Banks eye £90bn in mortgage asset swaps

The UK’s biggest banks are preparing to swap £80bn-£90bn of mortgage-backed assets for Treasury bills with the Bank of England – nearly twice as much as the central bank originally envisaged when it unveiled its scheme to unblock the frozen bank-lending market.

According to debt market sources, the banks have approached credit rating agencies about how to structure deals that will receive the triple A rating required for securities that lenders want to swap for Treasury bills that can then be used to raise cash. The move comes amid signs that lending in the interbank market is becoming particularly tight for banks that cannot post collateral to ensure their debt will be repaid.

When it set up the special liquidity scheme three weeks ago, the Bank set the level of funds available at £50bn after discussions with banks about the extent to which they are having difficulty raising cash for unsecured borrowing. However, it hinted it could increase that amount if needed.

It is not yet clear whether lenders intend to swap all their securitised mortgages for bills. But bond market participants believe that banks are looking to repackage £80bn-£90bn of mortgages into securities which will be eligible to swap under the Bank’s scheme.

The ratings agencies – Standard & Poor’s, Moody’s and Fitch – have declined to comment, saying that they do not disclose deals until they are finalised. But in recent weeks, HBOS has received triple A credit ratings for most of a £9.04bn deal while Alliance & Leicester has received similar ratings for most of a £10.37bn securitisation.

The Bank unveiled the liquidity scheme in April after it became apparent that banks were too nervous about each other’s financial position to lend cash without collateral. That has driven the interest rate for unsecured bank borrowing, known as Libor, up nearly a full percentage point above the Bank’s current 5 per cent rate. However, those with top-quality collateral can borrow much more cheaply.

There has been speculation that lenders would be reluctant to use the Bank’s liquidity facility because it has high fees attached and because of concerns that users will be marked as those who cannot borrow elsewhere. But the Bank has been encouraging all lenders to use its facility so that no one lender is singled out.

Separately, the European Central Bank on Thursday voiced its “high concern” at growing evidence that banks are exploiting its efforts to unblock the frozen funding markets by using its liquidity scheme to offload more risky assets than it envisaged.

Yves Mersch, a governing council member, said the ECB was now “looking very hard at whether there is not a specific deterioration of collateral” that the central bank is accepting in return for funds.

He was speaking amid signs of some banks creating low-rated assets specifically so they can be traded for Treasuries at the ECB.

However, this week, Glitnir, the Icelandic bank, is in the process of clearing the use of a €890m (£706m) collateralised loan obligation (CLO) for funding at the ECB. Similarly, Lehman Brothers recently structured a €1.1bn CLO, which it is expected to use for ECB funding.