Allen & Overy kept its confidence in the securitisation market, and an expanded team has been repaid with the role of advising Nationwide on the first UK building society securitisation to be sold into the US. Writer Edward Russell-Walling

Having traversed the investment vogue from red hot to ice cold, residential mortgage-backed securities (RMBS) have been warming up again over the past year. But law firm Allen & Overy never lost faith in the securitisation market, and quietly strengthened its team even through the bad times. It recently advised Nationwide on the first UK building society securitisation to be sold into the US, another sign of the market's gradual thaw.

As mutuals, owned by their members, most building societies were resistant to pre-crunch securitisation mania, and have tiptoed into it very gingerly indeed. At least half their funding must come from members, which limits their scope for diversification. Perhaps more to the point, since securitisation involves a transfer of assets, societies have had to take great care to fully protect members' interests. It was only in late 2005 that Nationwide, the largest UK society by some margin and the pathfinder for the sector, issued its first covered bond, secured on cash flows from mortgages that nonetheless remained on its balance sheet. Allen & Overy acted for Nationwide. Others, such as Coventry Building Society and Yorkshire Building Society, have since followed this conservative route.

Nationwide is the UK's third largest mortgage lender of any kind and in 2008, it finally set up a securitisation master trust - Silverstone - to take advantage of the Bank of England's Special Liquidity Scheme. Then, in October 2009 and advised by Allen & Overy, it used Silverstone for its first public securitisation, issuing £3.6bn ($5.7bn) of RMBS with the backing of JP Morgan, which took £2.25bn of the deal. In an effort to restart the market, the US bank had provided similar support to a September issue from Lloyds Banking Group's Permanent vehicle, taking £2.8bn of a £3.9bn transaction. To address concerns of the day, both incorporated a maturity purchase option to protect investors against extension risk.

Those concerns arose from the only problematic UK RMBS vehicle, Northern Rock's Granite Master Trust. "When Northern Rock went into bankruptcy, it chose not to refinance or to refresh the mortgage pool," says Salim Nathoo, Allen & Overy's head of securitisation. "Instead, it allowed a step-up and extension. Investors hadn't expected that and they didn't like it." The spread on the AAA bonds doubled from 20 to 40 basis points (bps) but, with secondary market spreads moving closer to 150bps or even 200bps, investors felt they were getting a raw deal.

Consequences for issuance

The generosity of spreads available in the secondary market has been one of the factors inhibiting primary securitisation issuance since 2007. While the low-risk covered bond market revived quickly after the crunch, it was not in sufficient volume to satisfy banks' overall funding needs. With government liquidity support on a finite time horizon - the three-year UK scheme has one year left to run - financial institutions are being encouraged to get back into the capital markets. So an apparent return of confidence in the securitisation market has been welcome.

Allen & Overy has strong links with UK building societies, having advised on many of the mergers that have characterised the sector. It has nurtured its team through the worst of market conditions. "We decided to expand the number of partners in the securitisation team even in the midst of the financial crisis," says Mr Nathoo. "Our medium- to long-term view was, and remains, that collateralised funding will always be an important component of the market. If anything, the response of the central banks and regulators to the crisis has borne this out."

London-based securitisation specialists Sally Onions and Tim Conduit became partners in 2009. More recently, Hooman Sabeti was promoted to partner in Singapore and a big hitter, Ed De Sear, joined the New York office as partner. A former head of structured finance at Orrick, Herrington & Sutcliffe, Mr De Sear created and structured many of the earliest asset-backed securities (ABS) deals. Back in London, the firm has recruited a US ABS specialist, Hank Michael, as counsel.

This year has done little to undermine the team's faith in recovery. It advised on a £2.47bn issue from Lloyds' Permanent in February, followed by a £1.4bn deal from Santander's Fosse in March. The latter helped foster the impression that things were returning to normal, by being the first post-crisis transaction to dispense with a maturity purchase guarantee.

US demand

US appetite for the UK product has been an important factor in the return of confidence. All things being equal, UK mortgages are of better quality than those in the US, with lower default rates, no history of fraud and issuers retaining exposure or 'skin in the game'. "Confidence has been gathering momentum," says Mr Nathoo. "This autumn saw banks coming back to the market because they believed the things they saw in the spring were repeatable. At recent ABS conferences, well attended by UK banks and building societies, investors have been asking when they would bring out more issues - and most of those investors have been from the US."

That fed in to Nationwide's decision to get the US market in its sights. "We want to extend our franchise to a wider investor base," says Mark Hedges, Nationwide's head of structured products. "A big slice of the traditional investor base is in the US, which makes it an appropriate place to target."

Legal input is always core to a securitisation offering, but even more so with a Rule 144A issue into the US. "One key difference lies in what is in the offering document," says Mr Michael. "In Europe, the issuer decides what is material. In the US, the lawyers make the decision - it's their call. Lawyers can disagree, and that can be an extra source of tension."

With the US in the throes of major regulatory reform, actual and pending, the team had to work against a backdrop of some uncertainty coupled with concerns over investor litigation. One new regulation already in force is the Securities and Exchange Commission's new Rule 17g-5, which requires structured product issuers to set up a website carrying all the issue information, so that non-hired rating agencies can give unsolicited ratings. Nationwide was one of the first issuers to comply, though non-hired agencies have not been falling over themselves to do unpaid work.

The AAA rated issue - Silverstone 2010-1 - was launched in late October, with an anticipated size of £1.5bn, though Mr Hedges says £1bn would have been adequate. It was divided into three floating rate tranches - two US dollar slices with a three-year and a five-year bullet, and a five-year euro slice. The euro was offered only in five years because the issuer did not want to tempt dollar investors, who tend to look to the shorter term, to migrate to a three-year euro. The coupon, of necessity, was 15bps to 20bps over prevailing secondary market spreads, at 140bps over Libor for the dollar three-year and 150bps over Libor/Euribor for the five-year tranches.

Although it began with relatively modest expectations, Nationwide was very pleased with the response, which allowed it to raise its hoped-for £1.5bn. US investors took 84% of the dollar tranches. "Silverstone will become a feature of Nationwide funding," Mr Hedges says. "We will probably use it at least once a year to complement our covered bond and unsecured programmes."

The market may be picking up, but it has a long way to go to full recovery. Mr Michael notes that now is a good time to revisit RMBS documentation. "The high-yield bond market is basically a US market, so everyone does things the New York way," he says. "But this market is so well-established here that there is also a London way of doing it. In a few years, as standards continue to evolve, the market will settle for one or the other, but that process is still happening.

"Before the crunch, issuance programmes were well-oiled machines, with a few issues every month, and no one felt the need to reflect on elements of the documentation. But now we're back to bicycles and have more time to consider why we take this or that position. Is this particular way still right? Now that we have been able to reflect on it, perhaps we will want to do some things differently."

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