The rapid growth of U.K. prime loans in the late 1990s and early 2000s pushed U.K. mortgage lenders to find other ways to fund their mortgage book expansion, rather than through deposits. They diversified away from retail deposits by using residential mortgage-backed securities (RMBS)--favoring master trust programs as a way to access a wider investor base, and to adapt to investors' varied risk appetites. U.K. RMBS master trust issuance began in 2000, with about half of the programs still active.
In this Credit FAQ, S&P Global Ratings takes a closer look at U.K. RMBS master trusts. Specifically, our view on potential future developments, their key structural features, how they differ from pass-through RMBS structures, and our analytical considerations.
Frequently Asked Questions
Which U.K. RMBS master trusts are active?
|Active U.K. RMBS Master Trusts|
|U.K. master trust||Originator||Latest issue date||Collateral type|
|Permanent Master Issuer PLC||Bank of Scotland (Halifax)||October 2019||Prime owner-occupied|
|Holmes Master Issuer PLC||Santander Bank PLC (Abbey National PLC)||August 2022||Prime owner-occupied|
|Fosse Master Issuer PLC||Santander Bank (Alliance & Leicester PLC)||October 2019||Prime owner-occupied|
|Lanark Master Issuer PLC||Clydesdale Bank PLC||November 2022||Prime owner-occupied|
|Silverstone Master Issuer PLC||Nationwide Building Society||December 2022||Prime owner-occupied|
|Economic Master Issuer PLC||Coventry Building Society||June 2021||Prime owner-occupied|
|Investor-Placed U.K. Master Trust RMBS Issuance 2018-2022|
|Year||Number of transactions||Bil. €|
|Source: S&P Global Ratings.|
How have these master trusts performed over the past few years? And how have they performed against other U.K. RMBS transactions?
If we compare the overall historic performance against our U.K. RMBS index, most master trusts performed in line or better than the index (see chart 1). One exception however was Granite Master Issuer PLC (see "Case Study: Granite Master Trust PLC"). Although performance has been robust, trusts can be actively managed, meaning loans in arrears may be repurchased from the trust which may result in reported arrears being lower than actual arrears.
What does the future look like for U.K. RMBS master trusts?
Although master trust utilization is down from the peak years of the financial crisis, (also due to U.K. banks favoring the establishment of covered bonds programs after the global financial crisis), several reasons for optimism point to increased utilization in the future. Firstly, in a market where pricing volatility is pronounced, the ability for master trusts to issue quickly is an advantage. Rising and unpredictable interest rates may also support master trust issuance as master trusts can facilitate bullet maturing issuance which, combined with the ability to issue quickly, allows issuers to tactically target specific "sweet spots" which may aid pricing. Furthermore, with no expectation of renewal of the Term Funding Scheme with additional incentives for SMEs (TFSME), banks that have recently relied on central bank funding will increasingly be forced to look to market-based secured funding solutions such as RMBS. Our current estimate of TFSME drawdowns is £180 billion. Although not all this amount necessarily funded residential mortgages directly, it indicates the scale of refinancing required for U.K. banks. The end of the TFSME combined with the possibility of faster issuance to market, may lead some banks to favor master trusts as a solution.
Case Study: Granite Master Trust PLC
Although the credit performance of U.K. RMBS master trusts has been strong and issuers have more recently stood behind their master trust issuance platforms, the fallout from Granite Master Issuer's non-maintenance of its seller share is a useful lesson that issuer support cannot always be relied on.
Granite Master Issuer was Northern Rock's master trust. It had a capital funding structure and a socialist funding structure. In November 2008 the trust hit a non-asset trigger event as the seller share fell below the minimum required level. At that time, Northern Rock was in the process of being nationalized and the creditors and depositors were already guaranteed by the U.K. government. The investors of the master trust and overall market participants were not thinking that a breach could happen because a breach of the seller share would have resulted in non-payment of any principal for Northern Rock (the owner of the seller share in the trust).
