New-Breed Banks Lead U.K. Mortgage Bond Market Revival

The Alder tree, a member of the birch family that thrives in landscapes where others fail, is inspiring a British bank as it challenges established issuers in the $346 billion U.K. residential mortgage-bond market.

Aldermore Bank Plc, which raised 333.3 million pounds ($557 million) from its first sale of mortgage bonds last week, is among a new breed of lender that will sell more of the debt than the largest banks this year, according to Royal Bank of Scotland Group Plc. Banks including OneSavings Bank Plc, together with building societies, surpassed issuance of the securities from traditional lenders such as Barclays Plc and RBS for the first time in 2013 and are on course to do so again in 2014.

Banks set up since the financial crisis to compete with incumbents for home-buyer and business loans are using mortgage-backed financing to tap into growing investor demand for credit as the U.K. economy strengthens. The RMBS market, the biggest in Europe, shrank to the smallest in four years in 2013 after stricter regulatory capital demands discouraged fundraising and the Bank of England offered money at cheaper rates.

“Issuers beyond the biggest banks are key to the sustainable revival of the post-crisis securitisation market,” said Ganesh Rajendra, head of fixed income, credit and mortgage strategy at RBS in London. “Structured finance has become marginalized as a mainstream bank-funding tool on account of regulatory treatment and central-bank accommodation.”

Financing Costs

Peterborough, U.K.-based Aldermore, which was established in 2009 with backing from Anacap Financial Partners LLP and Morgan Stanley, paid 67 basis points more than the three-month London interbank offered rate for its AAA rated note, according to JPMorgan Chase & Co.

That’s less than the 145 basis points over Libor paid by OneSavings Bank, which was created in 2011 through the rescue of Kent Reliance Building Society by funds advised by J.C. Flowers & Co. The group raised 273 million pounds from its debut sale of mortgage bonds in October.

The extra yield investors demand to hold top-rated U.K. RMBS instead of benchmark rates fell to 48 basis points last week, the lowest since November 2007 and down from 425 basis points at the end of 2008, according to JPMorgan data. The spread on AAA rated Dutch RMBS has shrunk to 60 basis points, down from 425 basis points in 2008, the data show.

Britain’s RMBS market is the largest in Europe with 252.1 billion euros ($346 billion) of the debt outstanding, compared with 249.7 billion euros in the Netherlands and 118 billion euros in Spain, JPMorgan data show.

Falling Sales

Sales of the debt in the U.K. declined 77 percent last year to 5.3 billion euros as the Funding for Lending Scheme, introduced in 2012 to cut borrowing costs for small businesses and homebuyers, provided banks with a cheaper source of funds. The BOE ended the program for household loans on Dec. 31.

Barclays, the second-largest U.K. bank by assets, last issued mortgage bonds in June 2012, and RBS last sold the securities in October 2011, according to Citigroup Inc. Lloyds Banking Group Plc, the largest mortgage provider, hasn’t issued the debt since April 2013.

Smaller banks will account for most of the mortgage bonds issued this year, according to Ratul Roy, a London-based analyst at Citigroup.

“There is little overlap between the users of the FLS money and the potential issuers of new RMBS,” he said “Smaller and lower-rated lenders did not borrow much from FLS and would prefer RMBS funding over unsecured and covered debt.”

Sales of prime U.K. mortgage bonds will total about 13 billion pounds in 2014, with as much as 10 billion pounds coming from smaller lenders, Citigroup estimates.

“The big banks have not gone away forever but I don’t foresee much change from 2012 and 2013,” said Rob Ford, a London-based money manager at Twenty Four Asset Management LLP. “In three years or so, we may start to see some of the bigger players return to pre-FLS issuance levels, but for now banks’ biggest focus is not funding, but improving capital ratios.”

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