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Specialist lenders eye bright future after surviving Covid test

By Owen Sanderson
02 Jun 2021

In mid-May GlobalCapital convened representatives of three RMBS issuers with different business models and approaches for a wide-ranging discussion about the state of the UK mortgage markets, funding strategies, and much more. Kensington is the most frequent issuer in European RMBS, with a track record stretching back to 1995, and more than £10bn of assets under management, including about £6bn of servicing mandates. LendInvest and Habito are fintech lenders, with LendInvest originating bridging loans and buy-to-let, funded through securitizations (LendInvest has completed two public deals so far), retail bonds, funds, and private capital, including a £500m partnership with JP Morgan. Habito mixes technology-enabled mortgage broking with its own buy-to-let originations, funded through Citi’s securitization shelf, and has recently launched the first long-term (up to 40 years) fixed rate mortgage product in the UK, funded through a partnership with CarVal Investors.

Euro_securitization_reportParticipants in the roundtable were:

Alex Maddox, capital markets and product development director, Kensington

Hugo Davies, capital markets head, LendInvest

François Tual, chief capital officer, Habito

Moderator: Owen Sanderson, structured credit editor, GlobalCapital


GlobalCapital: How did the pandemic affect your funding plans last year? I’ll turn to Hugo first, since you priced a deal in the teeth of the crisis!

Hugo Davies, LendInvest: We had launched that transaction (Mortimer 2020-1) before the pandemic, and the crux of the decision we had to make at the time was: what’s most important to us? Is it returning liquidity back to the business, or is it securing the tightest spreads we can? We opted for liquidity.

So we managed to return crucial mezzanine and subordinated capital back to the business, which fundamentally allowed us to remain open during that period and continue writing loans. But I think that’s where it was a bit different for us, because we were one of the last transactions before the market really ground to a halt. In the following quarter or two, clearly, origination levels were low as well. But when lockdown lifted and the market began to thaw, valuers were able to go back out and physically inspect properties. Naturally, securitization markets followed suit. But in that intervening period, we hadn’t had the opportunity to really build up our book again.

In order to take advantage of that window, when it did appear, we decided to access private capital markets. You will have seen that we then established a separate account mandate with JP Morgan for half a billion pounds. So we were able to diversify our funding structure through accessing private funding lines.

GlobalCapital: How was the pandemic period for your funding, Alex? You clearly have a rather larger funding programme than Hugo or François to look after…

Alex Maddox, Kensington: We had been running a pretty conservative funding strategy up until the end of 2019, as a result of the Brexit deadline. So we went into 2020 in a reasonably strong position, with quite a nice deal in the first couple of months of 2020 (Finsbury Square 2020-1). At that point, all our management conversations were about moving to a more neutral funding stance, just as the pandemic kicked off. So we were quite lucky that we were still in that conservative funding position. We also took a decision to sell out quite a lot of bonds that we had retained, but weren’t part of CRR during March, just to give ourselves excess liquidity.

And then in April the market closed down. It’s part of our funding plan to deal with situations like this. There are lots of reasons markets shut down, but a market shutdown always looks like a market shutdown — you can’t issue bonds. So we have a mode that allows us to continue to operate for a certain time without the market being open.

As the government stepped in, though, and we saw more and more demand from investors, then we were able to issue our first deal in June, which was a Finsbury Square (Finsbury Square 2020-2). We subsequently issued an RMS (RMS 32) in July, when the market had fully re-opened, which represented the first public fully syndicated deal since the beginning of the pandemic.

If we had gone according to our original plan, we would have done the RMS deal first, but given the standard and benchmark nature of the Finsbury Square shelf, we decided to bring that deal forward. There were lots of discussions at the time around whether to pre‑place deals or not, but we were just glad the market was open at that point.

In the scheme of things, a market shutdown for three months, even if it felt like a pretty intense three months, really wasn’t too bad compared with other periods we have been through. 

GlobalCapital: Were you able to open new warehouses at that point?

