Lloyds TSB is about to do something it has never done before. In the next few months, the UK’s fifth-biggest bank is expected to issue bonds secured by its portfolio of home mortgages.
Lloyds’ move is evidence of how big British banks are more aggressively turning to the capital markets. Last month Royal Bank of Scotland securitised mortgages and a portfolio of commercial loans worth about £8bn.
Barclays took a similar step at the end of last year, while HSBC, the world’s third-biggest bank, issued securities backed by commercial loans for the first time last November.
There are many reasons for the recent flurry of securitisations. Banks have been prompted to think more carefully about their capital base by changing regulations, while growing appetite among institutional investors has made it more attractive to issue the securities. Banks have also increased their lending more quickly than they have been able to attract new deposits.
However, the recent shift is also evidence of a fundamental change in the financial services industry. For years, banks made money by taking deposits and making loans at a higher rate of interest.
But, with the evolution of the capital markets, banks are gradually moving to a business model where they arrange loans and then pass on a substantial portion of the risk to other investors.
“Our lending business should not dictate the shape of our balance sheet,” says Helen Weir, Lloyds’ finance director. “The real value is in the customer relationship, and we can meet the needs of the customer without assuming all the risk.”
This is not to suggest that securitisation is particularly new. Barclays issued its first mortgaged-backed securities in 1989, while banks such as Northern Rock have based their business on tapping the market for mortgage-backed securities around the world. Credit card debt and personal loans are also increasingly funded by securitisations.
The boom in the past ten years is eye-opening. According to the Bank of England, issuance of asset-backed securities in the United Kingdom has risen from $5.5bn in 1995 to $165bn (£89bn) last year – more than four times the total amount raised through share issues on the London Stock Exchange.
The wave of growth of securitisation, as well as the development of other instruments that transfer risk – such as credit derivatives – has prompted many executives to declare the banking system safer and less prone to crises than in the past.
But regulators are concerned the techniques may be encouraging banks and investors to take greater risks than before.
“The financial system cannot reduce the amount of risk in the economy, but only repackage and transfer it,” Sir John Gieve, the Deputy Governor of the Bank of England, warned in a speech this week.
“As more instruments that transfer risk are added to the balance sheets of financial institutions, so leverage and connectivity grow.”
Much of the recent demand comes from investors searching for securities that offer a reliable yield. This has increased the attraction of securitisation for banks.
“The primary driver is the funding available and the low cost of that funding, which comes without damaging the credit ratings of a bank,” says Krishna Prasad, head of structured finance research at Lehman
For example, HSBC last month completed its first credit card-backed deal when it sold $1bn worth of bonds.
Even as a new player in the market, the lion’s share of the deal – $880m in triple-A rated bonds – pays a coupon of just 1 basis point over 3-month Libor, the risk free rate. The introduction of the Basel II framework for regulating banks’ capital is also expected to provide a further impetus for moving some risk off banks’ balance sheets.
Bankers argue that, in spite of the growth in securitisation, the amounts involved are small relative to their fat balance sheets. Most lending is still funded by retail deposits, or by traditional capital markets activity. Until a few years ago, the amounts lent by big UK banks were still roughly the same as their deposit base.
Some go further in defence of the practice, claiming that the main benefit of securitisation is ensuring the bank is rigorous in its lending.
“It imposes a real discipline on the business to show that everything on your balance sheet is capable of being securitised,” says one finance director.
But a sharp downturn in the financial markets might test the theory, knocking demand for asset-backed securities and prompting some banks to rein in their securitisation activity.
In the meantime, most analysts believe that – barring a financial meltdown – banks are likely to carry on shifting assets off their balance sheets, particularly if it allows them to grow more quickly.
“The market has grown as a consequence of loan growth,” says Sam Theodore, managing director for European financial institutions at Dominion Bond Rating Service, the credit rating agency. “But because you have these funding sources banks are also more eager to lend money.”