DBRS Comments on Eligibility Changes to BoE’s Funding for Lending Scheme; Issuance Increase Likely, Limited Impact on Outstanding RMBS

DBRS notes today that the Bank of England (BoE) announced that residential mortgages will no longer be eligible from January 2014 as collateral for its flagship Funding for Lending Scheme (FLS). The U.K. residential housing market is showing signs of recovery in mortgage lending and house prices, and BoE has chosen to focus the extension of its FLS program on lending to small- and medium-sized enterprises.

Overall, and as mentioned in the DBRS commentary on the U.K. Government’s Help-to-Buy scheme (see the link under Related Research at the right of the screen), DBRS expects mortgage rates paid by underlying borrowers to increase as a consequence. The removal of low cost funding from the Bank of England will oblige most banks to make greater use of higher cost funding for their mortgage lending. DBRS expects this change to have varying degrees of impact for the securitisation market.

Issuance of securitisation and covered bonds should increase in 2014 as U.K. banks look to fund mortgage lending from other funding sources. Since the introduction of FLS, securitisation issuance of U.K. RMBS has fallen to EUR 8.0 billion at 31 October 2013 from EUR 39.5 billion in 2012. U.K. covered bond issuance has fallen to EUR 1.6 billion in 2013 from EUR 37.0 billion in 2012.

U.K. mortgage borrowers who are already exhibiting stress will inevitably feel additional pressure if rate increases materialise. Therefore, there is a concern RMBS transactions already showing higher-than-average levels of delinquency may see deterioration in performance. DBRS does not expect significant stress to be exhibited by borrowers of more recently originated vintages, as underwriting standards in such vintages include an assessment of affordability stressed for potential interest rate increases. However, it should be noted that there is no standard approach to stressing affordability across all lenders and therefore different lenders may exhibit different sensitivity to interest rate rises.

Whilst DBRS expects the net result to be an increase in mortgage rates, quantifying this increase remains difficult. It will ultimately depend on a series of factors. It is likely that the decision to revise eligibility was made considering these other relevant factors.

Firstly, the cited reason for the change in policy and the exclusion of residential lending from the FLS scheme from January 2014 is that the scheme has achieved its stated objective of improving credit conditions for households. Increasingly, high street lenders have shown a renewed appetite for both lending volumes and risk. For example, certain high street lenders have recently re-launched 95% lending not backed by the government’s Help-to-Buy guarantee. Therefore, the forces of supply and demand may help keep mortgage rates relatively low by narrowing the spread between indices, such as LIBOR, the BoE base rate and the mortgage rates paid by borrowers.

Secondly, the FLS scheme has had the impact of reducing the need for U.K. banks to obtain funding through the capital markets. The removal of the scheme will, all things being equal, make it increasingly necessary for lenders to fund mortgage lending in the capital markets. Ultimately, investor appetite for debt backed by U.K. residential mortgages and the price investors are prepared to pay will have an impact on how borrowers’ mortgage rates are priced. An increase in supply may put pressure on existing spread levels, as well as investor risk appetite for mortgage loans.

Thirdly, the elimination of residential mortgages for FLS is occurring at a time when the market is increasingly expecting the BoE base rate to increase. For example, five-year mortgage rates have recently increased in response to increased swap rates. If the markets continue to price in an anticipated rate rise, this will naturally feed through to mortgage rates.

DBRS will observe the market response to the change in eligibility and make future comment if and when necessary.

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