Yield Grab Fuels Biggest U.K. Sub-Prime Mortgage Bond Since ’07

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Investor demand for higher-yielding assets is reviving the riskiest segment of the U.K.’s mortgage bond market, with Co-Operative Bank Plc’s sale of the biggest deal since the financial crisis.

Co-Op Bank sold 1.5 billion pounds ($2.3 billion) of notes secured by home loans to non-conforming borrowers, according to a person familiar with the matter, who isn’t authorized to speak publicly and asked not to be identified. That compares with $2 billion issued in all of 2014, according to data compiled by Morgan Stanley.

Demand for U.K. residential mortgage-backed securities is increasing as the European Central Bank’s bond-buying program soaks up assets and suppresses yields in the euro area. Notes that are backed by loans to U.K. non-conforming, or sub-prime, borrowers such as those with court judgments or previous insolvencies don’t meet the ECB’s purchase criteria.

“Many investors see value in bonds that are not eligible for the ECB’s purchase program because you can get a decent pickup over those that are,” said Srikanth Sankaran, head of European credit and asset-backed securities strategy at Morgan Stanley in London. “For non-conforming RMBS there is also strong demand because even though issuance is increasing, supply is limited in absolute terms.”

David Masters, a spokesman for Co-Op Bank at Lansons, declined to comment on the sale before it priced, referring to last month’s statement that the bank was considering reducing home loans susceptible to severe stress. The Manchester, U.K.- based bank is accelerating disposals of risky assets after failing the Bank of England’s stress tests.

Co-Op Bank’s sale brings total issuance of the debt in the U.K. to $4 billion this year, according to Morgan Stanley. That’s twice last year’s total, which was the most since 2007, the data show.

Senior-ranking bonds backed by U.K. non-conforming loans pay an average yield premium of 104 basis points, according to JPMorgan Chase & Co. That compares with a spread of 70 basis points for Italian securities and 76 basis points for Spanish deals that the ECB can buy, the data show.

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