However, against expectations, Northern Rock decided to not remedy this breach (it could have remedied as a non-asset trigger is officially breached only if the seller share remains below the required level for two consecutive interest payment dates). It decided to not add new loans to the trust, which could have remedied the breach of the non-asset trigger. Consequently, all of the notes started to pay in a passthrough manner, giving the senior noteholders greater protection than the junior noteholders. According to the transaction documents if a non-asset trigger breach occurs, the trust will firstly repay the class A notes, typically in order of legal maturity. Therefore, the junior notes could not be redeemed before the amortization of the senior notes, increasing extension risk for some of the investors that could not see their notes mature until maturity. This was exacerbated by the contracting risk appetite of the wider U.K. mortgage market, which made many of the loans backing the trust unrefinanceable. Consequently, prepayment speeds slowed, which compounded the impact of the non-asset trigger breach.
Granite Master Issuer was officially shut down in Q1 2016.
How do master trust structures differ from pass-through and covered bond structures?
Compared to standalone issuances, master trusts offer an originator advantages such as targeted maturity issuance, and potentially quicker time to market, making it appealing for reverse enquires. Additionally, they differ in many aspects on both the assets and cash flow side, as well as in the legal documentation. Table 3 highlights the main differences between pass-through RMBS, covered bonds, and master trusts.
|Differences Between Pass-through RMBS, Covered Bonds, And Master Trust Structures|
|Structural feature||Pass-through RMBS||Covered bonds.||Master trust|
|Recourse||Issuance is backed by a securitized pool.||The covered bond pool.||Recourse is to the "funding share". This is also sometimes expressed as the total trust collateral less the seller's share.|
|Collateral management||For each new issuance the seller sells assets to the SPE.||If there are enough assets in the cover pool, the originator does not need to transfer new assets.||If there are enough assets in the trust, the seller does not need to sell in new assets. The seller share (see below) can be lowered in favor of the funding share to collateralize new issuance.|
|Redemption profile||Pass-through, typically sequential, RMBS notes.||Typically bullet.||Hard bullet, soft bullet, and scheduled amortization notes.|
|Issuing entity||Typically different SPEs are created for each issuance.||The issuing bank, a dedicated subsidiary, or an SPE.||The same SPE can be used to issue the notes.|
|Documentation||New documentation created for each issuance.||Most documentation is already established, making issuance quicker.||Most documentation is already established, making issuance quicker.|
|Tranching||Senior and subordinated notes.||All the bonds rank pari passu.||Different types. Principal repayment can depend on a series of triggers.|
|Investor base||Different types of investor depending on the risk appetite.||One type of investor.||Different types of investors depending on the risk appetite.|
Since principal distributions can be channeled by virtue of a series of triggers, consequently a master trust can issue different types of liabilities on different maturity dates. This gives the investor a specific date on which a particular class of notes will be repaid and from an issuer's perspective, it decreases the cost of funding of the whole structure.
Our cash flow analysis addresses the timely payment of interest and the ultimate payment of principal depending on expected principal receipts to fully repay the notes when due, by their respective legal final maturities.
For bullet notes, low prepayment scenarios are the most stressful to test if the master trust can generate enough cash to repay the notes by its legal maturity.
How do master trust structures work?
The master trust enables the inclusion of new mortgages into the pool, and the issuance of different series of notes after its establishment. In a master trust, the originator sells the mortgages to the mortgage trustee, which holds the mortgages on trust for the master trust's beneficiaries. The seller receives a share in the master trust which is called the seller share.
The seller retains a percentage share of the trust called the "seller share". The portion not comprising the seller share is referred to as the "funding share" or "funding," which is established as a bankruptcy-remote entity. Funding enters into a loan agreement with another bankruptcy-remote entity, which issues the securitized notes. This issuer sells the notes and the proceeds from the notes are used from funding to finance the acquisition of its share in the trust. In this way, both the seller and funding are ordinarily entitled, depending on the percentage in the trust, on the principal and interest collections from the mortgages. The funding share and the seller share are collateralized under the same mortgage pool.
Under the master trust, funding and the seller share are cross-collateralized by the same mortgage pool, which is a revolving pool. We present a typical U.K. RMBS master trust structure below.
