The future shape of the UK mortgage finance market remains uncertain despite the publication on November 25 of former HBOS chief executive James Crosby’s report, which recommends the introduction of a £100 billion government guarantee for mortgage-backed bonds to be issued in 2009 and 2010.
A spokeswoman for the Treasury tells Liquid Real Estate that a response to Crosby’s report was unlikely before the next budget, which is due in March (although an emergency budget might be held sooner). The Treasury’s lack of urgency has raised concerns that it is reluctant to commit itself to a guarantee for mortgage funding.
Crosby’s report makes three main recommendations: the first is an uncontroversial suggestion that mortgage-backed securities should be standardized to make them easier for investors to understand. The second recommendation is that the government should use its influence to get the International Accounting Standards Board to reconsider when and how fair-value accounting should be used.
However, it is Crosby’s concluding suggestion that the government intervene to revive the mortgage financing market – something rejected in Crosby’s preliminary report in July – that has aroused most interest. Crosby’s apocalyptic prediction that net new mortgage lending could slump from £40 billion this year to "below zero" in 2009 unsurprisingly helped the guarantee recommendation garner headlines.
Government guarantee
So how would the plan work? The guarantee could be applied to both RMBS and covered bond financing of new triple A-rated assets, which could have a LTV limit. Banks would pay a fee for the guarantee, which is likely to be modelled on the existing government guarantee for senior bank debt – each banks’ median CDS spread in the year to October 7, plus 50 basis points.
The guarantee would mean that in addition to the mortgages underlying the bond, investors would have recourse to the government. "This means that instruments issued under the proposed guarantee will look similar to a covered bond," says Michelle Bradley, interest rate strategy Europe at Morgan Stanley. "Such a structure would therefore have a ready made investor base." The investor base for UK RMBS – which, with issuance of €132.5 billion in 2007, dwarfed the entire outstanding UK covered bond market of £56 billion – was credit buyers. Those investors certainly aren’t looking for further RMBS. In contrast, covered bonds are a rates product – real money investors buy them for the yield pick-up they offer over government bonds.
"Covered bond buyers are currently on the sidelines because they are largely unwilling to take bank risk," explains Bradley. "But a government guarantee would remove that barrier and there could be significant demand for paper. However, there is expected to be a 25% increase in government issuance next year and as much as €500 billion of guaranteed bank paper – all chasing the same investors."
Of course, it remains to be seen whether or not issuers will want to lend enough to require the funds such a guaranteed market could offer, notes Bradley. Moreover, the guarantee idea has yet to gain the commitment of the government. However, it has become increasingly evident that without government support a recovery in the mortgage finance market is impossible.