S&P Global Ratings expects European investor-placed residential mortgage-backed securities (RMBS) issuance in 2020 to be broadly in line with last year (see chart 1). We could see greater activity from challenger banks in the U.K. and buy-to-let (BTL) mortgage lenders in the Netherlands. RMBS credit performance looks set to remain broadly stable, with few signs of material deterioration in underlying collateral pools and unemployment continuing to fall in most RMBS markets.
End Of Central Bank Funding Could Support U.K. RMBS Issuance
Bank-originated European RMBS volumes have been depressed for several years given the availability of cheaper funding options offered by the European Central Bank (ECB) and Bank of England. In the U.K., however, these central bank schemes have been closed to new drawdowns since early 2018 and the maturities of past borrowings are on the horizon.
At the end of September 2019, borrowings of £108 billion were outstanding under the Bank of England's Term Funding Scheme (TFS; see chart 2), with a further £4 billion still outstanding under the older Funding for Lending Scheme (FLS). We estimate that about £17 billion will mature in the second half of 2020, but with more than £75 billion to come in 2021. As a result, some U.K. mortgage lenders are increasingly likely to once again tap the RMBS market among others, as they plan for the gradual run-off of this official sector term funding.
However, the ECB's equivalent scheme of targeted longer-term refinancing operations (TLTROs) re-opened to new drawdowns in 2019, potentially suppressing any similar effect in the eurozone. In the first two offerings under the so-called TLTRO III scheme, eurozone banks borrowed about €100 billion, securing cheap funding for a further three years. Another five offerings are currently scheduled under the scheme.
The recent re-start of the ECB's quantitative easing program—incorporating the asset-backed securities purchase program (ABSPP)—brings a significant RMBS buyer back to the market and could stimulate supply. Overall, the program will target monthly purchases of €20 billion net of redemptions among existing holdings. Although the securitization component will likely only constitute a small part of this total, primary spreads will still be affected. Of the current outstanding bonds bought through the ABSPP, €7 billion are scheduled to redeem in 2020. Although the securitization component will likely only constitute a small part of this total, primary spreads will still be affected. Dutch RMBS in particular has previously been the main recipient of ECB buying, but this activity could also affect other jurisdictions.
In 2019, close to half of primary European RMBS issuance carried the "simple, transparent, and standardized" (STS) label, brought in with the EU's new Securitization Regulation on Jan. 1, 2019. Use of the STS label should accelerate through 2020, in our view. In particular, from April 2020, only STS-labeled securitization exposures can count as high-quality liquid assets in EU banks' calculation of their liquidity coverage ratio—a key regulatory test (see "How STS Has Shaken Up European Securitization So Far," published on Nov. 20, 2019).
We anticipate increased interest in "green RMBS" across all European jurisdictions. To date, the Netherlands is the only market where this is a common feature. A few other countries—notably the U.K.—also have active originators of green mortgage loans. However, the currently limited origination volumes of these products elsewhere means that we may not see a material increase in "green"-branded RMBS transactions until 2021 or beyond.
|U.K. Issuance Forecasts|
|U.K. placed 2019 issuance: £25.2 billion||2020||Beyond 2020|
- Pound sterling issuance should remain broadly in line with 2019, but transaction volumes, as measured by deal count, could increase as first time and opportunistic issuers come to market (see chart 3).
- Bank-originated RMBS volumes could rise as some originators' early borrowings from the Bank of England's TFS mature. Furthermore, smaller capital constrained banks may use RMBS for capital relief purposes meaning RMBS offers both funding and capital benefits.
- That said, non-bank issuance of transactions backed by legacy collateral will gradually slow over time.
- We could also see increasing volumes of niche transactions including second lien and higher value property BTL transactions. 2019 saw three first time issuers, split between bank and non-bank lenders (see chart 4).
- RMBS is likely to remain a core funding source for challenger banks with existing programs. If the STS label further lowers securitization funding costs, this could make RMBS more attractive to these issuers, who tend to use RMBS opportunistically when market spreads are low relative to other sources of funding.
- We estimate that 20 transactions will see their liability margins step up in 2020, and we expect these transactions to be called (see chart 5).
- Future flow arrangements (where an originator originates assets to order without ever holding them on their balance sheet) have made a comeback and are likely to become more common. Here, the originating entity may not have direct exposure to credit risk, yet is paid origination fees based on the volume of mortgages that it originates. Such a model may, if not suitably controlled, break the normal alignment between the risks and rewards of origination.
