By Jane Baird
Britain should clearly define "prime" borrowers to help revive the moribund market for securities backed by home loans, a Schroders fund manager told Reuters.
A government-sponsored report by James Crosby, former head of HBOS, warned that wholesale mortgage funding would probably remain tight through 2010.
Chris Ames, asset-backed securities portfolio manager at Schroders, which manages 19 billion pounds in fixed income assets, said he opposed government guarantees or additional legislation to reinvigorate the market.
"The one thing the government can do is to make a very specific definition of 'prime' for the purposes of UK covered bonds, like there is in Germany for Pfandbrief," he said.
"Covered bond investors are used to dealing with very commoditised and homogeneous instruments, and the UK covered bond market currently allows too much leeway in terms of mortgage quality and structure," he added.
"A functioning, liquid covered bond market would go a long way toward resolving the current crisis," Ames said.
Also, Ames said the market for residential mortgage-backed securities (RMBS) would benefit from an official definition of 'prime'.
"A lender could fund prime loans via either covered bonds or RMBS, and non-prime loans via RMBS as well, with more credit enhancement and higher spreads", he said. "The market would be more standardised, transparent and liquid."
WOULD BUY MORE
Several analysts have estimated the market for new UK RMBS next year will be about a third of its size in 2007.
"I estimate that 60 percent of the investor base for European RMBS, including UK RMBS, is gone, or at least capital constrained," he said, mentioning specifically Structured Investment Vehicles (SIVs), conduits and leveraged hedged funds.
For his own portfolio, Ames said he would buy much more RMBS than before the crisis if offered the right kind of deal.
UK banks need to alter deal structures if they want to open the market up before 2010, he said. They currently issue RMBS from master trusts, in which they can add new deals based on new mortgages to the same collateral pool.
"If an investor buys a bond from a master trust issued in 2004 and another of the same size and rating issued in 2006, he's doubled his exposure to the same pool of mortgages. He hasn't diversified at all," Ames said.
About 150 billion pounds of UK master trust RMBS are outstanding, he estimated. If mortgage lenders sell bonds from master trusts, the wide spreads of existing deals in the secondary market will drive spreads wide on new issues, he said.
But if "each transaction is backed by its own discrete pool of mortgages, I think the market can re-open much sooner, and the bonds will price at tighter spreads", he said.
He would like to buy bonds based on post-crisis mortgages, particularly those with 75 percent or lower loan-to-value ratios, verification of income and fully amortising repayments.
"Given the conservative approach of UK mortgages lenders at the moment, mortgages originated in 2008 will probably be fantastic credit performers," Ames said.
THUMBS DOWN TO PROPOSALS
In October, a six-month Bank of England stop-gap facility that allows banks to swap pre-crisis mortgage-backed securities for Treasury bills is due to close.
Ames said letting the facility expire would "exacerbate the liquidity crisis" and he expected the BoE to extend the facility until banks have swapped all of their pre-2008 mortgages.
Speculation has circulated in the market that the Bank could extend the facility to include new mortgages.
Also the Council of Mortgage Lenders (CML) has proposed that the BoE should offer a repo facility aimed at investors who buy public issues of RMBS or covered bonds to encourage them to come back into the market.
Ames criticised both ideas.
By accepting RMBS backed by new mortgages, the Bank "would delay the corrections necessary for the wholesale markets to again finance mortgage lending", he said.
He described the CML proposal as unrealistic because it would effectively add back leverage to the RMBS market at a time of extreme volatility.
(Reuters)
