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Bank of England inadvertently fuels rebirth of securitization

The Bank of England's funding for lending scheme makes it easier for banks to push cash into the U..K economy. It is also contributing to the rebirth of esoteric securitisations.

How? Because commercial banks have less need to sell parcels of their high-quality mortgage loans in the market. After all, they can finance themselves more cheaply through the central bank.

One consequence is that the interest rate spread on prime mortgage-backed debt has almost halved in the last three months. And as spreads narrow, it becomes more economical to securitise a wider range of assets, since getting deals done requires a positive spread between the yield on the pool of assets and the cost of funding them in capital markets. The fall in supply of high-quality mortgage backed loans, combined with investors' search for yield driven by low policy rates, is also making it easier to get more esoteric securitisations off the ground.

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The shift works for issuers as well as investors. Berenberg Bank estimates a lender such as Paragon could earn a return on equity of at least 15 per cent by originating and securitising buy-to-let mortgages, compared with less than 10 per cent a year ago. According to Deutsche Bank estimates, meanwhile, asset managers can make returns of about 10 per cent by parcelling up pools of leveraged buyout loans and financing them through collateralised debt obligations. In June, they would have got only about 5 per cent.

Given the sector's niche status in Europe, the wider impact is unlikely to be earth shaking. But bonds backed by non-conforming mortgages and commercial real estate loans should pick up, and collateralised debt obligations could return. Easier securitisation conditions may also help banks sell off distressed or legacy assets. A recent deal by Royal Bank of Scotland – the first deal since before the credit crisis – could be a model.

Understandable concern surrounds the return of funky asset-backed deals; after all, securitisation fuelled the last credit bubble. For the moment, however, it can be seen as a benevolent trend, one which helps companies and consumers to borrow when banks are retrenching.

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