Andrew South, md, structured finance and Alastair Bigley, senior director, sector lead European RMBS at S&P Global Ratings, explore whether the European RMBS markets have weathered the Covid-19 storm

The Covid-19 pandemic has provided a novel test of European RMBS credit performance, which the sector looks set to pass with flying colors. As virus-related social restrictions led to an economic shutdown and mortgage lenders introduced unprecedented borrower forbearance schemes, RMBS investors seemed to be at risk of taking a hit.

Mortgage payment holidays posed a potential liquidity risk in RMBS, as they would temporarily reduce cash inflows to the transactions. However, structural mechanisms designed to deal with short-term cashflow disruptions generally proved ample to prevent any interruption to coupon payments for rated noteholders.

Government-backed short-time work schemes have also supported borrowers, limiting any rise in mortgage arrears. As a result, our RMBS ratings have held up well through the pandemic: we lowered only about 1% since March 2020 and upgrades have strongly outnumbered downgrades over that period.

Looking forward, RMBS credit performance will hinge on how borrowers respond to the wind-down of support schemes, which could unmask some underlying credit distress. This is likely to be greatest in pools of older-vintage, nonconforming loans, which were underwritten to looser standards than current originations. However, we expect the schemes' removal to be well-synchronised with the counteracting economic rebound, which has so far been strong.

Unemployment rates across Europe will likely be only slightly higher than pre-pandemic levels this year and will decline through 2022. Even where there are performance issues, we believe that servicers are typically better equipped to cope with the intensity of managing borrowers facing economic stress than they were in the wake of the 2008 global financial crisis, for example.

The European RMBS sector was not immune to wider capital market disruption at the onset of the pandemic, and investor-placed issuance in 2020 was almost 40% down on the previous year. However, RMBS volumes have bounced back strongly and look set to return to the recent pre-pandemic annual norm of more than €35bn by year-end.

The pandemic's short-lived effect on RMBS issuance broadly mirrored its effect on underlying mortgage originations. While lockdowns in early 2020 inevitably led to a hiatus in property transactions and associated mortgage lending, the subsequent recovery has been rapid, in some countries aided by policy measures to stimulate the housing market, such as the UK’s temporary reduction in property transaction tax. As a result, the UK’s mortgage loan book growth has recently been running at more than 5% per year, compared to normal levels of just over 3%. The lending trend is similar in the eurozone and has helped support RMBS issuance.

However, aspects of the policy response to the pandemic have also been negative for RMBS issuance. In particular, the expansion or relaunch of central banks' cheap funding schemes for financial institutions has exacerbated the multi-year trend of bank originators shying away from RMBS as a funding source, given the alternatives on offer. In fact, so far this year, more than three-quarters of European RMBS issuance has been from non-bank originators, compared with less than 5% a decade ago.

The longer-term effects of the pandemic on the structure of European mortgage markets are not yet clear. For example, more prospective mortgage borrowers could now have an adverse credit history or complex income record, potentially leading to greater activity among specialist lenders, who have historically been avid users of RMBS funding.

Conversely, traditional bank lenders could also have sufficient incentives to take on a wider customer base, given the continued low-yield environment for prime, vanilla lending, and an acquisition-led approach could remove specialist securitisers from the market. The end effect on the European RMBS market remains to be seen.