In this report, S&P Global Ratings presents a summary of the key developments in the European RMBS markets that have happened in the first quarter of 2021. Together with a loan-level analysis of recent origination trends in the U.K.

Analysis Of Recent U.K. Mortgage Origination

We analyze loan-level data of recently originated S&P Global Ratings rated RMBS transactions in the U.K. and compare it with that of recent quarters. The analysis covers loans originated in the periods highlighted in the charts and excludes legacy loans that may form part of recent RMBS transactions.

• Five-year pound sterling swap rates have enjoyed a roller coaster ride over the past 12 months. The consequence of this trend from an RMBS structural perspective is that swaps entered into in the second half of 2020 were considerably lower than in early 2020 and lower than rates in the first quarter of 2021 (see chart 1). This decline in swap rates broadly coincided with asset margins on underlying loans increasing in the summer of 2020. However, based on our observation of recent product launches, we estimate that margins on loans originated in the first quarter of 2021 have declined by approximately 20-30 basis points (depending on loan-to-value [LTV] ratio and product).
• At a time of rising swap costs (see chart 1) the very high levels of excess spread seen in some first-quarter 2021 U.K. transactions may have peaked.
• Although asset margins are under pressure, current levels are broadly in line with what was achieved in lending before the coronavirus pandemic.

Chart 1

The second half of 2020 saw the share of origination of loans fixed for five years peak (see chart 2). The movement to five-year fixed-rate origination is significant as lenders do not always stress the debt service coverage ratio (DSCR) at a rate beyond the five-year fixed rate, which would be required if the fixed rate was shorter than five years. The stress rate used is typically higher than the five-year fixed rate. Notably, this is happening when rental yields in some areas are under pressure, notably in central London (see table 1).

Chart 2

Table 1

Analysis of assessed rents in central London for properties that were in U.K. BTL transactions backed by recently originated collateral indicated that rents in London are falling (see table 2). Although likely to be a temporary phenomenon, which we expect to reverse when central London businesses reopen, it is something to be vigilant of as 2021 progresses.

Origination policies of lenders differ in how they stress the affordability of owner-occupied borrowers who take out a five-year fixed-rate loan. Some lenders will not stress at a rate above the five-year fixed rate, while other lenders will stress above the five-year fixed rate. Stressing at the five-year fixed rate allows, all other things being equal, the borrower to borrow more and obtain more leverage. The significance of and shift toward five-year fixed rates and whether it will continue is yet to be determined, but something worthy of monitoring. It is also noteworthy that the U.K.'s recently launched Mortgage Guarantee Scheme views using the five-year fixed rate as preferable. This is discussed in more detail below.

Chart 3

Our analysis of risk layering in U.K. BTL origination over the course of 2019-2020 supports the anecdotal evidence that lenders who remained actively lending did so in a considered way and managed risk accordingly. This is evidenced by portfolio-level DSCRs and LTV ratios showing no material negative shift. The analysis performed here assumes a stressed rate of 5.5% and is of transactions rated by S&P Global Ratings.

Table 2

Mortgage Market Updates

United Kingdom

Rental arrear and eviction ban  

• Rental arrears are increasing. A survey conducted by the National Residential Landlords Association indicates that in England and Wales in December 2020 11% of private renters were unemployed and 7% of renters had built arrears since March 2020 (up from 2% pre-pandemic).
• The increase in arrears is also partly linked to the eviction ban on tenants in arrears, which has been extended until at least the end of May 2021. We believe that there is a realistic possibility that this will be extended.
• Although the increase is notable, the current scale is not feeding through to delinquencies in BTL collateral. This is likely due to portfolio landlords using excess rental income on other properties to cover shortfalls. Indeed, BTL has seen very strong performance over the past year. The temporary inability to evict means that rental arrears are likely to worsen before they improve, so BTL performance should not be taken for granted.

