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The end of FLS: what does it mean for mortgage funding?


Published: 22 January 2014 | Author: Bernard Clarke

In this article, CML mortgage funding specialist Jon Saunders assesses the future prospects for mortgage funding markets, and addresses a fundamental question: what does the withdrawal of Funding for Lending mean for the UK mortgage market?


  • Following their collapse in the financial crisis, wholesale markets have been transformed since 2012. They are now functioning well – and making a positive contribution to mortgage funding.
  • At the same time, lenders are continuing to see very strong inflows of retail deposits. That is supporting a healthy balance of options for lenders in mortgage funding markets.
  • Strong retail flows mean that lenders do not have to rely too heavily on wholesale markets. That is easing pressures on these markets – even though they have recovered and are now working well.
  • Favourable conditions in both wholesale and retail markets mean that lenders are well placed to weather the withdrawal of the Bank of England’s funding for lending scheme. We do not foresee any disruption to funding for mortgages – even though we expect to strong growth in lending this year.

In an interview with the Financial Times at the end of last year, the Bank of England's head of financial stability Andy Haldane argued that securitisation need not be the "bogeyman" it was during the financial crash. It could instead be the "financing vehicle for all seasons".

While Andy Haldane was perhaps focusing primarily on the ability of securitisation to provide alternative sources of funding for small and medium-sized enterprises (SMEs), his views reflect a transformation in perceptions of wholesale funding markets over the last few years. Many will remember that, in the aftermath of the financial crisis, most commentators laid at least some of the blame squarely at the door of the residential mortgage-backed securitisation (RMBS) market, which was affected by a collapse in the confidence of investors concerned about re-packaged US sub-prime mortgages.

But, as we enter 2014, this market has been transformed. It is functioning well and making a positive contribution. So, while lenders will no longer have access to the Bank of England’s funding for lending scheme (FLS) to finance growth in their mortgage books, the cost of borrowing in the wholesale markets remains very competitive, and there is considerable demand from investors for issuance by UK banks and building societies.

The recovering securitisation market

It comes as no surprise that in the first weeks of this year we have seen a number of firms take advantage of favourable market conditions to issue both covered bonds and senior unsecured debt in a variety of currencies and maturities. We also expect issuers to use the RMBS market in the first quarter of this year. 

Obviously this increased supply may put some upward pressure on the cost of borrowing in order to tempt more investors into the market. But most commentators seem to believe that there is a sufficient overhang of demand from investors for an increase in supply to be absorbed without any significant adverse affect on the cost of borrowing. 

At the same time, lenders are continuing to see very strong flows of retail deposits. These are bolstering balance sheets and therefore easing pressures on lenders to access the wholesale funding markets too often. That is helping to maintain a healthy balance in wholesale markets between demand from investors and the supply created by issuance from lenders.

Withdrawal of the FLS

Current conditions in wholesale and retail markets mean that lenders are well placed to weather the withdrawal of the FLS without disruption to funding markets, supporting our expectation of robust growth of mortgage lending during 2014. 

But while there are good reasons for lenders to be broadly sanguine over prospects for funding, there is increasing comment about house prices and mortgages. While the Bank of England said in its recent Financial Stability Report that there was no housing price bubble, it remained concerned about the prospects for further "substantial and rapid increases in house prices and a further build-up in household indebtedness." 

The Bank has already tried to slow the momentum of the housing market with its use of forward guidance. Last year, the Bank’s financial policy committee (FPC) also recommended that firms should raise additional capital and that harsher stress-testing should be applied to lenders in 2014. 

Additionally, the Bank has said that the Financial Conduct Authority (FCA) should require mortgage lenders to act upon any future recommendations from the FPC on appropriate interest rate stress-testing when assessing affordability for individual customers. These regulatory changes – representing a "touch on the brakes" to slow the housing market – must also be seen in the context of the FCA’s mortgage market review (MMR), which will require more rigorous assessment of affordability as part of a series of fundamental changes to mortgage lending coming into effect in April. 

A lingering stigma – but should it apply to all securitisation?

In the run-up to the financial crisis, RMBS partly fuelled growth in the balance sheets of a number of banks, including Northern Rock. Politicians muttered gravely about the consequence of off-balance sheet financing and the use of offshore vehicles like Granite (the securitisation vehicle for Northern Rock). Indeed, Andy Haldane recently referred to the "lingering stigma" suffered by the securitisation markets.

In the aftermath of the crash, investors were wary of securitisation in general. But it is important to differentiate between the securitisation of different types of assets. The risk profile of an RMBS transaction is, for example, significantly lower than most of those backed by credit cards, car loans or even corporate loans. 

Although we must acknowledge that securitisations, and RMBS, were seen as risky assets, RMBS that packaged together UK mortgages have been particularly robust. While the ratings of some transactions have been downgraded (with ratings agencies taking the view that the possibility of default has increased), the fact is that no UK prime RMBS has defaulted over this period. 

