FIG Watch: RBS takes the RMBS market by storm

Ron Huggett: looking across the whole portfolio to apply securitization technology

What a difference a year makes. Fast forward 12 months and RBS is now the proud issuer of Europe’s largest ever securitization (the recently closed £6.5 billion Arran Residential Mortgages 2 deal, which assumes the mantle from HBOS’s £6 billion Permanent 4 transaction in 2004) together with further CLO, RMBS and credit card issuance totalling more than £10 billion – all in little more than six months. Indeed, its two recent RMBS deals (Arran Residential Mortgages 1 and 2) have seen £11.25 billion RBS-backed RMBS hit the market in roughly three months.

As a change of approach this takes some beating. “RBS has a very strong deposit base that has been a rich source of funding for us and a very available source of funding both on the retail side and on the corporate side,” Huggett tells Euromoney. “We therefore haven’t been as active in wholesale funding as some of our peers.” Certainly the likes of Abbey, HBOS and Northern Rock have been tapping the prime RMBS market for years, and sourcing more than 50% of their overall funding in this way. RBS clearly has some catching up to do.

“The growth in our deposits hasn’t kept up with the growth in our advances, so as part of our diversified funding strategy we are looking at alternative sources of funding,” says Huggett. “The disparity between deposits and advances has been apparent for a few years – although for the first half of this year our deposit base grew by about 14% and our loan book by 17%, so it is not massively out of kilter.”

A distribution focus

The securitizations are a major part of RBS’s strategic decision to become more of a distributor rather than just an originator of product. But they are also crucial to enabling the bank to maintain its growth targets. “We have historically been very good at originating product but more recently we have focused on being a distributor as well,” says Huggett. “Moving to distribution and origination will allow us to grow our business at the same pace that we have been doing over the last few years. We acquired NatWest in March 2000 and we have been growing our income by double-digit percentages year on year since then.” The RBS Group’s interim results, released in August, show a 10% rise in total income to £13.6 billion, but this is down from 14% growth for 2005 and 18% for 2004.

The strategic decision to focus on both distribution and origination necessitated a rethink of the bank’s traditional reliance on deposit funding. “We looked at various options when we started to do this,” Huggett says. “We wanted to put other sources of funding at our disposal.”

One of the first decisions RBS made was to set up a $20 billion US MTN programme, which is now roughly 50% drawn down. The bank then weighed up the relative attractions of RMBS and structured covered bonds – something that several UK institutions have recently been doing [see Why the sun hasn’t set on RMBS, Euromoney, April 2006]. But the decision has come down squarely on the side of RMBS for the time being. “I think it is fairly obvious from what we have done that we will be focusing on RMBS rather than covered bonds in the short term,” Huggett explains. “Covered bonds are particularly suited to companies with a very large mortgage book but perhaps without as strong a rating as we currently enjoy.” RBS is rated Aa1 by Moody’s, AA by S&P and AA plus by Fitch. “A covered bond programme only gives us a single notch increase to our current rating,” says Huggett. “Coupled with the fact that we haven’t issued as much senior funding as some of our peers we aren’t running up against the same problem with limits.” He says that covered bonds have not, however, been completely discounted, and the bank will continue to discuss their suitability.

Securitization won the day because of its combination of funding and capital relief. “It seemed a more obvious choice to us,” Huggett says. The bank’s debut RMBS transaction therefore came in June this year: a £4.75 billion standalone deal that attracted £9.5 billion of orders. The follow-up last month was similarly swamped and was therefore increased to £6.5 billion, becoming Europe’s largest ever securitization. With issuance of this magnitude, questions were immediately asked why the bank had not set up a master trust vehicle rather than go to the expense of issuing separate structures.

The reason is clear when the collateral backing the first two deals is taken into account. “The mortgages in both deals are off systems that we no longer use,” says Huggett. The first deal involved loans originated by RBS before October 2004 (when the new mortgage system was introduced) and the second deal involved loans written by NatWest between 1993 and 2004. “As such, these books are amortizing off and no new mortgages are going into the pool so we took the decision not to use a master trust as there are only a finite number of mortgages,” says Huggett. But what about the more recent loans? Surely a master trust would make sense going forward? “We started using our new mortgage system in October 2004 so the mortgages on that book aren’t particularly well seasoned. It was obviously easier to look at the back books,” Huggett says. “Once they are seasoned then we will look at the new mortgages as well – you certainly need a couple of years’ seasoning before you can consider loans for a securitization.” But given that the new mortgage system is now two years old, there must be a fair number of loans that are now suitable. And if the experience of the other UK prime mortgage originators is anything to go by, using a master trust to securitize them would make sense.