Government high LTV ratio guarantee scheme 

• The U.K. government announced the launch of its Mortgage Guarantee Scheme in early March 2021, with the policy desire to increase the amount of 95% LTV ratio lending. All regulated lenders are eligible to apply to use the guarantee scheme. To date, a number of mortgage providers have announced they will be participating in the scheme, which lasts until the end of 2022. The scheme guarantees any loss on the portion between 80% and 95% for a fee. Only mortgages between 90% and 95% are eligible and the explanatory literature accompanying the scheme makes clear that taking out a five-year fixed-rate mortgage is preferred. The combination of these two factors may, in some situations, encourage borrowers to leverage more, e.g., borrowers who were initially intending to take out an 85% LTV ratio mortgage find they can obtain more leverage under the guarantee scheme.

Repossession process 

• The repossession ban has been extended until the end of April 2021. Meaning that in all but exceptional cases, which are likely to be minimal, such properties cannot be liquidated until the end of April. Furthermore, the court process for other borrowers in late-stage arrears, but who do not have a possession order granted against them, will also be delayed. We understand that borrowers who were in late-stage arrears before the pandemic will typically be prioritized in the court process. The ban also applies to BTL properties, but there is an expectation that forbearance will be passed on to tenants.
• We expect that the ban and potential court congestion will lengthen the time to liquidate assets, although government intervention (furlough schemes and the equivalent for the self-employed) is designed to limit the incidence of late stage arrears. We updated our guidance on assessing of European RMBS to reflect the fact that we may run lengthened recovery timelines on a case-by-case basis.

Payment holidays end and no spike in applications. 

• The U.K. payment holiday (deferral) scheme was reintroduced in December 2020. Borrowers were able to request a maximum six month's payment holiday and could apply until the end of March 2021. Meaning that borrowers who had not previously had a payment holiday could request a six-month holiday between now and the end of March. Having spoken to a selection of U.K. mortgage servicers, we understand that there was no last-minute spike at the end of March in applications across any of the sub-asset classes in the U.K. (prime, nonconforming, and BTL). Therefore, we do not expect to see any increase in payment holidays being reported in U.K. RMBS.

Breathing space initiative 

• The U.K. government's debt respite scheme (breathing space) is effective on May 4, 2021, and will give borrowers in problem debt the right to legal protections from their creditors. Although mortgages are excluded debts under the scheme, arrears on them are not. The scheme allows the pausing of most enforcement actions, contact from creditors, and freezing of interest (on arrears) and charges on their debts for 60 days. Importantly, borrowers cannot self-refer and consideration for the scheme would need to be through a debt advisor. Given this, we would anticipate the effect on U.K. RMBS collateral to be limited, although something that should be monitored.

Issuance outlook 

• U.K. house prices are expected to fall 2.3% this year, and according to origination data from the Bank of England net originations in 2020 were approximately £9 billion lower than in 2019. In addition, the Bank of England's Term Funding Scheme (TFS) offers a potentially appealing funding solution for banks and makes RMBS issuance relatively less appealing. Non-banks, who cannot access the TFS, are likely to continue to be regular issuers, with refinancing activity a potentially significant source of issuance activity (see "Upcoming Calls"). Recently issued "social" bonds from Kensington and Yorkshire Building Society are likely to be the start of a wider trend. Indeed, environmental, social, and governance (ESG) factors may tempt some banks to issue RMBS to demonstrate capability in this sector despite the relative advantages of the TFS.

Netherlands

Stamp duty cuts may lead to more non-bank origination and securitization 

• The Dutch government has introduced a temporary stamp duty exemption for first-time buyers (FTBs) who are below the age of 35. The exemption will save such borrowers 2% on the purchase price and means that deposits will be easier to save for. This will likely provide some stimulus to this sector of the market. Although RMBS issuance in the Netherlands remains relatively muted, as FTBs tend to be higher LTV ratio borrowers and higher LTV ratio lending tends (although not exclusively) to be a sweet spot for non-bank lenders in the Netherlands, it could increase RMBS issuance as these non-bank lenders rely on securitization to refinance.

BTL tax reform unlikely to be a game changer 

• Stamp duty for the acquisition of BTL investment properties were increased to 8% of the purchase price from 2%. Similar measures were introduced in the U.K. in 2017 and, although economically negative to BTL investors, they did not appreciably curtail the market. BTL investment, by definition, is the mainstay of relatively small-scale private landlords. At a time when Euro Interbank Offered Rates (EURIBOR) are negative, BTL is still--even with a higher day one tax cost--attractive to individuals with the capital to deploy in the form of a deposit. In addition, BTL is a rare example where an individual, and specifically one who is not a sophisticated investor, can obtain a leveraged position and access to leveraged upside. So, although the higher tax burden will likely trim demand, our view is it is unlikely to stop the Dutch BTL market in its tracks.

