One thing that is often overlooked in the retail finance space is just how the mortgages that get sold day in, day out to Mr & Mrs Average Joe come about.  That isn't a slur on Mr & Mrs Average Joe, because they are retail customers, afforded the highest protection by the FCA, and are not assumed to know the workings of the credit market, but you might think that people working within the industry would pay attention to such things?

Perhaps they do but there is often a focus upon the Bank of England base rate which since March 2020 has been welded at 10bps and yet rates that you or I may pay in the market for our mortgages have been consistently falling since that time.  The answer as to why is contained within the credit market.

So during a conversation with a friend recently the subject of UK RMBS came up and in particular spreads to other credit.  RMBS are of course Residential Mortgage Backed Securities and the UK relating in this case to the territory of the United Kingdom.  Without dumbing it all down too much essentially Bank A decides that they would like to gain some funding to make loans for people who would like mortgage finance - maybe someone like you.

One quite vanilla way of achieving this is for Bank A to offer an attractive savings rate, which draws in funds that can be made into mortgages.  That is all fine except that it is quite a slow process and of course requires a large marketing effort to the masses in order to highlight the amazing savings rate.  Another way to achieve the same is via something called securitisation.

So Bank A goes to the credit market via an investment bank who sell Bank A's mortgage loan structure and in return charge Bank A some fee for their work.  The investors in this loan structure will typically get fixed interest payments over the period via some new entity, with a name that usually has no relevance what-so-ever with mortgages, and with a prospectus around what the money invested within this structure can be invested in along with a credit rating from a rating agency [best not mention Bradford and Bingley, Northern Rock, WaMu, Ambac Financial, HBOS, at this point...].  Its actually quite a complex process and outside of market professionals in the credit space the structuring of these loans is easier to explain with some real examples.

Take these recent issuances.  So in a structure called Gemgarto 2021-1, the seller (Kensington) intends financing owner-occupied (OO) mortgages to underserved borrowers with complex incomes, the self-employed, first-time buyers with limited credit history, contractors, and later life or younger borrowers.

Another Brass No. 10’s (Yorkshire building society) the proceeds will fund higher-rate savings products, as well as improving first-time buyers’ access to competitively priced mortgages.

Whilst Finsbury Square 2021-1 Green is the first UK RMBS transaction categorised as a Green Bond, meaning that the senior tranche complies with ICMA’s Green Bond Principles. Proceeds from the issuance of the class A notes will finance the origination of mortgage loans for properties with an Energy Performance Certificate of ‘B’ or higher (green projects) to be advanced within five years of the issue date.

Without getting bogged down too much with the various tranche's that are contained within these structures why don't we look at an  example, just a few weeks ago, about just how tightly these things are trading.  

Shawbrook Bank priced its Lanebrook buy-to-let (BTL) RMBS deal in September at the joint-tightest spread on any version of the product since the global financial crisis in 2008, according to sources familiar with the deal. The Class ‘A’ notes on Lanebrook Mortgage Transaction 2021-1, rated Aaa/AAA by Moody’s and S&P, which make up 88% of the deal have been priced at 65bp over Sonia. This was considerably tighter than initial price thoughts at the low/mid 70s.

The Aa2/AA rated ‘B’ notes were priced at 95bp over Sonia, while the class ‘C’ tranche was placed at 125bp over. The ‘D’, ‘E’ and ‘X1’ notes were placed at 165bp, 270bp and 290bp over, respectively. Together, the specialist mortgage and loan lender also priced a deal — a non-conforming RMBS. Despite the lower quality of assets in that deal, pricing landed right on top of where Lanebrook came. The class 'A' notes were priced just 5bp wider, for instance.

Just to translate that.  It effectively means that investors risk premium for BTL RMBS even at the worse tranche [i.e. the first tranche to default] is 290bps over.  With inflation beyond 3% that to me seems incredible.

In other examples you've seen Pepper Money release its latest non-conforming UK RMBS deal, called Polaris 2021-1. Citi, National Australia Bank and NatWest Markets were guiding the £425m deal at around 80bp or in the low-80bp for the senior tranche. The class ‘B’ tranche was being guided in the low 100bp, the class ‘C’ tranche was in the mid-100bp, the ‘D’ piece in the high 100bp, and ‘E’ tranche in the mid-200bp and the ‘F’ in the mid-300bp.

By comparison, the senior paper on Tower Bridge Funding 2021-2, another recent UK RMBS, was priced at 78bp on July 2. Recent data on the performance of UK non-conforming RMBS may have played into the wider pricing on Pepper's deal, as well as the facts that 22% of the creditors in the pool have county court judgements against them and 35% are self-employed. In Tower Bridge Funding 2021-2, CCJs applied to 10% of the collateral.

If you need proof of what central bank asset purchase programs have achieved then look no further and for the moment investors still have appetite for UK RBMS paper.  Enjoy things while they last...