By Ben Edwards
After a glut of UK RMBS issuance pushed spreads out to their widest levels in three and a half years in 2015, US money managers are eyeing UK deals for potential bargains and could help soak up what is expected to be another year of elevated supply.
“UK RMBS cheapened meaningfully this fall, which made it more attractive in terms of relative value to the US,” says Curtis Manning, senior ABS analyst at Henderson Global. US investors have been prompted to start buying again.
By mid-January the average asset-swap margin on mortgage-backed securities issued in sterling had jumped to around 140 basis points, the widest level since the summer of 2012, according to a Markit index. The average spread was 96bp at the start of 2015.
A lack of domestic UK RMBS investors means that any spike in new issuance can cause spreads to gap out, even if the underlying mortgages remain solid, says John Kerschner, head of securitization at Janus Capital, who has been buying UK RMBS again since last March.
Around $12.5 billion of prime UK RMBS was issued last year, almost three times what was issued in 2014, Dealogic data show. Investors and analysts expect supply to be robust again this year. Ratul Roy, analyst at Citi, forecasts an uptick of 10% to 20% on last year’s levels, a number that includes $6 billion of non-conforming and buy-to-let deals not included in the Dealogic data.
Any further increase in supply this year is likely to find an increase in demand among US investors, says Tracy Chen, head of structured credit at Brandywine Global, who started buying UK RMBS again at the start of last year and would consider adding to the position if the relative value persists.
“US investors need time to pick up the learning curve and get comfortable with UK collateral and deal structures before they enter the market,” she says. “The sell-off happened in this vacuum. I expect 2016 should be the year that this expanded US buyer base will materialise.”
A large chunk of issuance is expected to come from Cerberus Capital Management’s recent purchase of Northern Rock’s Granite mortgage portfolio from UK Asset Resolution. That deal could result in at least £2 billion to £3 billion of new supply this year, says Kerschner.
Investors may look to Kensington’s recent Trinity Square 2015-1 deal for hints about what kind of spreads any new Granite supply might offer, he says. “If a deal came in the next couple of months, that’s a pretty good indication of where it could price.”
The Trinity Square deal’s top-rated class-A notes were priced at a discount margin of 140bp over three-month Libor.
|John Kerschner, Janus Capital|
Investors also expect further supply to come from UK Asset Resolution’s potential sale of Bradford & Bingley’s Aire Valley mortgage portfolio.
“We expect it to happen this year,” says Anup Agarwal, head of MBS/ABS at Western Asset Management. “It’s a matter of the price the seller is looking for versus what is achievable in the market place. At the moment, the market is not quite there.”
Yet while some money managers are preoccupied with the potential deluge of Granite and Aire Valley supply, Agarwal says he will seek to strike deals with originators in underserved areas of the market.
“When everybody is focused on the gigantic trades, we’re the guys picking from this hoard of diamonds in the rough that nobody wants to pay attention to,” he says. “Because these large transactions are going to dwarf the market, that will give rise to more private transactions where people like us buy the whole deal.”
Agarwal likes the UK’s buy-to-let sector because it is possible to pick up an extra 100bp to 200bp in spread over conforming mortgage loans. “It’s very much in our view a prime credit, but just because it happens to be a buy-to-let, borrowers have to pay significantly higher rates,” he says.
Chen also notes that the lower-rated tranches on some UK RMBS deals can cough up an additional 200bp to 300bp of spread relative to the senior portion, which she finds attractive given the quality of collateral is usually still very good.
Co-operative Bank’s Warwick Finance Residential Mortgages Number 2 deal issued in September, for instance, was priced at a discount margin of 170bp over three-month Libor for the class-A notes and a chunky 525bp for the riskier F class notes.
Kerschner says, as well as participating in the recent Trinity Square deal and an earlier Kensington issue in March, his funds also own some of Co-op Bank’s pre-crisis Leek RMBS series because the bank is due to redeem a batch of those bonds over the next year or so as part of an investor put option it agreed when the notes were restructured in 2011.
“You can get decent upper 2%, low 3% yields depending where you think the forward curve is because they’re floaters, and it’s obviously very short dated. We like those kind of plays,” he says.
Outside the UK, both Chen and Kerschner like some parts of the Spanish mortgage market. Chen says the European Central Bank’s ABS purchase programme has largely ignored deals in Spain in favour of core-country issuance, meaning ECB-eligible Spanish RMBS can come with around a 100bp pick-up.
Kerschner is hopeful that Blackstone will follow through on plans to securitize part of a Spanish mortgage portfolio it owns that investors had expected to see issued by the end of last year.
“Where it’s seasoned collateral with a good track record from a good issuer, we would probably like a deal like that,” he says.