- Increasing prevalence of five-year fixed rates in BTL and owner-occupied transactions will lead to lower refinancing activity, although an increase in new lenders gaining scale and reaching the market is likely to boost overall transaction volumes.
- Retirement interest-only collateral to feature in RMBS transactions either on its own or as part of a more standard transaction.
- Loan products designed to cater for liberated mortgage prisoners.
- Help-to-buy scheme scheduled to end in 2023. Therefore, only private sector initiatives will address the issue of borrowers with insufficient deposits.
|Netherlands And Other Northern European Countries' Issuance Forecasts|
|Netherlands placed 2019 issuance: €6 billion||
- Increased buy-to-let (BTL) activity, with the market estimated at approximately €2 billion of originations, most of which we would anticipate to be funded through RMBS. Macroeconomic fundamentals to remain supportive.
- The evolution of unstructured mortgage funds is likely to suppress new issuance activity in the owner-occupied space.
- Volumes are likely to be affected by programmatic issuers and lenders utilizing originate-to-distribute models.
- We estimate seven transactions to have a step-up margin in 2020, which will be called.
- Likely increase in number of BTL originators and resultant RMBS transaction volume as recently formed BTL lenders gain scale.
- Later life lending products including reverse mortgages and transactions concentrated in retirement product lending.
|Other Northern European countries placed 2019 issuance: €4.0 billion||
- Ireland: No significant increase in volumes expected, due to conservative mortgage regulation. Transactions are likely to feature increasingly esoteric collateral and/or legacy assets purchased as part of whole loan portfolios that were seen as too problematic to securitize in reperforming transactions in 2014-2018.
- Scandinavia: Minimal use of RMBS anticipated in the short term, but emergence of fintech lending may eventually see RMBS used as a financing tool.
|- Peer-to-peer lenders may, as in the U.K., evolve into capital markets funded non-bank lenders.|
|France, Italy, Spain, And Belgium Issuance Forecasts|
|France placed 2019 issuance: €1.7 billion||
- The secured funding market has been historically oriented toward covered bonds.
- Several originators have reasonably active RMBS platforms, which are mostly used for retained issuance.
- Over the last nine years, there was €128 billion of French RMBS issuance (93% retained).
- We expect issuance to remain broadly stable, with the likes of BPCE (among others via its subsidiary Banques Populaires) and Credit Agricole continuing as the main originators.
- SapphireOne Mortgages 2016-2 could be called in Q4 2020 and may refinance. Sapphire Mortgages 2016-1 fully repaid in 2019.
|Italy and Spain placed 2019 issuance: €0.6 billion||
- Banks in southern European jurisdictions have traditionally favored covered bonds over RMBS. We expect the Italian and Spanish RMBS markets to have modest, but stable investor-placed issuance.
- As a result of the ECB's TLTRO III scheme, banks in these jurisdictions could continue to issue retained RMBS for use as collateral for central bank borrowing. This means that most of transactions will feature simple structures with one or two rated classes of notes, similar to those issued last year.
- Some smaller Italian banks that refrained from retained or investor-placed issuance last year because of the introduction of the new Securitisation Regulation, may return to the market.
- In Spain, we expect to see an increase in transactions backed by portfolios of reperforming mortgage loans, which have been restructured due to weak performance following the property slump after the financial crisis. Investors who have been interested in these types of transactions in other jurisdictions, such as Ireland for example, may be interested in similar portfolios of Spanish loans.
|Belgium placed 2019 issuance: €0 billion||
- Belgian RMBS issuance is almost exclusively retained by originators.
- In the past nine years, only €800 million from a total of about €40 billion has been placed with investors.
- Annual issuance since 2011 has only comprised one or two transactions totaling between €1 billion and €6 billion, and we expect this pace to continue.
Stable Asset Performance Expected
The continuation of accommodative monetary policies set by the Bank of England and the ECB will help support credit fundamentals in RMBS markets. While we expect GDP growth to slow slightly in many European countries in 2020, unemployment rates continue to fall, supporting RMBS collateral performance. However, risks are emerging in certain markets, notably the U.K.
U.K. Market Summary
In the U.K. mortgage market, competition on loan pricing remains intense and excess spread in RMBS transactions is likely to be lower for more recent vintages. Smaller prime lenders increasingly need to occupy market niches not served by larger lenders or think of other ways to differentiate themselves from larger competitors. They may seek to relax further their tolerance for borrowers with an adverse credit history.
U.K. prime mortgage lenders tend to price for risk based only on loan-to-value (LTV) ratios, and may therefore be taking on additional risks for which they are not compensated. According to the Bank of England's December 2019 Financial Stability Report, between 2016 and 2018 the stock of mortgage loans with LTV ratios exceeding 75% increased to approximately 20% from 15%, implying that recent originations have higher LTV ratios.
