Specialist lenders continue to drive growth in UK RMBS

Specialist lenders in the UK are making good on their promises to serve the underserved while ramping up RMBS issuance – and are showing no signs of slowing down. Following the GFC, the speciality lending sector (SLS) redefined its approach to lending and – between the first transaction in 2016 and 2023 – the share of UK RMBS issuance accounted for by SLS RMBS surged from just 6% to 37%. 

“The sector has really proven itself, both in terms of the volume of originations and performance,” states Kali Sirugudi, md at KBRA Europe.

A recent report from KBRA highlights the swift rise in SLS RMBS issuance in the UK. Specialist lending itself has grown from £18.2bn to £20.5bn in the last decade, demonstrating the sector’s resilience and persistence through challenging times. The pandemic, rising interest rates and cost-of-living pressures have all tested the market, but SLS has remained robust – underpinned by RMBS.

“Securitisation is a key source of funding in this sector, and post-covid volumes ticked the box in terms of proving its lending capabilities,” says Sirugudi.

Despite this growth, current market data shows some potential reduction in the SLS RMBS market share for this year, as the pace of new lending has slowed. As borrower affordability issues mount and prime lenders recover,  KBRA anticipates a slight decrease in market share for 2023-2024 as a result of stresses on originations. However, issuance volumes are expected to be bolstered by refinancings – as long as spreads remain attractive. 

These niche lenders have demonstrated keen abilities to meet the demands of the ever-changing market through constant innovation. Later-life lending is a significant area of focus for these specialist lenders, and has gained much traction as the age of borrowers in the UK continues to rise.

SLS lenders have evolved to meet the needs of the market given such demographic shifts and financial challenges by developing new products, which can meet the needs of underserved borrowers – such as with interest-only retirement mortgages.

“Specialist lending has developed into a position where these lenders are originating loans from across the credit spectrum,” explains Sirugudi. “That includes prime loans where their performance is now comparable to that of the banks and the building societies.”

He continues: “And they’re also active on the other end of the spectrum too, where the risks are higher, and they mitigate these higher risks of defaults and losses with lower LTVs and robust servicing capabilities.”

More growth is still to come for the sector too, according to KBRA. There remains significant scope for more issuance to be seen yet in the later-life, second-lien loan, and bridging finance sections of the market.

“As interest rates come down, you can expect that borrowers in the later stages of life – around 55-60 plus – are motivated to lower interest rates on their current mortgages,” Sirugudi says. “Just as we saw with the first issuance from LiveMore, the interest-only retirement product is pretty attractive to UK mortgage prisoners. So that volume is likely to continue to grow.”

At a different end of the spectrum, second-lien loans have also seen some growth. While these loans carry greater risks, specialist lenders mitigate said risks through lower LTV ratios and strong early-arrears management.

“Second lien lending – I certainly expect to see that grow, given the high costs of living and high interest rates,” comments Sirugudi. “These loans bear higher interest rates,  which incentivise borrowers to pay down the loan as quickly as possible.”

Furthermore, activity in the bridging finance space could also grow, despite no UK issuance seen thus far backed by these loans.

“There are some issues originators are working on with banks and others to understand the risks in those types of issuances,” Sirugudi notes. “In that sector, if there’s an issuance that stands the test of the rating agencies [and] regulation – and the investors are accepting of that type of asset – that would push more and grow issuance in that area.”

This particular corner of speciality lending, by its very design, means working with borrowers who the banks and building societies are less likely to serve.

“The underserved segment by nature means that these speciality lenders are taking a share of the lending potential from the banks and building societies,” states Sirugudi. “Although these banks aren’t looking at the finer details on the borrower, it doesn’t mean such a lender shouldn’t take the risk at all.”

Specialist lenders have also shown resilience in managing delinquencies. Delinquencies in the SLS sector have remained low – ranging from near-zero to 2.8% – given the challenges of the broader economic environment. Repossession levels have also remained low and major losses have been avoided through proactive approaches seen across the SLS, strong loan performance bolstered by low LTV originations, and robust servicing. 

“The bottom line is that specialist lenders have created a niche for themselves lending to the underserved segment, which exists because banks and building societies aren’t able to due to their reliance on automated decision models and inability to offer riskier mortgage products,” comments Sirugudi. “The SLS sector relies more on manual underwriting, which provides the best possible insight to the under-served segment. This style of lending can look to mitigate risks that the banks and building societies simply cannot take on.”

Specialist lenders will continue to work to meet the demand from such borrowers. While banks and building societies are unlikely to ever touch these types of products, according to Sirugudi, the dawn of AI in the structured credit space – specifically in underwriting – means it may be too soon to tell for sure.

As the market continues to evolve, the ability to innovate and adapt to changes will become more critical for lenders. As specialist lenders continue to serve this decreasingly niche corner and leverage securitisation for funding, they are likely to remain an integral part of the UK RMBS landscape.

Claudia Lewis