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A version of this article first appeared in Total Derivatives.
Total Derivatives is the prime source of real-time news and analysis of the global fixed income derivatives markets.
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The problems with the sub-prime mortgage market in the US – both real and imagined – rumble on. In the UK, however, there has been a stoic refusal to panic.
This was made clear earlier this month as Merrill Lynch, Lehman Brothers and Kensington Group sold bonds backed by sub-prime or, to use the UK terminology, non-conforming, mortgages, bringing the 2007 total of such issuance up to 150% of the sum achieved at the same point in 2006.
Ahead, Britannia Building Society says it is planning to raise an equivalent of £840 million in a multi-currency sterling, euro and dollar-denominated RMBS to be backed by the non-conforming section of Britannia’s loan book.
According to Standard & Poor’s analyst Sean Hannigan, there are good reasons why the UK credit market is able to retain its sang-froid while doom-mongers in the US warn of meltdown. In the UK, sub-prime loans are called non-conforming loans, and the difference runs deeper than just the name.
In the UK, Hannigan says, "the market was born of necessity. The tighter underwriting criteria following the recession of the early 1990s pushed a lot of not very risky people suddenly into the non-conforming category."
Hence while the UK description of non-conforming borrowers suggests unusual, rather than risky, the US sub-prime name suggests a clear risk of problems. As Hannigan says: "The US sub-prime market has been around longer and has always been there to serve people with genuinely bad credit records."
In addition, UK RMBS is a more diversified creature than its US cousin. Hannigan says that "while the US sub-prime market consists of the mortgages not picked up by either higher-quality securitizations or Freddie Mac, Fannie Mae and Ginnie Mae, here any deal will likely be a mix of prime, near-prime, buy-to-let and non-conforming, so there is more diversification within individual transactions."
One clear comparison between the two markets is the loan-to-value (LTV) ratio. In the US sub-prime market in 2006, RMBS transactions averaged in the mid-80% area while in the UK it was in the mid-70% range, a sizeable difference that leaves the UK equivalent with significantly more embedded equity (as well as a better-rated borrower base).
Perfect storms
In February, S&P issued a report stating that the performance of UK non-conforming loans had been deteriorating. It warned that the general performance of its nonconforming delinquency index deteriorated throughout 2006, and said that since December 2004, the market had experienced consistent rises in the index for 90-plus day delinquencies, which had risen to almost twice their 2004 levels. Total delinquencies, it said, were also generally increasing.
Since that February 19 statement the quarterly S&P non-conforming delinquency index has not been updated. According to S&P’s Hannigan, though, the picture probably will not deteriorate much further. "I think that rising interest rates will obviously have an effect on UK delinquencies but what effect this has on UK RMBS transactions will depend on the level at which the delinquencies peak", he says. "Last year saw credit card delinquencies affect that [securitized debt] market but there have still not been any downgrades as a result. For some individual [RMBS] deals, rising delinquencies and earlier realized losses may just come at the wrong time in the transaction."
The wrong time in this case could include a number of factors that make any given RMBS deal particularly vulnerable to cashflow problems. An obvious example of this is the possibility that the reserve fund on such a deal hasn’t had a chance to build up sufficiently to insulate it 100% from default. Also another feature could have an impact, for example a detachable coupon rate increasing.
As Hannigan says: "At the wrong time certain structural elements are in danger of working against you." However, he adds that while it is impossible to predict with absolute certainty the problems that will develop in the non-conforming loan business – and that while all the lenders have suffered some losses – he believes the fallout will be limited.
"If there are any downgrades as a result of non-conforming delinquencies then they will probably be very few," Hannigan concludes. "There may be one or two deals where the perfect storm strikes at just the wrong time for the structure but, if you look at events in the US, we are already seeing RMBS deals where individual tranches might be downgraded without affecting the overall deal. In other words where there have been problems, contagion to better-rated tranches simply hasn’t happened."
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A version of this article first appeared in Total Derivatives.
Total Derivatives is the prime source of real-time news and analysis of the global fixed income derivatives markets.
|
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