For the issuer, to repay hard bullet, soft bullet, and scheduled amortization notes, the structures typically include certain rules pertaining to principal allocation, cash accumulation, payment restriction, and deferral that determine (i) when the principal is allocated to funding, (ii) for how long cash needs to accumulate for the notes to be repaid, and (iii) if during the accumulation period principal can be channeled to the scheduled amortization notes. These allocation rules are determined by additional tests that look at prepayment speed.
The seller and the funding entities constitute the beneficiaries of the trust. Interest and principal collections from the underlying assets are split between the trust's beneficiaries in accordance with certain allocation rules. The master trust ordinarily distributes interest collections pro rata between the seller and funding. Similarly, also the losses are shared pro rata among the beneficiaries, according to their shares in the trust property.
As opposed to interest and losses, the trust allocates principal receipts according to the master trust's needs and specific rules. If issued notes need to be redeemed on a certain date the trust can divert the principal receipts to funding to repay the notes. Consequently, this decreases the percentage of funding's share and increases the seller share. If funding does not need liquidity, then the trust diverts the collection to the seller. The seller at this point has three options:
- To retain the principal receipts;
- To sell the mortgages with an amount equal to the principal receipts from the underlying mortgages; or
- To sell new mortgages to the trust.
In option three above, the seller can fund the sale of the new mortgages through new series. Consequently, the funding share will increase if funding purchases an interest in the new mortgages.
|Change In Master Trust Composition|
|Change in trust size||Change in the seller share||Change in the funding share|
|Option 1: Principal receipts not used to purchase new mortgages and no need for repayment of any notes.||Decreases||Decreases||Increases|
|Option 2: All the principal received from the underlying mortgages is used to purchase new mortgages and no need for repayment of any notes.||N/A||N/A||N/A|
|Option 3: The seller sells the mortgages in excess of the principal receipts received from the underlying assets to the trust. No need to repay any notes.||Increases||Increases||Decreases|
What is the difference between a capitalist and a socialist master trust?
Two generic types of master trusts have been used in the U.K. market--capitalist and socialist. Master trusts are now typically socialist.
- In a capitalist structure each issuer is a legally distinct entity (see program structure chart above). Each issuer will take its pro rata share and will only pass excess spread to a special-purpose entity (SPE) with a shortfall when it has paid all its own obligations. Principal and interest are paid sequentially like a standalone pass-through RMBS transaction. Similarly, losses are allocated "bottom up" within that SPE structure. For example, a class B note in one SPE could suffer a higher loss than a class B note in another SPE.
- Socialist master trusts usually utilize only one issuance entity. Therefore, interest and principal are allocated by class, and then within each class by revenue or principal due to each class scheduled for payment in that specific period. After this allocation is determined, excess cash flow is passed on to the next senior tranche. In a socialist structure, losses on equally ranking notes are the same. For example, any loss a class B note suffers would be the same for all class B notes within the structure. Given these mechanics, the issuance of additional senior notes can affect the creditworthiness of existing more junior notes. Consequently, a rating confirmation on the existing notes is usually required to make further issuances.
What is the minimum seller share? Does the seller share provide credit enhancement?
The seller share according to the transaction documents of most U.K. RMBS master trusts, cannot typically drop below a certain threshold known as the minimum seller share. This considers different risks related to the originator/seller, mainly linked to setoff risks: (i) Deposit setoff risk, (ii) setoff risk from flexible mortgages, and (iii) employee setoff risk, among others.
If an originator/seller becomes insolvent or if the seller share drops below the minimum seller share level, no further notes can be issued and a non-asset trigger would be breached.
A non-asset trigger affects the allocation of principal receipts. Interest allocation remains the same, but the trust allocates principal first to the funding share, until the issuer has repaid all the notes, and then the remaining to the seller. To prevent a trigger breach, the seller share cannot drop below the minimum seller share. This means that, if before the default of the originator/seller, the seller share was just above the minimum seller share, the effect of borrowers exercising their setoff rights would not affect the transaction.
The minimum seller share is not a form of credit enhancement, as losses are allocated proportionally to the seller and funding share. The minimum seller share maintains a certain exposure of the originator/seller in the master trust and mitigates the abovementioned risks.
What are the typical triggers in a master trust?