Maddox, Kensington: We didn’t need to. We run our warehouse with very low utilization, so we have a massive warehouse which we frequently empty out. Again, that’s all part of our normal funding strategy — so that if the market does shut for a certain period, we can continue to operate within our existing facilities. In my experience, you can’t get warehouses in those periods. So you have to go into these stressed periods with the right kind of funding model and not try to set it up during that period of financial stress.

GlobalCapital: And for you, François, how was that highly stressed period in markets for Habito?

Euro_securitization_reportFrançois Tual, Habito: We are much earlier in our journey than LendInvest or Kensington of course, so when the panic started we were starting to roll out a buy-to-let (BTL) product to selected external brokers. So we had to pause that, which gave us a bit of time to fine-tune the tech, make sure everything was working the way we wanted, which allowed us to hit the ground running when lending markets re-opened.

During the first lockdown, people weren’t able to visit houses. So even our brokerage business was impacted, and physical valuations also became almost impossible. That has changed how we do business to a certain extent.

Also at the time we were starting discussions on Habito One, our long-term fixed rate product, and I can only concur with Hugo and Alex: the market basically shut down. LendInvest’s deal was among the last deals out. Citi did another Canada Square deal just before the crisis, but the pricing was somewhat less attractive.

We were also having discussions with investors about private origination opportunities on a forward-flow basis, but everyone was showing the same behaviour as in public markets — focused on their existing portfolio, without any capacity to discuss new trades. Banks had to review all their existing warehouses, and sometimes restructure them, because of the excess spread tests which were under some strain.

GlobalCapital: How did the performance of your mortgage books look through the most intense period of the pandemic? 

Maddox, Kensington: Performance has been excellent. We obviously ran a lot of different stress tests; we use a proprietary model called Vector to predict performance at the loan level under different macroeconomic scenarios. We ran a huge number of different scenarios — U-shaped, L-shaped, V-shaped recoveries and so on through last year.

The majority of the economic scenarios we put in were unemployment going to 8% or 10%, house prices dropping massively and so on. In reality, as a result of the government support and interest rate cuts, house prices didn’t go down at all. As François said, there wasn’t an awful lot of valuation or house selling going on initially, but towards the end of the year, the market got back on its feet.

We saw a huge amount of payment holidays: 23% of our book, including our serviced book, were on payment holidays at some point. But that came down pretty quickly by the end of the year. And now payment holidays are a very small, single-digit percentage of our book.

The big question for us at the time was whether those payment holiday customers would turn into arrears customers. It’s all very well getting them off payment holidays, but what you actually want is them back to paying — that’s good for the customer and it’s good for us.

But it has been very positive — we actually found ourselves at the end of the year, within our Kensington book, with lower arrears than we had 12 months ago, which is pretty amazing, all things considered. But of course we are watching the economic outlook very closely, especially when the job support schemes from the government will end. If we run a more severe downturn stress scenario from here, we would expect arrears to pick up again.

One area where we have seen arrears worsen is in very late stage arrears, and that’s due to the repossession moratorium, which is a government policy that makes sense in this period. But ultimately if the route to repossession is blocked, then we are going to see a slight pick‑up in later stage arrears.

GlobalCapital: And is that relatively positive picture reflective of your experience Hugo?

Davies, LendInvest: Yes, absolutely. We are a BTL lender, we are fundamentally subject to different dynamics from owner-occupied lending, but even within BTL we are targeting a slightly different customer base from Kensington.

But to build on what Alex said, in April last year some of the headlines around house prices were genuinely cataclysmic, but I think the absolute opposite of what everyone feared actually happened. We ended the year with house prices up 5% on an annualised basis, and now we are a year from the pandemic beginning and we are up 8%, according to recent Halifax figures. That sets the scene for a double digit increase through to summer, once we go through the first checkpoint of the stamp duty window, which is incredible.

Euro_securitization_reportI would say that the stamp duty holiday has been the single greatest driving factor behind origination levels, particularly in 2021. That has coincided with confidence as a result of the vaccination programme. We are probably doing around twice the volume we were pre-crisis.

Mortimer 2020-1, our crisis-era trade, peaked just over 4% in terms of mortgage payment holidays or payment deferrals. We had a similar thought process over whether these payment holidays would ultimately amount to arrears when they began to roll off. But we found that the vast majority of them, once the three month holiday was over, were keen to get back on track almost immediately.

