UK RMBS remains 'robust' in face of Brexit

While the UK buy-to-let (BTL) sector has suffered under new regulatory policies and Brexit uncertainty, market participants believe it still has room to expand in terms of new lenders and products. This was according to panellists at a recent Fitch conference that also suggested that more aggressive underwriting practices, such as extended loan terms, could be a concern for the future stability of the UK RMBS market.

Alessandro Pighi, co-head, EMEA RMBS at Fitch, comments that the BTL sector has encountered a number of challenges after a period of strong growth. “The BTL market grew substantially”, he says, “until 2016 when new challenges emerged, slowing growth, including new regulation and Brexit risk. As lending appetite from established lenders reducing, I still think there is room for new lenders in BTL. In terms of rating the product, lack of originator-specific performance data is a shortfall.”

Despite this, Pighi feels that the sector may still see some upside from more recent developments. He comments: “However, given the PRA rules clearly sets origination boundaries and a comparison of lending criteria between new entrants and established lenders is possible, we believe historical data from traditional lenders can be a good guide to new lenders’ performance.”

Greater standardisation of the BTL market is something that Simon Allsop, director of capital markets at Charter Court, agrees with. He adds that increased regulation has created a more generic product set in BTL.

Allsop adds, however, that the market does see added complexity in the underwriting of BTL loans, which lends itself well to specialised lenders. These include firms such as Charter Court which, he adds, has seen BTL lending volumes remain resilient in recent years.

It was also noted that there has been a growth in more aggressive underwriting policies across the UK mortgage market, including a rise in five-year fixed rate mortgages. Anuj Babber, co-head of ABS credit research at M&G Investments, comments: “New lenders are perhaps taking a more aggressive approach when it comes to underwriting.”

He adds: “From our perspective when we evaluate deals from new lenders we do tend to do an onsite due diligence and focus on underwriting very carefully. The theory is that strongly underwritten loans are less likely to go wrong or delinquent.”

He continues: “We are witnessing a big rise in five-year fixed rate mortgage originations, especially in the BTL lending space and this significant increase is a concern for us. This lending pattern is part of the more general aggressive underwriting approach of new lenders. We have yet to see how the performance of these loans play out.”

Grant England, senior director, structured finance at Fitch, seconds Babber’s view, adding that lenders need to think more about interest rate risk as a result of this growth in five year fixed rate mortgages which, he says, appeal to borrowers due to the extra certainty offered and competitive rates.

England also says there has been growth in longer terms to 30 and even 35 year mortgages, which is also in part a result of changing attitudes to retirement age. He adds that there is a growth too in lending to self-employed individuals.

In terms of UK RMBS structures, England suggests that these have not shown a great deal of innovation. What is of note more recently is how deals are structured in terms of subsequent product switches, after the initial fixed rate period expires.

“In some deals”, says England, “if the mortgage is switched to a new fixed rate period the mortgage is treated as a prepayment and the loans are switched out of the transaction. In others, the loan can switch within the deal and this requires a more complex arrangement in terms of building in hedging options. More variation in terms of hedging and swaps might therefore lead to more variation in RMBS structures.”

In terms of other nuances within RMBS, England says that help-to-buy (HTB) mortgages are treated in a slightly different fashion to other mortgages, particularly in terms of how the LTV is assessed.

He says: “An important thing for us when looking at HTB is how it affects LTV. Whereas a regular mortgage that might make up 55% of the total value of the property would be looked at by us as having 55% LTV, with a HTB mortgage we will combine the mortgage value and the government loan to come to a much higher overall LTV when assessing the default risk of the mortgage.”

Allsop suggests that HTB is no longer an unusual product in the RMBS sector it has not caused them any extra difficulties. He adds that his firm did the first HTB RMBS in the UK with no pushback from investors and that HTB is well understood and regarded as quite a mainstream asset class.

Additionally, he says that it now makes up a reasonable part of his firm’s “overall prime resi book” and while there “might be a small price differential on a HTB RMBS” his firm has been happy with the pricing achieved.

Looking to the future, uncertainty caused by macroeconomic factors, such as Brexit, is a cause of concern, although Allsop feels that his firm is well placed at present. He says: “I am of course concerned like most rational people would be - but I think we are entering into it as prepared as we could be. As a bank, we are well capitalised with a low cost of risk; we have a strong retail arm and a range of funding options, so we are entering the period on an assured footing.”

On the investor side, Babber comments that while Brexit is a concern for his firm, there might actually be other things that are as much, if not more, of a worry including the US-China trade war and central bank policy.

On a similar note, England agrees Brexit is a worry, but adds that it may be manageable, even in the worst of circumstances. He concludes: “On the whole the UK mortgage market is in a good position. Repossessions are at almost record lows, for example, and most RMBS transactions are well positioned to survive the short term disruption of a no-deal Brexit scenario.”

Richard Budden