The Bank of England levelled the playing field for UK financial institutions last month when it followed the lead of the Federal Reserve and provided a facility for domestic banks and building societies to refinance mortgage-backed bonds for government bonds. Continental European banks have long been able to use the European Central Banks repo facility for their mortgage-backed securities. Until the European securitization market shut down, UK banks were by far its biggest users accounting for between 40% and 50% of annual issuance over the past three years alone. The Bank of England has carefully constructed its programme to ensure that banks retain all credit risk.
For the next six months, the special liquidity scheme (SLS) enables the swap of treasury bills for triple-A-rated mortgage, credit care, and covered bonds, provided the collateral was originated before 2008. The initial size of the programme is £50 billion ($100 billion) but no absolute limit has been set by the BoE. The swaps last for one year but can roll over for three years.
According to Ganesh Rajendra, head of European ABS research at Deutsche Bank: "The new Bank of Englands special liquidity scheme will ostensibly provide quasi-term funding to banks at Libor flat. [But] the finer details show this financing to be less than generous, namely on account of the seemingly punitive haircuts and the fact that the banks remain on hook for market-based rates..."
BoEs funding lifeline
Estimated all-in mortgage financing costs
Source: Deutsche Bank
The Bank of England haircuts are more onerous than those exacted by the ECB. For instance, for up to a one-year maturity, fixed or floating, the BoE charges 12% (an extra 3% is charged for foreign-currency bonds) compared with 2% at the ECB. Nevertheless it is still the cheapest financing avenue available and no doubt all banks in a position to use it will do so (see chart). Users of the SLS will pay the BoE the difference between Libor and the general collateral repo rate (banks will repo the treasuries to obtain hard cash). There are also requirements for banks to replace any bonds that are downgraded below triple A.
The initial size of the programme is £50 billion according to Lehman Brothers research, net mortgage lending since July 2007 is just over £60 billion and the size of the overhang in the UK mortgage market is £35 billion.