Investec's brave move to launch a sterling bond transaction backed by subprime mortgages, a market that had been closed since 2007, appears to have paid off. Writer Joanne Hart
Ever since Lehman Brothers collapsed and brought the global financial markets to their knees, the phrase 'subprime' has unsettled regulators, policy-makers, investors and even certain bankers.
So South African banking group Investec's decision to launch a sterling bond transaction backed by non-conforming (or subprime) mortgages was distinctly courageous. The deal was the first to be launched in the UK since 2007 when Lehman, of all banks, brought a £730m ($1.17bn) transaction to market.
But times have changed considerably in the intervening years. The pricing environment is very different and the investor base is very different too.
"Back in early 2007, the typical spread over Libor would have been about 20 basis points for an AAA tranche. We paid 325 basis points. Back then, the investor base was far larger, including money market funds and structured investment vehicles. Today, the investor base has shrunk but it is predominantly [made up of] real money accounts - an investor base we want to continue to develop," says Derek Lloyd, head of banking at Investec's financial markets group.
The waiting game
Investec became closely involved with the securitised mortgage market in 2007, when it rescued troubled subprime lender Kensington Group. Just a few months later, Northern Rock collapsed in the UK and securitisation fell out of favour.
"The market was closed for a long time, but as securitisation is a very important funding route for us, we wanted to test it and see if we could reopen it. Someone had to be first," says Mr Lloyd.
Investec was particularly keen to complete a successful transaction because Kensington has started to issue mortgages again, which the South African bank hopes to securitise in the future.
"We wanted to work with investors, get them comfortable, get the deal done and build relationships. We see this as an iterative process as we hope to tap the market again," says Mr Lloyd.
Investec first considered a securitisation deal in 2009. But discussions with investors only began this summer and the process, described as 'consultative', took many months.
Ultimately, Investec launched a multi-tranche deal, comprising £128m of AAA rated notes and £55m of more lowly rated notes, ranging from AAA to BB-. There is also a £12m equity tranche, which includes £7m of reserve funding, designed to provide extra comfort for investors. The notes are all backed by non-conforming mortgages, but Investec chose to sell only the first £128m tranche.
"We have kept the rest on our own books but we are in discussions with investors about the equity piece. Pre-crisis, you would have sold everything from AAA to BB and the deal would have been done much more quickly. But we are in a buyers' market now and we needed to understand investor concerns," says Mr Lloyd.
Cut-price portfolios
The notes are securitised against UK mortgages from Kensington Group, Bank of America and the former financing unit of General Motors, GMAC RFC. In each case, Investec acquired portfolios of mortgages at a substantial discount to their face value. The Kensington portfolio was sold by Investec in 2007 and bought back last year; the other portfolios were acquired earlier this year.
"The key point about this deal is that the majority of the mortgages were originated in 2007 so, while non-conforming at origination, they are seasoned loans and performing well. The borrowers have demonstrated good payment and this was tremendously important to investors," says Mr Lloyd.
The final maturity date on the deal is 2050 but it can be called before then, the first call date being 2018.
"Investors were concerned about extension risk, in other words, how quickly their notes would be repaid, driven by the redemptions of the underlying mortgages. We purchased a gilt strip maturing in 2018 and we will make a one-off, £2.2m payment to A1 investors then, if the deal is not called," says Mr Lloyd.
"We were very pleased to be the first out there. We were delighted with the quality of the order book. It was a long process but will stand us in good stead. We now feel up to date with the latest thinking and the latest technology, as far as the rating agencies and investors are concerned."
Looking ahead, Investec is hoping to return to the securitisation market next year, perhaps even in the first quarter. Kensington has been originating new loans since the beginning of this year so supply is growing. This time though, the firm is focusing on prime borrowers.