From our perspective, it has been important for us to continue investing in the platform over that period. Our origination and underwriting platform is effectively consuming over 50,000 data points from around 20 different third party APIs, and all of that is helping underwriters make a better decision. As a result of that, we were able to comb through some of these payment deferral cases and work out which cases actually warranted a payment deferral. 

It was also clear, when the forbearance measures were first announced, that not everyone fully understood what they were getting themselves into — particularly that they were going to continue to accrue interest over the holiday period. As soon as you started to communicate some of these aspects to customers, a number of the requests faded away. To wrap up, the bounce-back or recovery has been incredibly positive, but we approach the future with caution.

GlobalCapital: Same for you François? What kinds of questions did you get from investors or counterparties about mortgage performance during this period?

Tual, Habito: The most interesting view we had was through our brokerage arm — we are now originating around £3bn of mortgages per year across all the lenders in the UK, so you get a good look at where the market is moving. There was a lot of stress in the system, so you had people coming to us and asking “can I take these payment holidays, will it impact my credit score” and so on. 

The government was quite supportive, between the furlough scheme, the SME support, the Future Fund and various other initiatives. As a French national, it seems quite normal to me, but for you guys it has been bliss!

There is a bit of uncertainty about what’s going to happen when the furlough scheme is actually rolled back, what’s going to happen to all those government-guaranteed business loans that have been issued of course. It’s not completely over — the scars are still out there from the stresses.

Davies, LendInvest: To add to that, the fears around last April were really about the scarring in the economy. But over the last few months, it feels like every week, the bounce-back is improving. Even the most bullish commentators in November last year, when the vaccine news had just come out, are having to come back now and revise their forecasts up again. The Monetary Policy Committee is expecting unemployment to peak at no more than 5% towards the end of the year — incredible, compared with where we were a few months ago. 

Tual, Habito: The only caveat I have to that view is that in BTL especially, the government needs to make some money back at some point, because they have been quite generous. We are monitoring closely what further regulatory action might happen in the real estate segment, which isn’t the always most loved sector by governments.

GlobalCapital: In the terms of the lending landscape last year, to what extent did you see the competitive landscape change? Did the high street lenders pull in their horns?

Maddox, Kensington: It was tough last year because, as François said, initially there were no valuations. Early in the pandemic lenders pulled out products aggressively. So for the majority of the year you couldn’t get a product over 75% LTV. One of the reasons for the new government mortgage guarantee scheme is to support higher LTV lending, which is definitely needed. 

Although rates did go up initially, between what we saw from the government support schemes such as TFS and the drop in the swap rate, it was possible to keep product rates to customers at the same level, but net interest margins were quite high to cover for the increased credit risk and uncertainty about the macroeconomic outlook.

Euro_securitization_reportThe QE strategy really worked for us in some ways. A number of us in the specialist lending sector looked to see if we could get access to government funding in the same way as the banks and building societies, and we were ultimately unsuccessful. But I do think we have benefited indirectly, because as those banks were awash with cash and didn’t need to go to the securitization market, there was a knock-on effect as the regular investors were trying to work out what to buy, and really the only product available for them has been from non-deposit funded specialist lenders. And of course QE supported the macro picture as we have already discussed.

Going forward, it’s a really exciting period for specialist lenders. The mortgage payment holidays are designed not to impact customer credit scores. But at the same time, for the self-employed segment, or those that have been on furlough, it’s increasingly difficult for the high street lenders to serve those customers. So there’s a great opportunity for specialist lenders generally, particularly in the owner-occupied and complex prime segment we serve.

GlobalCapital: Do you see similarly positive opportunities in the BTL space Hugo?

Davies, LendInvest: It’s a slightly different dynamic, but certainly we see opportunities. There was a Knight Frank survey which said that 27% of landlords are looking to grow their portfolios in the near term, which is excellent. And I’ve also seen research about landlords increasingly enquiring about green products and how they can improve energy efficiency, which is really positive and a strong theme in the securitization markets at the moment.

