Central bank interventions have helped drive a sharp rally in bonds backed by good-quality mortgages although conditions are not yet strong enough to boost new mortgage lending.
The safest UK residential mortgage bonds have seen the biggest moves, while across Europe risk premiums on such debt has more than halved since the end of March. Even the more fundamentally troubled US markets have improved.
This rally still leaves risk premiums – or spreads over “risk-free” rates on assets such as government debt – on mortgage- backed bonds many times higher than pre-credit crunch levels and far above rates that would encourage the new deals that are needed to help mortgage lending.
Average spreads on triple A rated European mortgage backed bonds have fallen almost 100 basis points to less than 100bp, says Ganesh Rajendra, head of European securitisation research at Deutsche Bank. UK deals have seen spreads drop from about 185bp at their peak at the end of March to about 80bp now, say analysts at Barclays Capital.
To put these moves into context, before the credit crunch European triple A mortgage-backed debt was yielding spreads of less than 10bp.
“This unprecedented performance [over the past month] was underpinned by the noticeably stronger credit market tone and the continued ‘central bank bid’, with the Bank of England joining the fray,” said Mr Rajendra.
It first emerged in late March that the Bank was finalising plans to join its counterparts in the US and eurozone in offering a facility for banks to swap difficult-to-shift mortgage debt for more liquid government bonds. The Bank finally unveiled the initial £50bn ($97bn) facility late last month.
Hans Vrensen, head of European securitisation research at Barclays Capital, said trading had picked up dramatically as buyers and sellers had begun to agree on price, although absolute trading volumes remain fractional compared with the volume of deals outstanding. “Some investors are already complaining that it is difficult to find sufficient volume in the secondary market,” he added.
Anecdotal evidence suggests that buyers in Europe have been mainly well-capitalised banks – including, surprisingly, some smaller regional players – and some traditional debt fund managers.
However, one experienced mortgage-backed bond investor in London warned that the recent positive tone might not be long-lasting.
“There is still a lack of natural buyers of the triple A rated bonds since SIVs [bank-run off-balance sheet investment funds], money market funds and banks’ own treasury departments have stopped buying,” he said.
Mr Rajendra also remains cautious, saying that the market continues to be characterised by investors with a sizeable asset overhang who are far more interested in selling than buying.
“The US ABS market, where the extent of forced selling has arguably been more meaningful and where spread performance has been unremarkable compared to [corporate] credit, may provide some insight in this regard,” he said.
