Mortgage Securities Build from Strong Base

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Byline: Francesca Murra

If 2002 was a stellar year for European residential mortgage-backed securities (RMBS), it is difficult to describe the first few months of 2003 any differently. Total asset-backed securities (ABS) volumes at the end of April stood at [euro]51bn ($59bn) equivalent and were up 83% year-on-year, while RMBS issuance stood at [euro]30.8bn equivalent (66% up from last year).Alan Appen, managing director at Barclays Capital, says: "Last year, we saw around $50bn ([euro]43bn) equivalent in total European RMBS issuance. Although a stretch, it is not inconceivable that issuance volumes in 2003 will be double that of the previous year."

The record RMBS supply this year is mainly driven by the UK master-trust issuers - of which there are at present five. Others are also expected to join the fray, as Colin Evans, managing director at JP Morgan, predicts. He says: "I think there is potential for at least one new master-trust entrant this year either from the UK or the Continent, and perhaps more next year." Barclays Capital and Bradford & Bingley are two strong possible candidates.

The changes in liquidity in the banking sector in these past few years are strong reasons for the increased volumes of issuance. Even two years ago, highly rated European banks tended not to value highly the funding aspect of securitisation - this was mainly because they were sitting on excess liquidity and also had access to the unsecured market at very competitive rates.

However, Appen says: "To some extent, what we see now is a degree of spread convergence between securitisation and unsecured borrowing alternatives, making the funding effect of the former more attractive than it has been in the past."

Another important factor is the increased value that treasurers are placing on match-funding their residential mortgage portfolios. He says: "As liquidity generally becomes harder to come by, banks will seek to reduce asset-liability mismatches - and securitisation is a very good tool to address this."

Although the market at the beginning of the year saw initial tightening, this wore out quickly and spreads widened under pressure from massive supply.

Alexander Batchvarov, head of ABS/MBS international research at Merrill Lynch, comments in the bank's European structured credit report for the second quarter: "We would have seen MBS spreads even wider had it not been for the dollar-denominated tranches of UK mortgage master trusts."

David Basra, managing director in the securitisation group at Citigroup, says the European market is digesting record volume of supply during the first half of 2003, which has partly resulted in a modest widening of spreads in the euro and sterling sector.

Aside from the increases in volumes, the most important trend witnessed in the first quarter has been the large component of dollar-denominated tranches. In the latest Abbey National deal, Holmes 7, some 75% of the issuance was in dollars. Likewise, with Northern Rock, in its second deal this year, the percentage of US dollar issuance increased from 52% to around 70%, even though the overall size was down from the January issue.

The large appetite in the US is driven largely by the attractive pick-up investors are obtaining on these European master-trust deals, compared with their domestic consumer assets. At the same time, these deals enable them to diversify away from US assets. …