Taking a step back, there’s clearly a bit of yield pressure in London at the moment, which shouldn’t come as a surprise. If you think about house price growth in London compared with the rest of the UK since the financial crisis, it has been pretty meteoric. Yields in the rest of the country have been a bit more resilient than we are seeing in London at the moment. Coming into the crisis from a purely LendInvest perspective, we were quite keen to position our offering for portfolio landlords, and they have been quite well insulated during the period, just through natural diversification in their portfolios.

We think that the government is fundamentally a government which supports home ownership, which is fine. Lots of specialist lenders in the owner-occupied space have been helping to serve potential home-owners with low deposits, but it’s difficult to square away both low deposit and low income, and many of those potential customers are still going to be tenants, meaning robust demand for private rented property. 

From the point of view of a portfolio landlord, house prices are excellent, so even if you may not have been able to complete on a purchase in time for the stamp duty window, maybe now is the time to refinance, maybe release some equity. When the dust settles towards the end of the year, that could be the time to get back into growth mode. 

GlobalCapital: What have been the operational challenges for the past year, as the housing market has flipped from stasis to full speed?

Tual, Habito: The closure of the market, which meant nobody could visit anyone else’s home, lasted for a good three months, and there were lots of industry initiatives that were done to push out safety guidelines, so that appraisers could visit homes, so that buyers and sellers could visit homes and so on.

But it took a few months to kick in. So the first lockdown was a disaster, when everyone just stopped breathing and waited for the easing of the government position.

We saw some positive steps forward, however — for example, on valuations. Some lenders that were historically reliant only on physical valuations were starting to consider how to do business in a world where it’s tricky to get an appraiser visiting houses.

It wasn’t only the Covid situation slowing the market down; a lot of people in the property industry were on furlough, there was a quite a lag in activities, with conveyancing taking much longer — perhaps double in lockdown compared with what it was before. For Habito, that meant having to live with a longer cash cycle, for example, since transactions were taking longer to complete. But when you get out of this situation, you try to figure out how to keep some of the benefits of what you have learned.

GlobalCapital: On the question of physical valuations, let’s turn to Alex — given that Kensington has been around a bit longer, are you a physical valuations traditionalist?

Maddox, Kensington: There were lots of things that had to be done differently in 2020, and we did move to a hybrid model. For any wholesale-funded specialist lender, however, it’s not just down to us, it’s also down to what our warehouse lenders and others will approve, and how we do valuations is always going to be something they care about.

So we went through a process of approving that hybrid valuation model, mixing a desktop and a visit by a surveyor. As it happened, surveyors had largely opened up again by the time we had those approvals in place.

I think AVM (automated valuation models) have a place in the armory of most lenders, but it needs to be used cautiously. It can provide a good customer experience in terms of turnaround times. We are not doing it right now, but I think we will be at some point in the future.

Tual, Habito: We have a slightly different approach to AVM. We use it right now in most cases where the LTV is very low or it’s a very straightforward case or there’s a lot of liquidity in the area. We use it in every case, though, to give us a degree of confidence in whether we then do a desktop or a physical valuation as well. And we have seen that working quite well, in terms of getting investors and warehouse providers comfortable. The caveat to that is that a lot of the US banks and investors have to work within the confines of SEC rules which do not allow a lot of desktop valuations.

Davies, LendInvest: I completely agree with both François and Alex. The problem is that it’s difficult to see a scalable path for non-physical valuation methods. Some of our US funding partners were able to support desktop valuations or drive-by valuations during that period, but it was largely because physical valuations weren’t possible. So as soon as valuers were able to go back and physically inspect properties, most of these concessions fell away. 

But also, from my perspective, landlords want to maximise leverage, so they want their valuation to be as high as possible. So they are thinking that they’ll probably get a discounted valuation through a non-physical method.

So there are a few things that need to move at once. I think the biggest stumbling block at the moment is probably credit rating agencies. They will haircut you if you use a non-physical valuation method, though there are some ways to navigate that.

