in the liability-driven investment (LDI) market.
Alex Maddox, capital markets and digital director at Kensington Mortgages, says both sides are being squeezed with higher interest rates.
“When assessing consumer affordability, you have to take into account the higher debt cost and the higher expenditure that we’re all experiencing,” he says. “Both sides of the consumer balance sheet are being squeezed, which is one of the reasons why average loan balances are coming down a bit.”
Steve Harrison, director at Together Money, another UK specialist lender and frequent RMBS issuer, says that getting ahead of the game is key for non-banks — which is why lenders like Together have increased stress tests.
“There’s no point making changes now, it’s too late,” he says. “The key to surviving tough times is often what you’ve done in the run-up to those periods.”
Together, for example, has added additional stress tests for affordability and income assessments.
“But the ONS [UK Office for National Statistics] data is lagging,” says Harrison. “By the time you get it, it’s stale. Therefore, it’s sensible and prudent to make additional adjustments in light of what we’re seeing with inflation and the cost of living crisis.”
The impact of the rising cost of living continues to be at the front of people’s minds, but mortgage performance is mainly dictated by “life events” like unemployment, illness or family break-up, notes Rowan of Belmont Green.
“Generally, what you’re currently seeing is people are taking into account the cost of living, the rising cost of interest rates, and adjusting their lifestyle,” he says. “We’ve gone from a period where people were saving during lockdown to a more normal cycle, but they’re being prudent.”
Similarly, Harrison says there’s “nothing significant” coming through, in the consumer data that Together analyses, to suggest that payment shocks are causing performance deterioration.
Of course, this doesn’t mean those stresses will not ultimately materialise. But unsecured credit can often be an early indicator.
“So far, customers have proved to be a lot more resilient than many were concerned they might be,” Harrison adds.
Proactive over risk
Risks still lurk. Miles Hunt, managing director at NatWest Markets, says it is a particularly difficult time for some originators, such as those in buy-to-let mortgages, because increased financing costs have made margins so thin.
“You’re originating risk that you are funding close to where you are originating it, or maybe even below where you are originating it,” says Hunt. “You can do that in the short to medium term, [but] you can’t do it in the long run. If you’re buy-to let or near prime, your funding costs too much.”
Kensington’s Maddox, similarly, says that dealing with the “rapid rate movement” of the last year is a big challenge for issuers.
“If you have to put hedging swaps into these securitizations, you’ve got a timing mismatch between when the assets were created and when the swaps were created and that will have a material impact on excess spread,” he says.
As a result of the heightened macroeconomic risks since 2022, investors are keeping an even keener eye on their portfolios. Rowan says the key for Belmont Green in maintaining good relationships is being proactive.
“We offer update calls to investors proactively and get a very good reaction from that,” he says.
The hope, he says, is that — by maintaining greater interaction with investors between deals — when a new issue does land on an investor’s desk, the background checks on the issuer do not have to be so extensive.
“In a crowded market, if you don’t need to remind everyone who the issuer is, that’s helpful,” says Rowan.
Ability to adapt
Despite the tricky environment, new potential entrants to the securitization market continue to emerge. LiveMore Mortgages, a specialist lender for people over the age of 50, is one such example.
Leon Diamond, CEO and cofounder of LiveMore, says securitization is a “natural component” of a diversified funding structure, even as the team considers a first public European retirement interest only (RIO) RMBS.
“For the shorter duration products, we have our 2 year and 5 year fixed rate period loans,” Simon Webb, LiveMore’s managing director of capital markets, says. “This is standard collateral for an RMBS type structure, the only difference being our customer base is slightly older, on average around 65 years of age.”
Indeed, Atul Bajpai, chairman at LiveMore, retains confidence in the European securitization market as, he says, it seems always able to “understand and accommodate” regulatory challenges. Moreover, liquidity appears to have increased significantly since the LDI crisis.
“We have a retirement interest only product that we think investors and rating agencies will be able to get their heads around,” he adds.
More to come
So far, at least, issuers largely retain a certain steely hardiness — having stood up well to the challenges of the past year. And there are further reasons for issuers to be hopeful about the future. The return of flagship prime RMBS programmes like Lloyds’ Permanent shelf, for example, could also be positive for the broader market, Rowan says.
“It’s good to have prime back, on the basis that the broader asset class therefore gathers more momentum,” he says.
Together’s Harrison hopes that investors who perhaps moved into the specialist lender market as a “substitute while prime issuance was limited”, could be tempted to stay even as bigger issuers return.
“We could see some of those investors who had moved into the specialist lender RMBS space stick around for a yield pick-up now they have done their credit work and got comfortable with the sector,” Harrison adds.
Moreover, in January, GlobalCapital reported that the finance ministries in France and Germany had called on the EU Commission to make securitizations easier, calling the current regulations too “conservative”.
Ever since, speculation has been rife about what lighter regulations may mean for the industry.
Matthew Jones, head of EMEA specialised finance at S&P Global, believes the message to the Commission was a response to the ending of cheap central bank funding schemes and the upcoming Basel proposals.
“My guess is they’ve realised that they can’t be weaned off ECB money through covered bonds alone, due mainly to regulatory capital constraints and encumbrance limits,” Jones says. “There’s likely to be a big increase in capital requirements as a result of the current Basel proposals for mortgages.
“Banks are going to need RMBS to manage regulatory capital.”
What Jones calls “fairer and more appropriate” regulations could provide a boost to regular issuers, deepening the investor base. Whichever way the regulation issue evolves, expect the recent generation of securitization issuers to continue to take the initiative when it comes to uncovering more investors.