JUICY yields and British home owners’ reliability when it comes to mortgage repayments have pushed returns for home loan-backed notes to the highest since the financial crisis.

Prime residential mortgage-backed securities in the UK delivered over 6 per cent last year, the most since 2009, according to data compiled by Bloomberg, even as the cost of borrowing rose sharply. Issuers sold notes worth the equivalent of 9 billion euros (S$13.1 billion) in 2023, more than double the previous year and the highest since 2019, according to Barclays data.

Demand isn’t letting up either, with lenders such as Lloyds Banking Group and Virgin Money UK issuing more than £2 billion (S$3.4 billion) so far in January as investors race to lock in yields in anticipation of the Bank of England easing monetary policy.

The strong appetite is good news for British banks, which are battling to secure deposits for the funding of loans. It is also easing a funding crunch ahead of a 2025-deadline to repay the BOE what S&P Global Ratings estimates are £150 billion for cheap loans that were handed out during the pandemic.

The high returns from mortgage-backed securities demonstrate the resilience of prime home loan owners in the UK at a time when borrowing costs are at their most painful, with delinquencies of less than 1.3 per cent, according to S&P Global.

“The main story here is the strength of the British mortgage consumer and how that’s feeding through to the performance of the RMBS notes,” said Ellie Aylen, an analyst for asset-backed securities at TwentyFour Asset Management. “Your mortgage is the last thing that you stop paying even when times are tough.”

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The outlook for this year bodes well too.

House prices have so far defied predictions of a slump, which economists at the start of 2023 anticipated would reach as much as 10 per cent in an era of higher rates, capping risk for the value of the underlying assets.

In addition, rates are expected to remain elevated even if the Bank of England starts to ease policy, with traders betting on three cuts of 25 basis points by the end of the year, compared with increases of more than 500 basis points since the tightening cycle started in 2021.

On the downside, a potential economic downturn and increase in joblessness could weigh on the ability of mortgage holders to pay their instalments, while some homeowners who took out loans in the low-rate era face expensive refinancing.

“We should see more mortgage resets this year and arrears and repossessions should increase,” said Altynay Davletova, an analyst for mortgage-backed securities at Bank of America.

Unemployment will likely increase slightly by 1 per cent over the period for 2024 to 2025, with historical data suggesting a 0.1 percentage point pickup in repossessions for every percentage point’s hike in joblessness, Davletova said.

“Prime arrears will rise but not in a way we class as significant,” said Alastair Bigley, a structured finance analyst at S&P Global, who expects defaults for prime owner-occupied loans to remain within 2 per cent this year. “Investors are realistic, they expect credit deterioration but they understand like us that the underwriting process for collateral in recent years is significantly better than it was in the past.”

Covered bonds

Last year, British banks sold £20.7 billion’s worth of covered bonds, which is secured by assets, to help push their total debt issuance to a record £75.9 billion, according to data compiled by Bloomberg.

The sale of asset-backed securities is relatively inexpensive compared to senior unsecured debt, while it removes the underlying loans off the balance sheet.

“Even if 5 per cent of that total gets refinanced via residential mortgage-backed securities, that’s a big shot in the arm for the market,” S&P’s Bigley said. BLOOMBERG