But fundamentally, whether it’s AVMs or any other digital solution, that’s going to get better over time, as more people use them and the data sets get richer. So I do wonder whether it just takes someone willing to stick their head over the parapet and say “I’m going to do a BTL trade, mostly on AVMs, take the haircuts and get over it”. In doing so, they would start that cycle of getting better data for the rating agencies; they can then track those losses, and hopefully through time you can begin to remove some of those discounts and open up the market to a new solution.

GlobalCapital: Would you say that the bond investors care as much as the rating agencies or the SEC about physical valuations, or are they willing to be a bit more constructive?

Davies, LendInvest: They are always willing to be constructive! We have probably had to engage with investors more so in the past year than at any point since the business was started, because really this was the first cycle our business has been through. We were more than happy to talk about alternative valuation methods, whether it’s drive-bys or desktops, and all of the investors understood the merits of doing these. 

But it’s also not a blanket approach. You’re not necessarily going to value a single self-contained residential unit in the same way that you value a large HMO [house in multiple occupation]. So there are nuances in the risk profile, but if you’re looking at an ordinary semi-detached house, why not use a faster method?

GlobalCapital: Looking ahead, what do you see in terms of new products or innovations? François has launched the first 40 year fix — can you tell us about the decision to do that?

Tual, Habito: Well, you have to be innovative, because Alex is offering all the other products! We launched into long-term fixed a few months back. We have a hybrid business model where we are both a broker and a lender — so for us, having servicing fees or brokerage commission every two years doesn’t really make any difference. So if there’s one lender that could bring this kind of product to market, it was us.

The timing was also right, in the sense that you’ve got a lot of fears about inflation, people have been on furlough and have struggled to refinance at the end of the two year period. And so we actually have a lot of people coming to us and saying “yes, we understand it’s more expensive, but I just can’t live with remortgaging every two years — plus, if interest rates go up I’m protected”.

We have done a lot of research and due diligence in launching this product, and tried to bring something very consumer-centric. The mortgage market overall is quite limited in terms of innovation at the product level — you can innovate a lot with the technology behind underwriting, and with other elements. For example, we have a product that integrates conveyancing, so you have everything up to the point where you get the keys to your house. 

In terms of the other products we are seeing, it seems like new BTL lenders are coming to market every month. We quite like the idea of green mortgages, though Alex and Hugo may have more to say on that. We think that one impact of the pandemic is that people are spending much more time in their homes, and people are going to want either to move to find more space, or upgrade what they have, which plays into the logic for green mortgages that fund improvements.

In the US, they have a product called a home equity line of credit, or HELOC, which is like a second charge mortgage, but acts like a credit card — you can withdraw money from the equity you have in your house. This could of course be used for home improvements, and could be quite impactful as an innovation if it was brought to the UK market.

GlobalCapital: What are your views on new or innovative products, Alex? What does Kensington have in store?

Maddox, Kensington: Just at the moment there’s a huge amount of volume out there, and we are focused on keeping service levels high for customers. We are expanding our range slowly to make sure that we maintain service quality. But we did our first green mortgage, the eKo cashback product — we were probably one of the first ones out with something like that. It’s a standard mortgage but rewarding the borrower with a £1,000 cashback if they improve the environmental performance of their home. It was tough for customers during lockdown, because I’m not sure everybody wanted someone to come in and upgrade their house at that point, but I think we will see it more going forward. 

The other main change is, with the rates curve being so flat because of all the QE, the long-dated fixed rate market is an interesting area, and different lenders will choose to play it differently. There’s a question over how much demand there is from customers for those naturally higher rates that you pay for the certainty.

Another area which will see product expansion is in the 95% LTV market, which we have seen the government step into. But product for first time buyers and new builds will continue to be a massive focus for specialist lenders, ourselves included. As I mentioned earlier, many self-employed customers have had a really tough time, particularly in the hospitality sector. So products designed to look to them might grow, though that really comes down to how you underwrite, rather than any specific product.

But it’s an area where the high street lenders just don’t have the depth of underwriting capacity they need. They want to automate of course, because it’s very efficient, but there are a lot of customers whose situation in the last 12 months has not been straightforward. They may still be prime borrowers, but complex prime, and that’s an area where we have excelled over the past few years.