Stagnating house prices will lower further advance activity and affect RMBS prepayment speeds differently depending on whether further advance loans are repurchased from transactions.
A competitive lending market is leading to increased risk layering in the owner-occupied space. Lenders are increasingly using some or all of the following lending policies to maintain or grow market share:
- Assessing affordability using longer term fixed rates, rather than a stressed rate;
- Original loan terms beyond 25 years and occasionally up to 35 years;
- Higher LTV ratio limits; and
- Lending secured on properties of non-standard construction.
Such policies will likely result in higher defaults and loss severities for earlier vintage originations. If lender credit appetite contracts, loans with such features will be difficult to refinance.
More than nine out of 10 U.K. remortgagors opted for a fixed-rate loan in October 2019, and nearly half of them chose a five-year product, rather than one with a two- or three-year term. The basis between two- and five-year fixed rates has reduced significantly over the last couple of years, meaning that the cost of a longer-term fixed rate is no longer prohibitive. In addition, two-year mortgage lenders will have to apply a stressed interest rate that is three percentage points higher than the fixed rate at origination when assessing borrowers' affordability, according to the Financial Conduct Authority's (FCA) recommendations. This is not the case for five–year mortgage loans.
The recommendations of the FCA's March 2019 "mortgage prisoner" consultation are likely to speed up prepayments in legacy U.K. nonconforming RMBS transactions. Some borrowers have been performing but have been unable to remortgage due to a tightening of affordability assessments since they took out their loan. The mortgage prisoner initiative intends to selectively relax affordability assessments for such borrowers, meaning that those who have been trapped in their existing deal can refinance. See our research report about mortgage prisoners in "Related Research".
As with the owner-occupied market competition in the BTL mortgage sector remains intense. Historically, even lenders that are not regulated by the Prudential Regulatory Authority (PRA) have effectively operated according to the rules that PRA-regulated entities are required to follow. However, we consider it likely that non-PRA lenders may increasingly look for ways to operate outside regulatory guidelines for competitive advantage.
Moreover, compared to when the PRA rules were first introduced in 2016, we believe, based on a trend of underwriting to lower interest coverage ratios, that recent vintage BTL loans generally have less headroom to deal with void periods between tenancies.
Rest Of Europe
Prescriptive mortgage regulation in Ireland should support stable credit performance for post-crisis loan originations, and the Central Bank of Ireland recently confirmed that there are no plans for any revisions to these rules. For such originations, material performance deterioration is only likely to occur alongside significantly increasing unemployment or underemployment.
Legacy RMBS transactions backed by restructured and/or reperforming loan collateral are likely to see deleveraging slow. Some the loans have been easier to work out, due to lower LTV ratios, improving borrower financial health or being BTL, where the court process is generally less lenient to the borrower. In our view, many of these loans have now exited RMBS pools, contributing to speedy deleveraging. However, this may leave transactions with a higher concentration of high LTV loans, for which it is more difficult to reach a suitable resolution with the borrower and where resolution potentially involves a lengthy court process.
Prescriptive mortgage regulation and solid macroeconomic fundamentals will support strong credit performance in the Netherlands, France, Belgium, and Sweden (see chart 6).
Improving macroeconomic fundamentals should also support collateral performance in Spain, Portugal, and Greece.
Although we forecast modest house price declines in Italy, natural deleveraging will likely mean the overall impact is credit neutral. Furthermore, LTV ratios are typically low and will further help to insulate transactions from the effect of declining house prices. Although ongoing macroeconomic uncertainty will weigh on default and delinquency performance, this is likely to be within our current expectations.
- European Structured Finance Outlook 2020: Steering A Steady Course, Jan. 15, 2020
- How STS Has Shaken Up European Securitization So Far, Nov. 20, 2019
- Rise In Repayments Expected For U.K. Legacy Borrowers, Nov. 13, 2019
- More Than One-Third Of U.K. Legacy Borrowers Are "Mortgage Prisoners", Sept. 4, 2019
- Will Innovation Give The U.K. Mortgage Market A Boost?, Sept. 4, 2019
- U.K. RMBS Refinance Risk Is All About The Call, June 3, 2019
This report does not constitute a rating action.
|Primary Credit Analyst:||Alastair Bigley, London 44 (0) 207 176 3245;|
|Secondary Contact:||Arnaud Checconi, London (44) 20-7176-3410;|
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