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An end of Term (Funding Scheme) Party?

18 August 2017 by Rob Ford

At this time of year, whilst markets are quiet, we have a chance to take a look back at some of the slightly less prominent, but no less important, news stories over the last few weeks.

Whilst a party might be a slight exaggeration, there is no doubt that most participants in the UK RMBS and ABS markets are at least quietly celebrating that the BoE confirmed that its Term Funding Scheme (TFS) will come to an end, on schedule, at the end of February next year.

By way of recap, the TFS was introduced alongside the 25bps base rate cut last August in order to encourage banks to pass-on that rate cut, by providing term funding to the banks at rates close to the base rate.

The good news for the BoE is that it has worked – in fact it’s more than worked!

Mortgage rates are now at pretty much all-time lows; the average cost of a fixed rate mortgage has in fact fallen by 34bps in the last year according to the Council of Mortgage Lenders, and the average rate is down by 32bps. Furthermore, the banks have embraced the scheme, utilising £78bn so far according to the BoE, who expect the scheme could grow to up to £115bn by the time it finishes. They did have the option to extend the scheme but have chosen to close it as originally scheduled, which indicates they think it has done its job.

There has however, been a reverse knock-on effect for the capital markets.  With all that cheap funding available, banks have been borrowing less from the bond markets and therefore issuance of senior unsecured debt, covered bonds and in particular RMBS has fallen. Outstandings of UK Bank and Building Society RMBS have fallen by about 70% since the beginning of 20161, as issuers have allowed existing deals to run off and most likely replaced them with TFS funding instead.

There is thankfully, every expectation that once the TFS ends, issuance patterns will gradually return to normal levels, but this is likely to take a while because the TFS has provided the banks with 4 year funding so there will be no hurry to replace it. However, it is worth remembering that prior to TFS banks also had the BoE’s previous programme, the Funding for Lending Scheme (FLS) which began in 2012, so the loans from that will be coming up to maturity sooner and will of course need financing.

We’ve commented on the current technical factors that are driving the supply and demand imbalance in the ABS markets on numerous occasions over recent years, and this is just one of those factors alongside other direct QE such as the ECB’s ABS Purchase Programme and TLTROs as well as the central banks’ discount window repo facilities. Whilst we are far from the end of the road, the confirmation that the TFS has done its job and is coming to an end is at least a sigh of welcome relief for the RMBS market in that more regular issuance may gradually return, giving investors a renewed opportunity to gain exposure to one of the safest, and best performing asset classes in fixed income.

Furthermore, whilst many parts of the fixed income market are living in fear of the beginning of tapering in Europe, the ABS market would probably be quite keen for the ABS Purchase Programme to go as well – start planning the party!

1 Source: Bloomberg

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