GlobalCapital: So extending on the curve a little bit, but maybe not to 40 years like François?

Maddox, Kensington: At the moment we are seeing more customers taking five years. That has been very popular in the BTL market as well. Hugo probably has better data on that, but even in owner-occupied we are seeing more five years than we have seen in a while.

GlobalCapital: Can you tell us how the Habito One project is going so far?

Tual, Habito: It’s going well. I think, as with every new product, you go through a painful learning curve of trying to sell it and explain the benefits, and you lose some customers along the way, but so far, we are quite happy with the launch. It’s not a product that’s going to readily sell itself — you can’t just leave it out there and expect people to take it, you need to explain the benefits every time, otherwise it doesn’t work.

With high street lenders offering historically low rates, if you look at Habito One for 25 years and compare it with Barclays for two years, the headline rate isn’t going to look good. But that doesn’t take into account the fees you will pay to keep refinancing, for example. Overall, there are going to be some customers that get it, but for others it’s going to be a steep education curve.

GlobalCapital: How about you Hugo, what’s new from LendInvest?

Davies, LendInvest: The psychology of buy-to-let is different from that in owner-occupied. We are big supporters of long-term fixed rate in owner-occupied, but it’s a harder nut to crack in the context of BTL because of how frequently landlords want to be able to replenish or improve equity. We believe the BTL market has already gone through incredible professionalisation, and any further moves in that direction are going to be limited.

If you think about the tax changes and regulatory shifts over the last several years, 2021 is actually five years on from the first round of tax changes back in 2016. So you’ve got a load of five year fixes coming up for refinancing this year. With a background of strong house prices, it’s another great period to lock in for a further five years, depending on your inflation expectations.

There’s still a debate over whether that fix period increases from five to seven, which is maybe a bit of a leap in landlord psychology 

We think ESG-related products are also incredibly important. We think the markets are moving away from what I would call ESG 1.0, which is rewarding customers for energy performance improvements with cashback — we have a similar product to Alex — and towards giving customers further capital to finance those improvements.

In buy-to-let, the government consultation on lifting EPC ratings will be a big driver — it’s very important and timely. But the UK’s housing stock is quite old and fundamentally inefficient. So I think you are only going to get so far if your strategy is to reward people for improvement. You need to start pushing the dial a bit and incentivising people to spend the money on energy improvement. Otherwise we are going to find that the stock of top-rated properties is going to be incredibly low. So I think there will be more green mortgage products over the next 12 months, definitely.

GlobalCapital: Perhaps it’s a good moment to consider what the securitization investor thinks about these issues — Kensington has led the way on this, with the first social RMBS in Europe. Alex, could you tell us about your experience doing the deal?

Maddox, Kensington: It was great to be able to put a social badge on that GMG deal (Gemgarto 2021-1). It basically validated our business model, which is that we are here to provide home credit to underserved communities. But it took quite a lot of work. I think there hasn’t been much in the way of securitization that has had an ESG label, it has been largely green RMBS out of the Netherlands.

There’s a relatively small stock of green properties, if your definition is based on the EPC. Perhaps if you’re a major high street lender you would have a large enough stock of those mortgages [for green securitization] but as a specialist lender, it’s going to be hard to come up with a large enough portfolio of just loans secured on ‘A’ and ‘B’ EPC rated properties. So we decided to go down the social route. It took a lot of education, but ultimately it was well received by investors.

As you can imagine, investors see us quite a lot between the various roadshow meetings and our general investor updates, but we had 20-30 investor meetings on that deal, with everyone keen to understand how the social aspect worked.

It was a super-successful deal, though it’s tough to know how much the social aspect really changed the pricing. That’s always the question we want to know as an issuer — can we get a better price with a labelled ESG bond and then reinvest that back into the products? The reality is, if you’re a high yield bond issuer with a 6% yield, and you save yourself 50bp by issuing an ESG bond, that’s a big deal. But if your bonds are trading at 70bp over Sonia, you might pick up 5bp-10bp at best, and how much difference does that make to customers?

