UK guarantees AAA RMBS in bid to jump-start lending

The UK government has launched a scheme to guarantee up to £50 billion in residential mortgage-backed securities (RMBS) for the first time, finance minister Alistair Darling said yesterday.

Presenting the annual Budget in the House of Commons, Darling announced the launch of the ABS Guarantee Scheme, which was first outlined on January 19 as a means to "improve banks' access to wholesale funding markets, help support lending, and promote robust and sustainable markets".

Despite assurances in the January announcement that the scheme would "provide full or partial guarantees to be attached to eligible AAA rated asset-backed securities, including mortgages and corporate and consumer debt", the outline of the programme released yesterday by the UK Debt Management Office included only RMBS as eligible assets.

The scheme will provide two types of guarantees on RMBS portfolios. The first is an "unconditional and irrevocable" credit guarantee provided by the Treasury, that RMBS holders will receive timely payment of all amounts contractually due from the security issuer.

The second is a liquidity guarantee, which will allow an RMBS holder to exercise a put option to sell the security back to the issuer at par, while issuers will also be able to call in securities from investors after a certain due date.

In its role as guarantor, should the RMBS issuer fail to pay the security holder the relevant price on the due date, the government will purchase the assets from the holder, at the principal amount outstanding, adjusted to include any accrued but unpaid interest but reduced to take into account any losses that might have been incurred on the underlying mortgages.

Any AAA rated RMBS issued in the six months from April 22, containing underlying mortgages made no earlier than January 1, 2008, can apply for the benefit of either the credit guarantee or the liquidity guarantee, but not both. Two-thirds of the guarantees have a maximum term of three years, but up to one-third are applicable for a five-year term.

The Treasury will charge a fee of 25 basis points plus 100% of the participating institution's median five-year credit default swap spread between July 2, 2007 and July 1, 2008 for providing RMBS purchasers with the guarantees.

The scheme was welcomed by Rick Watson, the managing director of the Securities Industry and Financial Markets Association, as a "comprehensive set of initiatives which decisively addresses a variety of important market concerns and is an important additional step in helping to restore investor confidence".

Analysts at Fitch Ratings observed that, while the guarantees might provide additional comfort for investors from a credit and liquidity perspective, "the degree to which the scheme will spark new lending by improving funding conditions is uncertain, as other schemes - such as the credit guarantee scheme - offered by the UK government might result in competing funding options for eligible financial institutions".

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