EUROPACE ABS Monitor
24 September 2007
Northern Rock and the Granite programme
The crisis in the securitisation markets finally spread into the broader economy this week, with the UK government stepping in to guarantee deposits at Northern Rock, following the worst run on a UK high street bank in thirty years.
Northern Rock, via its Granite programme, has been one of the biggest issuers in the European securitisation market, having completed twenty four very sizeable offerings. The Granite Master Issuer plc trust had Pounds47.8bn worth of mortgages in the pool as of the end of July.
Northern Rock has relied upon securitisation, interbank lending, and to a lesser extent covered bonds, more heavily than any other major UK mortgage originator. Its funding mix is typically 71.5% wholesale, with only 28.5% provided by customer deposit funding. In comparison, Nationwide Building Society utilises 73% customer deposit funding and 27% wholesale funding.
Thus, as the securitisation market dried up in August, accompanied by an unwillingness on the part of banks to lend to one another in the interbank market, Northern Rock was left without adequate sources of funding. The news last Thursday that it had agreed emergency funding from the Bank of England triggered a mass panic, with queues forming outside branches across the UK on Friday, when Pounds1bn was withdrawn in a single day.
After another rush to withdraw deposits on Saturday, the UK government stepped in on Monday with full guarantees for all deposits, and by Tuesday withdrawals had slowed dramatically. The question now is how much the damage to the reputation of Northern Rock will impact its mortgage origination, and securitisation market funding, going forward.
Performance of the collateral in the Granite master trust
In spite of fairly aggressive lending practices (though similar to many other UK mortgage originators) the collateral in the Granite master trust has been performing quite well, and analysts are not unduly worried about the quality of the loan book still on the balance sheet, or sold to the Granite master trust.
Trust performance could however weaken if top quality borrower decide to prepay and move to a new mortgage provider, while less creditworthy borrowers who cannot refinance remain within the trust. And there could be some technical master trust triggers breached, which may for example force Northern Rock to collateralise its swap agreements.
Clearly mortgage origination is going to be much lower in the second half of 2007, but there should still be enough new collateral needed to keep the master trust topped up. But the excessive use of securitisation in what is now viewed as a broken business model is going to have to be scaled back.
Recent spreads of RMBS
On 18 September Fitch Ratings affirmed the ratings on the Granite master trust, as well as a new offering of notes, which analysts believe has been structured to hold on balance sheet and use as repo collateral with the Bank of England.
Over the past week Northern Rock five year Triple A tranches have been seen trading at a 75bp spread over Libor in thin secondary market trading. In general, other prime UK RMBS are currently being marked to market at 50bp, with Dutch RMBS at 50bp and Spanish at 70bp.
At the Triple B level UK tranches have ballooned out over100bp in a month to around 200bp, and Triple B Spanish tranches are trading as wide as 350bp.
Most buyers remain on the sidelines
Such pricing appears to offer good value, but potential buyers are cash constrained, leaving a few small trades in a thin market to cause the write down of assets. As one analyst comments, buyers have been facing a dilemma, in that they see good value, but forced disposals mean that spreads could widen out yet further, meaning that buying opportunities could get even better.
Thus most buyers remain on the sidelines. And many banks are also having to commit liquidity lines to ABCP conduits, and have billions of Euros of unsyndicated leverage loans on their books, and may withhold permission from their trading desks to add more ABS risk to their portfolios.
The markets are expected to remain choppy over the next few months. But if investors do commit more cash to buy, spreads at the Triple A level could suddenly tighten in again as a few big buyers enter the market.
At the Triple B level the situation is more complex, since there are some real credit concerns about potential falling property prices, over aggressive lending policies, and pool performance. And in addition to credit concerns, Triple B tranches have lost a sizeable part of their investor base, as CDO buyers are unlikely to return soon, and SIV- lites are out of the market, having lost their principal ABCP funding source.
Credit worries about the non conforming UK RMBS market
Non conforming UK RMBS are a particular focus of credit worries, especially as higher lending rates mean that they cannot easily refinance mortgages as discount rates expire. Thus, borrowers who are overstretched will find themselves unable to refinance, and both arrears and delinquencies in non conforming pools are expected to deteriorate.
Spreads on Triple A UK non conforming RMBS have doubled from 45bp to 90bp in only one month, while Triple B tranches have also doubled, from 200bp to around the 400bp level.
Given the flow of bad news out of the UK, it will be up to other jurisdictions to re-establish the primary market, though volume is expected to remain very light for the next few weeks.
The market in the next months
In primary there was a deal listed for prime mortgage RMBS issuer IM Cajamar, with the Triple As priced at a 20bp spread. But analysts believe that it was held on balance sheet, possibly for use in repo operations.
It seems unlikely that any significant volume of deals will price during the next few weeks, and the volatility in the market could run through until Christmas. With RMBS, CMBS and CLO issuance all expected to be light, analysts are adjusting their volume forecasts for 2007.
The full year figure of Euro450bn of funded issuance for 2006 was on track to be comfortably exceeded during the first half, but the market may now have to be content with a number around the same level for 2007, or perhaps even slightly less.
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