So I think there’s a lot of work still to do in the capital markets to make sure what we are doing is really getting through and making a difference to customers and the environment and so on. Certainly the social piece is a core angle for specialist lenders in the owner-occupied space. It’s challenging to do in the buy-to-let space, but I’m sure Hugo is working on it.

GlobalCapital: Did investors up and down the stack feel similarly? Was there any difference in the level of social interest between the senior investors and the junior mezz?

Maddox, Kensington: It was really right across the stack. You typically have more investors in the senior class, so in a sense it skewed that way, but everyone wanted to talk about it. It made a nice change, actually, after nine months talking only about payment holidays, to have something more positive to discuss.

GlobalCapital: Looking at other bond labels, we have just seen the first BTL deal with an STS label come out, from Domivest in the Netherlands. Hugo, is that something you’ve contemplated?

Davies, LendInvest: The short answer is yes. We think at a certain point STS will just become a standard which most issuers just have to meet, irrespective of whether you get the actual attestation. I think it will be easy to demonstrate to rating agencies and investors that a deal ticks all of these boxes, and that this is effectively the equivalent of an STS trade. My understanding is that, now, UK buy-to-let is an incredibly difficult asset class to fit within LCR, which makes the STS point rather moot in some respects. But in terms of its role as a standard for data quality and governance and so on, it’s absolutely something we will look to do in future.

GlobalCapital: So it’s kind of a process to get there, and without LCR there isn’t a pricing benefit, but it’s still a target?

Davies, LendInvest: Yes, I think in two or three years’ time, investors will just turn around and say “why not — this is the new standard”.

STS, in a sense, has the greatest correlation with the governance aspect of ESG, so we will see more securitizations in future considering their governance. Governance is a far-reaching concept; it’s not just about corporate governance — it’s about data, and about transparency.

GlobalCapital: Turning back to Alex, as Kensington runs STS and non-STS shelves — how much of a difference does it make?

Maddox, Kensington: We have done a number of different deal structures and labels — 144A, US risk retention, European risk retention, now UK risk retention, STS, LCR. There’s a lot of rules and frameworks out there, and you have to be careful not to try to tick all of the boxes, because I’m not sure you would have any collateral left or a structure that fully passed everything. But we have been able to work our way through it.

It all matters, though, it’s great if you’re able to issue deals that meet those criteria. The LCR and STS designations do seem to make a difference. I think having just owner-occupied or just buy-to-let gives you a better chance of matching these labels than a blend of both, which is our standard Finsbury Square shelf. But that’s one reason we use the GMG shelf, because it’s pure owner-occupied which allows us to get the social badge and the STS and LCR as well. So it’s going to be interesting to see how the GMG bonds trade versus Finsbury Square going forwards.

That said, we do muddy the waters a bit by having a slightly longer call date on GMG than Finsbury Square, and they are often revolving deals as well. So it’s hard to have a direct comparison. I think one general trend in the market that we are seeing is a slight extension of call dates. The latest London Wall deal (London Wall Mortgage Capital 2021-1) was a five year, for example, and I think as we see more five year collateral, it does make sense to have that five year step-up and call.

GlobalCapital: What are you seeing on the broad investor demand side, François?

Tual, Habito: We are part of the Citi programme, Canada Square, which is very helpful as a new lender, because clearly it’s difficult to come up with half a billion of origination for your first deal, so being able to get out in the market in the Canada Square shelf is a good way to bridge that gap.

For the next deal, Habito One is ultimately going to be securitization funded, and there’s a lot of work to be done there. A five year call might be the solution, but we might also think of selling a triple-A tranche, which is Solvency II compliant. There are pension funds which are not that keen on securitized products, but for an asset which is right, which comes with a decent yield compared with the sovereign, and has a WAL of 15-17 years, that becomes quite attractive.

We probably need a solid 18 months before we even contemplate exiting, and do the actual structuring, but there is a lot of work in the background linked to this new product. Because we wanted to do a customer-friendly product without any early repayment charges, it brings difficulties for investors, because even some of the insurance companies would rather have ERCs and have their investment protected.