Issuance outlook 

• In recent years, RMBS issuance in the Netherlands has been less linked to mortgage origination volumes as unstructured mortgage funds have taken up a large share of origination volumes. As mentioned above, the relative prevalence on non-banks and the burgeoning BTL market are likely to shore up issuance.

Ireland

Shake up of the Irish lending market 

• There have been recent announcements from both Ulster Bank DAC and KBC Bank Ireland PLC that they intend to withdraw from the Irish markets. Both lenders are active in the residential lending market and their withdrawal and/or change of ownership raises questions as to what happens to their respective shares of the mortgage market and whether it would disrupt market dynamics. If this withdrawal or change in ownership lowers the appetite for mortgage risk, non-bank lenders would be well placed to capitalize on potentially higher margins ensuing from less competition. The news also raises the question of what happens to the existing portfolios of the two banks and whether these will find their way into secured funding refinancing.

First European RMBS jurisdiction to exit payment holiday regime 

• The Irish authorities have not extended their payment holiday schemes, which effectively ended in September 2020. On a case-by-case basis payment holidays may be granted, but will need to be assessed in line with the Mortgage Arrears Resolution Process (MARP). The recent extension of the pandemic unemployment payment and the employment wage subsidy scheme until the end of June 2021 means that any deterioration is likely to be contained in the short term.

Issuance outlook 

• Although house prices are expected to increase by 2.7% in 2021, the balance of outstanding mortgages declined by approximately €11 billion in 2020 according to data from the Irish Central Bank. Furthermore, for banks the availability of other funding options means that issuance of RMBS purely as form of funding is likely to be limited for the foreseeable future. Although non-banks do figure in Ireland, tight macro prudential rules mean room for maneuver in origination policies is limited. Therefore, securitization of reperforming/restructured loans is likely to form the bulk of issuance in the near term. Call activity is also likely to drive activity to some degree in 2021 (see "Upcoming Calls").

Spain and Portugal.

Payment holidays and repossession update 

• Following the European Banking Authority's (EBA) Dec. 2, 2020 announcement, which in effect offered member states the option to extend payment holiday schemes, borrowers in Spain are able to apply for a statutory payment holiday up to the end of March 2021.To date, statistics published by the Bank of Spain do not show material increases in uptake since the extension of the scheme. We have contacted servicers and it seems that there was no last-minute spike in applications.
• In Spain, it was recently announced that all foreclosures related to defaulted residential mortgage borrowers without alternative housing (vulnerable borrowers) cannot be evicted until August 2021. This is a three-month extension to the original moratorium and means that any increase in liquidation activity will be limited in 2021.

Expediente de Regulación Temporal de Empleo (ERTE)  

• The short-term work scheme (the Expediente de Regulación Temporal de Empleo [ERTE]), which was already extended until May 31, 2021, might be extended until September and possibly December if necessary. The Ministry of Labor has started negotiations with trade unions and business organizations. Transition out of the ERTE scheme is likely to result in gradually rising mortgage arrears in late 2021 and early 2022, depending on the final extension date.

Negative rates in Portugal. 

• The introduction of a law in 2018 eliminated interest rate floors on mortgages or loans in Portugal (see "Portugal's New Interest Rate Law Has No Ratings Impact On RMBS Transactions Or Banks," published on June 26, 2018). At that time, only 6% of loans in the transactions that we rated had a negative interest rate. Since then, EURIBOR continued to decrease, going below -0.5%, which exposes more loans to negative interest rates. Combined waterfalls and funded reserves mean that transactions should continue to pay senior fees and any interest due. However, the effect of any future reductions in EURIBOR should be monitored.