Nonetheless, issuance in wholesale markets in general and, in particular, securitisation shrivelled in the aftermath of the financial crisis as investors were understandably nervous. At the same time, banks were shrinking their balance sheets by selling off non-core assets and not advancing loans, so that their need for funding diminished.  

The FLS – filling the gap

As the mortgage market stabilised and slowly began to recover, concern began to grow over the cost of funding and the ability of financial institutions to secure the amount and term of debt required. This was part of the reason behind the creation by the Bank of the FLS in July 2012. In simple terms, the FLS provided lenders with an alternative to the wholesale securitisation market. Rather than bundling and packaging assets – in this case, residential mortgages – into a security to be sold in the wholesale markets, those assets could be placed with the Bank in return for funding.

At a period when the wholesale market was reluctant to invest in RMBS – or, at least, would only do so at a prohibitively high cost (see Chart Two) – the FLS provided lenders with a low-cost source of funding, and particularly longer-dated funding. This was a very useful option for lenders, in particular those who, because of their size and therefore, to a certain extent, their credit rating, were excluded from the wholesale markets. 

It should be noted, however, that lenders were also changing the way they were funding mortgages. Before the crisis, there was a greater reliance on the wholesale markets, in the form of senior unsecured debt, covered bonds or securitisations. Afterwards, financial institutions chose to increase the use of retail funding.

The turning point

Looking back, the year 2012 was clearly a turning point in funding markets. At the beginning of that year, there were still considerable doubts in the market over the immediate future direction of the UK and European economies. In the UK, there was talk of a triple dip recession and, in Europe, there were still major concerns over the strength of key financial institutions. In fact, one of the rationales for the introduction of the FLS was the fear that there might be another liquidity crisis, with the Bank scheme seen as a way of providing lenders with long-term liquidity support in the event of funding markets drying up.

By the end of 2012, however, the economic outlook had changed, and the market’s view of the prospects for significant financial disruption had diminished.  With the Bank providing liquidity through the FLS, and the European Central Bank also offering support, lenders had access to liquidity from a variety of non-traditional sources (central banks) to replace the ones they had traditionally used (wholesale funding markets).

This, in turn, created a positive spiral. Investors, confident that lenders had access to sufficient liquidity from central banks if necessary, were more prepared to invest. At the same time, because lenders had access to liquidity, and needed less funding anyway because they were shrinking their balance sheets, there was less of a need to rely on wholesale funding markets. Demand from investors outstripped supply, and, consequently, credit spreads – or the cost of borrowing – for financial institutions declined (see Chart Two).

Chart One: Value of UK covered bond and RMBS issuance, £ million

News & Views 1-Covered bond and RMBS Issuance
 Source: Citigroup Global Markets

Chart Two: UK RMBS credit spreads, basis points (see paragraph above)

News & Views 1-Credit Spreads for UK RMBS
 Source: Citigroup Global Markets

Fast forward to the end of 2013, and these positive conditions have been amplified. In the last year, investors have become increasingly confident about the prospects for the UK economy and the relative strength of domestic lenders over their European competitors. Credit spreads for UK financial institutions continued to tighten and, as 2013 progressed, eventually edged down towards the levels we last saw before the crisis.

Across wholesale markets, there has been a pick-up in investor demand. In the RMBS market, there has even been issuance comprising some non-prime mortgages – something we have not seen for a number of years. But while there has been a slight pick-up in issuance levels over the year, other factors have reduced the need for lenders to issue debt in the wholesale markets. And, of course, the access of lenders to the FLS has taken some funding out of the wholesale market.

Some banks have also been continuing to re-structure their balance sheets, and so have had less need for funding. At the same time, lenders generally have seen strong inflows of retail deposits and, by and large, have not needed to increase deposit rates to attract funds. So, lenders have been able to continue the switch in funding profile that we have seen in recent years – increasing retail over wholesale funding, and at an attractive cost.  


Confidence in the housing market has accelerated considerably since last spring, partially supported by government initiatives like Help to Buy. This has coincided with a period of sustained and continued strength in wholesale funding markets, culminating in the the Bank effectively closing the FLS to mortgage lending.

We do not believe that the withdrawal of the FLS represents a threat to an adequately-funded mortgage market. Wholesale funding is now much more robust than it was in the years 2008-12, supported by an increasing risk appetite from investors, particularly from those "hunting for yield" in a low interest rate environment. Alongside more buoyant wholesale markets, we continue to have a very strong market for retail deposits. 

So, despite the strong growth in lending that we are anticipating this year, we expect robust retail and recovering wholesale markets to deliver an adequate and sustainable supply of funding. Significantly, however, this is also underpinned by the lessons learned from the financial crisis, which mean that the Bank and other authorities are now much better prepared to intervene decisively and shore up markets in future, if necessary.