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BOE’s Cheap Cash Smothering Mortgage Bond Market: U.K. Credit

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BOE’s Cheap Cash Smothering Mortgage Bond Market
A pedestrian shelters from the rain beneath an umbrella as he passes construction hoardings decorated with British Union Jack flags in London. Britain stands on the brink of another recession after contracting 0.3 percent in the final three months of 2012. Photographer: Simon Dawson/Bloomberg

April 12 (Bloomberg) -- Britain’s residential mortgage-backed securities market, the biggest in Europe, is being choked off as cheap Bank of England cash makes issuance of the debt uneconomic.

Lloyds Banking Group Plc, the nation’s largest mortgage provider, hasn’t issued the securities since February 2012. Santander U.K. Plc last sold notes in August, the same month banks got access to about 80 billion pounds ($123 billion) of state-backed money at rates as low as 0.25 percent. Investors demand a yield of about 1.2 percent to hold senior bonds backed by U.K. prime mortgages, according to JPMorgan Chase & Co. data.

The so-called Funding for Lending Scheme is designed to cut borrowing costs for households and companies as Chancellor of the Exchequer George Osborne struggles to avert a third recession in five years. Analysts say lenders risk becoming dependent on a program that is due to end in January 2014.

“The longer-term consequences could be detrimental for the securitization market because the Bank of England’s scheme isn’t meant to be infinite, and so we need a proper bank funding market in place when it stops,” said Harpreet Parhar, a London-based credit strategist at Credit Agricole SA. “It will be difficult to grow it again because anemic volumes for a few more years means fewer raters, originators, structurers and investors in the future.”

Removing Liquidity

London’s property market powered a seventh month of increases in U.K. house prices in March as values reached a five-year high, according to Acadametrics Ltd. The average cost of a home in England and Wales rose 0.2 percent on the month to reach 230,078 pounds, Acadametrics and LSL Property Services Plc said in a monthly report published in London today. Excluding the capital, prices fell 0.1 percent on the month.

Sales of asset-backed securities in Britain, including RMBS, declined 83 percent this year to 2.67 billion euros ($3.5 billion), according to JPMorgan data. A total of 35.8 billion euros of assets were securitized last year, of which 22.8 billion euros were residential mortgages.

“The FLS and other schemes mean banks keep the assets on balance sheets and fund through central banks,” said Henry Cooke, the London-based head of European ABS at Threadneedle Asset Management Ltd., which manages about $120 billion of assets including European securitizations. “The FLS is definitely removing liquidity from the system.”

Wholesale Funds

Under FLS, banks and mutual lenders can borrow Treasury bills from the Bank of England for a fee starting at 0.25 percent, and then use the bills as collateral to raise wholesale funds. The three-month London interbank offered rate is about 0.50 percent.

Britain stands on the brink of another recession after contracting 0.3 percent in the final three months of 2012. Gilts have returned 1 percent this year compared with a 0.2 percent gain for Treasuries, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. The pound has fallen about 4.4 percent, the worst performer after the yen among 10 developed-market currencies tracked by Bloomberg Correlation-Weighted Indexes.

Investor Demand

There’s about 355 billion pounds of U.K. mortgage-backed bonds outstanding and the dearth of new issuance, with no deals since November, is boosting prices. Investors demand 69 basis points more than interbank borrowing costs to buy a five-year pound-denominated senior bond backed by U.K. prime home loans. That compares with 160 basis points a year ago, and as high as 425 basis points in January 2009, JPMorgan data show.

In euros, the spread over interbank rates is 63 basis points, compared with 91 basis points for Dutch mortgage-backed debt and 345 basis points for Spanish bonds.

Lloyds debt sales declined as the lender “continues to improve its liquidity position as part of our strengthening balance sheet,” said Matt Smith, a London-based spokesman at the bank. “This is evidenced by the increase in customer deposits and continuing reduction in our non-core assets.”

The shortage of new deals is prompting investors to turn to higher yielding assets such as collateralized loan obligations, that have been moribund since the start of the credit crisis, and commercial mortgage-backed bonds. CLOs pool high-yield, high-risk loans and slice them into securities of varying risk and return.

European CLO

Cairn Capital Ltd., a London-based credit manager, in February sold the first European CLO since 2011. Pramerica Investment Management Ltd. priced a 300 million-euro fund this week. Leon Black’s Apollo Global Management LLC plans to increase the size of its first European CLO to 325 million euros from the 306.5 million euros initially offered, according to three people with knowledge of the matter.

Yields on the top-rated slices of CLOs average about 150 basis points, or 1.50 percentage points, more than the Euro interbank offered rate, down from 280 in January 2012, according to JPMorgan. Investors demand 285 basis points to buy senior bonds backed by commercial mortgages compared with as high as 10 percentage points in August 2009. Investors are accepting a lower spread even as Moody’s Investors Service says that underlying collateral will perform “poorly” over the next two years because of lack of refinancing opportunities and weakness in the economy.

“The lack of issuance out from the U.K. means stronger bids for the existing ABS and RMBS paper,” said Dalibor Jarnevic, a Frankfurt-based trader at DZ Bank AG. “That is forcing investors to go down the credit-quality curve to capture some yield.”

To contact the reporter on this story: Esteban Duarte in Madrid at

To contact the editor responsible for this story: Paul Armstrong at

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