So suddenly you move from something that really fits a five year call, because you have something like a blended five year mortgage to put inside it, to something which is a bit more unpredictable. Whether you’re going to move your home, what’s the average duration when you move your home — that’s something a lot of countries like the Netherlands and France are quite used to. But in the UK, there’s not a lot of statistics available to substantiate any analysis. So we’ll see.

Maddox, Kensington: In the past, long dated balance-guaranteed swaps have been really expensive and got in the way of these long-dated products. Do you see that as a problem? Do you think the derivatives market needs to come up with some kind of solution, or do we need an investor base that will take prepayment risk, as in the US agency or Danish market?

Tual, Habito: Absolutely. They are expensive, because when you look at the longer end of the yield curve, the first 10 years are really cheap, and then suddenly rates start to go up. And that’s reflected in the swap.

We see there is limited credit given to different structures, so your BGS looks the same whether you have a Dutch mortgage, or whether you have a UK mortgage. At some point there must be investors that are happy to take a view and say, ‘well, I know how borrowers behave when they are not tied by an ERC — how often they move, whether they want to raise more equity and so on’. There’s just a bit of data missing and a bit of market appetite missing there, but we are working quite hard to develop that!

GlobalCapital: Thanks! Could we wrap up with a little look at the future: how do you see the next 12 months in the UK mortgage market?

Davies, LendInvest: As I said, over the next three months, I expect house price year-on-year growth to lift above 10% for the first time in a while. But as the first check point in the stamp duty window disappears, and we head towards the new, lower £250,000 stamp duty threshold, which will fall away at the end of September, I think year-on-year price growth will probably fall back down towards 5%.

But we’re not expecting a correction. And we’re not expecting a correction largely because, fundamentally, over 50% of the population has now been vaccinated and many people are on to their second dose. So we think confidence is coming back, we are already seeing a GDP bounce that has come with non-essential retail opening up and hospitality opening up. So we’re quite positive, particularly for our customers on the professional portfolio landlord side over the next 12 months.

Tual, Habito: I think H1 is going to be really good, because you’ve got a lot of strong momentum. We can see H2 slowing down a little bit, in terms of volume and house prices. I don’t think there’s much room for a correction.

There’s a few reasons for that. People have saved massively, so they’re now in a position to invest, either through having a larger deposit or considering getting on to the housing ladder for the first time. So I think there will be strong price tension.

But I think we will see a regional rebalancing. We’ve seen a lot of people moving into the countryside, looking for a bigger house, and accepting longer journeys into their place of work. It’s all going to depend on whether people are being asked to go back to the office, and for how much of the week. Certainly a smaller flat in London doesn’t seem so bad if the alternative is enduring a four hour commute every day.

We’ve seen everything but London having massive price increases, but London itself could see a rebalancing. 

I think the massive uncertainty hanging over all our heads is potential inflation. There’s a lot of noise in broader markets about that, and questions over whether there is too much liquidity in the system which is distorting prices and behaviour.

Maddox, Kensington: On the macro and consumer side, we definitely see the risk of inflation there, and the risk of rates picking up on the back of it. Curves have steepened quite a bit in the last couple of months and maybe we’ll see more of that.

But mortgage rates are relatively low for customers, and funding costs are low, so there are pretty attractive profit margins for lenders, and we think they will continue to be active. We’ve got to watch for the impact of the end of furlough, and the macroeconomic effects flowing from that.

On the liability side, we will continue to see very little issuance from the high street banks in the next six to 12 months. The big UKAR mortgage sales are now out of the way, so that’s going to put a drag on issuance as well. So overall, spreads stay low, unfortunately for investors, but good for us as lenders. We are seeing pretty good demand for forward flow agreements and whole loan sales as well, as Hugo and François are aware.

We are going to see expanded ESG issuance, more issuers doing social bonds for example, and I think we are going to see some green RMBS bonds in the UK. I think some of the high street banks have capacity to do that, and it’s a really exciting space.

So watch the macro carefully, but it’s probably going to be OK, and issuance is going to be mostly specialist lenders.

GlobalCapital: So Kensington remains the largest RMBS issuer?

Maddox, Kensington: Not sure about largest, but certainly the most frequent.

By Owen Sanderson
02 Jun 2021