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The Covered Bond Blog: It's not just about the bonds

20 May 2015
Richard Kemmish

We secured debt people do tend to go on about bonds rather a lot. Capital Markets Union is about increasing the scale of bond funding relative to banks. The ECBC’s latest initiative is about trying to design bonds that better meet the requirements of society. Inconvenient legal forms – like secured loan notes – are generally categorised as close enough to being a bond to not really worry too much about.
But I read something recently that reminded me that the first mortgage secured financing I ever worked on – a securitisation by the way, yes, I know, sorry – was in loan format.

Twenty years ago a building society (now no longer with us) decided that issuing a securitised bond to investors was technically impossible. But they did want to transfer some risk from their mortgage book to third parties and at the same time raise funding. If I remember correctly 5 banks signed up for £20mn each - we thought small in those days. The loans that they advanced were secured on the mortgages but the repayment of which would be impaired if an infeasibly large number of mortgages in northern England defaulted.

As far as I know there was only one other deal of this type, also for a northern building society, also no longer with us. The securitisation bond market went from strength to strength and the securitisation loan market was consigned to history.

This is not just me being nostalgic though. There seems to me to be a very distinct trend back towards lending based on mortgages without all of that messy ‘putting them in a bond and getting it rated’ business. There are two elements to this, the public and private sectors.

The ECB started to accept residential mortgages as repo collateral in their Additional Credit Claims Framework in December 2011 as ‘a temporary measure’. Other central banks have been accepting them for even longer.

This is straightforward enough if it is intended to be used as a short term emergency or technical facility – as central bank funding used to be. If you are only advancing funds over night it really doesn’t matter what the mortgage credit structure is like or whether they will pay off as a bullet maturity in five year’s time. A rough haircut to nominal is the only risk mitigation needed.
But central bank facilities are getting longer – into the territory of bond funding. Are ECB credit criteria keeping up? With this type of asset included in the ever growing ‘non-marketable assets’ line of the ECB’s balance sheet, it is becoming an ever more pressing question.

Then there is the private sector lending secured on unstructured pools of mortgages. Either bilateral or pooled in a vast exchange with associated term repos of blocks of mortgages. It’s a growing use of mortgage collateral that would otherwise be put in covered bonds. Do we secured bond specialists fully understand this trend or its implications?

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