Issuance outlook 

• The story for Spain and Portugal is one similar to other Eurozone countries. Overall, the amount of mortgages registered in December 2020 was approximately 15% lower than in the same month of the previous year, according to data from Instituto Nacional de Estadística. We expect modest house price increases of 1.6% in Spain in 2021. Likewise, in Portugal the number of mortgaged dwellings fell by approximately 13% in the year to the end of February 2021, according to data from Instituto Nacional de Estatística. As for other Eurozone countries, however, issuance is likely to remain limited as other funding avenues offer more appeal for banks. For Spain, any increase in issuance is more likely to come from securitization of nonperforming loan portfolios. A recent example of this is Retiro Mortgage Securities DAC.

Italy

Payment holidays steadily declining 

• The outstanding balance of mortgage loans benefitting from payment holidays, according to the government scheme ("Gasparini" fund), is currently at €5 billion (end of March data from Bank of Italy). This represents 41% of the total of €13 billion in approved suspensions since March 2020. In relation to the suspensions granted under the ABI (the Italian Banking Association) scheme, the percentage that is outstanding is similar at 38%, with €9 billion still outstanding from the €25 billion in approved payment holidays since March 2020. The Italian government scheme will be available until the end of 2021, while the ABI's scheme expired at the end of March 2021. According to the draft of a new government decree (Decreto Sostegni Bis) expected to be approved next week, the government scheme will be extended again to. The previous decree, at the end of 2020, had excluded self-employed borrowers.

Issuance Outlook  

• According to provisional data from the National Institute for Statistic (ISTAT), in the fourth quarter of 2020 house prices went up by 1.6% compared with the same quarter in 2019. On average, in 2020 house prices grew by 1.9% compared with the same period in 2019. The mortgage market is also showing positive trends. According to the latest study from ABI, in January 2021 residential mortgage loans increased by 2.5% year on year, which is higher than the 2.3% increase recorded in December 2020.
• The most recent quarterly bank lending survey from the ECB does not report any tightening of the credit standards from Italian banks in relation to residential mortgage loans during the fourth quarter of 2020, and the expectation is for a moderate loosening in in the first quarter of 2021. Despite this, RMBS issuance is still likely to be muted as the non-bank securitization market is negligible and alternative funding channels are likely to be more attractive for banks. The new decree "Sostegni Bis" contains measures to support young people purchasing their home with a mortgage loan. People under 36 years of age will benefit from tax exemptions and, in some cases, from tax credits.

France

Mild softening in Article R-2021-1 recommendations:  

• The French High Council for Financial Stability reviewed and adjusted the tightening of residential lending underwriting standards recommendations initially made on Dec. 20, 2019. Here is a short summary of the amendments announced on Jan. 28, 2021: The affordability ratio (monthly mortgage payment divided by net monthly income) increases to 35% from 33%; A two-year buffer may increase the 25-year maximum initial loan maturity if the mortgage holder moves into a property whose renovation cost was at least a quarter of the total purchase price; and Exceptions to the first two amendments may represent up to 20% (from 15%) of the new loan origination (flexibility provisions) and the debt-to-income cap of seven times is dropped for the loans granted under the flexibility provisions.
• Despite the relative softening of the recommendations, we view them as credit positive, given their intention to stabilize the overall residential market by limiting banks' mortgage-book risk and preventing borrowers from excessive financial hazard.

Issuance Outlook 

• Although French house prices are not expected to decline over the course of 2021, the lack of non-bank lending and more attractive alternatives for banks mean that RMBS issuance is unlikely to see any significant increase in the short term.

Upcoming Calls

European RMBS transactions with a call in the next nine months, together with the estimated weighted-average margin initially, currently, and after step-up, are shown in charts 4 and 5. The U.K., Ireland, and the Netherlands are likely to provide the main refinancing activity in 2021, in our view. Chart 5 shows our estimation of the weighted-average cost of funding post step-up. Although margins can and do increase and decrease, broadly speaking, current liability costs achievable would give issuers incentive to refinance relative to the cost of the step-up.

Chart 4

Chart 5

Related Research

• Europe’s Housing Market Will Chill In 2021 As Pent-Up Pandemic Demand Eases, Feb. 22, 2021
• European Structured Finance Market Accelerates Transition From LIBOR, Feb. 9, 2021
• European Economic Snapshots: Policy Is Keeping The Impact Of The Second COVID Wave At Bay, Dec. 16, 2020