The End Of The World As We Know It?

After almost ten years, the Bank Of England is finally calling time on its measures to support market liquidity. These began in April 2008 at the height of the credit crisis with the Special Liquidity Scheme (SLS), being replaced by the Funding For Lending Scheme (FLS) and ultimately the Term Funding Scheme (TFS). Combined with a prolonged period of ultra low interest rates, the schemes succeeded in stabilising the markets and restoring a significant degree of stability to the markets.

Whilst the schemes provided stigma free cheap funding to all, it could be argued that the secondary effects were at least as important. The cheap funding meant building societies and the smaller banks no longer had to pay up for retail funding, resulting in best buy rates plummeting from north of 3% to below 1%. This in turn dragged down mortgage rates, albeit to a lesser extent, resulting in higher net interest margins and a strengthening of capital ratios. Inevitably, the impact of cheap funding filtered through into the wholesale markets with the costs of securitisation, covered bonds and senior unsecured funding all reaching post crisis lows and a similar story in Europe as a consequence of the ECB’s actions.

So what happens next? While SLS and TFS have both been substantially repaid, over £75bn of FLS remained outstanding from the 51 financial institutions that used the scheme as at 30 June 2017. This is expected to rise significantly by the time the drawdown window closes on 28 February 2018. Post this is when it gets interesting. Most building societies and the smaller, challenger or newly formed banks have little or no access to the wholesale markets, denied by a lack of credit ratings and or assets to use as collateral. The Bank of England has made it clear, there is no successor to FLS planned. So in many cases they will be forced back to a retail market rising in cost as a result of lack of supply and quite probably steadily rising base rates.

Or will they? The much maligned option of securitisation is potentially open to all on both a public trade and private placement basis. It requires no underlying ratings and is currently in robust shape with the large asset sales of recent times largely concluded. Current pricing is significantly inside retail funding and combined with low over-collateralisation levels, it offers a genuine alternative.