The different types of notes allow investors to determine the weighted-average life and duration of their investment, subject to certain triggers not being breached. A master trust has two types of triggers (i) asset triggers, and (ii) non-asset triggers.
Asset trigger An asset trigger is breached when the 'AAA' principal deficiency ledger is booked as a consequence of the underlying assets' collateral performance deteriorating. When the asset trigger is breached all of the underlying notes become pass-through notes and the trust's transactions start to amortize. The trust allocates principal receipts from the underlying mortgages pro rata among its beneficiaries. Consequently, as the notes amortize, the seller share increases.
Non-asset trigger A non-asset trigger relates to the seller's insolvency, and happens when:
- The seller/originator becomes insolvent;
- A back-up servicer is typically not appointed within 60 days after the servicer's termination;
- The seller's share drops below its minimum level; or
- The total trust size drops below certain minimum levels (this applies only to some trust structures).
If a non-asset trigger is breached, then similar to an asset trigger, all of the notes become pass-through. However, for a non-asset trigger, the trust allocates the principal receipts from the underlying mortgages first to funding, until all notes are fully repaid. Only when this occurs, is the seller entitled to principal receipts.
|Different Examples Of Non-Asset Triggers|
|Case 1||Case 2||Case 3|
|(i) One funding socialist structure; (ii) seller.||(i) Two funding socialist structures; (ii ) seller.||(i) Two fundings: one socialist and one capitalist structure; (ii) seller.|
|Principal first paid to funding; all notes become pass-through; socialist structure principal allocated to pay down the 'AAA' rated notes in order of maturity dates; and after the redemption of these notes, the 'AA' rated notes are redeemed in no order of maturity date.||Principal receipts will be shared between funding 1 and funding 2 pro rata; funding 1 will take the principal receipts allocated to it and will first pay the 'AAA' rated notes issued by funding 1, then pay the 'AA' rated notes. Funding 2 will take the principal receipts allocated to it and will first pay the 'AAA' rated notes issued by funding 2, and then pay the 'AA' rated notes.||Principal receipts will be shared between funding 1 and funding 2 pro rata; funding 2 (socialist) will take principal receipts allocated to it and will pay the 'AAA' rated notes issued by funding 2. After the repayment of all 'AAA' rated notes, it will pay the 'AA' rated notes. Funding 1 (capitalist) will take the principal receipts allocated to it and will then allocate the receipts to each of the underlying issuers according to their shares in funding 1. Each of the issuers will then use the receipts allocated to them to pay their 'AAA' rated notes first, followed by the 'AA' rated notes.|
Both triggers are very important as they can alter the notes' repayment profiles and could result in an extension or shortening of their weighted-average life. In our analysis we typically model two scenarios: An originator solvent, and originator insolvent. In the former, we consider the breach of an asset/non-asset trigger in our cash flow analysis.
How is the revolving nature of the master trust managed?
The revolving nature of the master trust pools means that the underlying mortgage pool could change substantially over time. To control the pool profile, lenders have traditionally provided several eligibility criteria. Any new loan to be included in the pool is expected to comply with those criteria. Lenders have also added performance-related triggers to control the substitution in the master trust. Some examples of eligibility criteria or triggers in U.K. master trusts include:
- Performance-related triggers: (i) Arrears or defaults exceed a certain level, (ii) draws under the reserve fund, and, (iii) a debit balance on the PDL.
- A restriction on the maximum percentage of new mortgages to be sold to the master trust.
- New loans added in the master trust should not exceed 30 days in arrears.
- The product of the weighted-average foreclosure frequency and weighted-average loss severity is maintained within a certain level.
- The mortgages are originated according to the same underwriting criteria. We expect to be notified if these criteria change, as this could affect our credit analysis.
If one of the triggers are breached then the substitution terminates. This differs from a non-asset trigger breach which occurs if the event that caused the substitution to stop is not cured within a relatively short timeframe. This is because, for example, the minimum seller share might drop below the minimum seller share required amount.
This report does not constitute a rating action.
|Primary Credit Analyst:||Fabio Alderotti, Madrid + 34 91 788 7214;|
|Secondary Contact:||Alastair Bigley, London + 44 20 7176 3245;|
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