The reduction of the quantitative easing measures coupled with a tightening Base Rate are expected to positively impact the activity within different areas of the credit markets.
Ten years after the 2008 financial crisis, central bankers across the globe are still targeting normalisation of their monetary policies. An example of this is the closure of the Term Funding Scheme (TFS) in the United Kingdom as at 28 February 2018. The scheme was originally introduced in September 2016 as one of the Bank of England’s (BoE) quantitative easing (QE) measures in a response to the expected adverse impact of Brexit on the markets’ liquidity. Under this initiative, eligible institutions were able to borrow at margins near to the Base Rate.
In response to positive readings of the macro-economic indicators, towards the end of last year the Monetary Policy Committee (MPC) has also started implementing an ongoing ‘tightening’ programme for its monetary policy. Market participants are expecting this trajectory to continue, with the MPC to vote for further rate increases which, according to February committee minutes, will be likely to be of a gradual and limited magnitude. These expectations have been reflected in the current upwards trend observed in the short-term rates.
The reduction of the QE measures coupled with a tightening Base Rate are expected to positively impact the activity within different areas of the credit markets. Using the TFS, institutions across the UK have drawn down an accumulated amount equal to circa £130 billion at very advantageous terms. The end of the scheme is expected to force lenders to find alternative funding sources in a rising rate environment.
First signs of the trend can already be observed in the asset backed securities (ABS) market, where the issuance volume in Q1 2018 has been over 40% higher than during the same period last year. In particular, the UK Residential Mortgage Backed Securities (RMBS) market seems to have picked up in activity during the same period, issuing almost €5.6 billion (£4.9 billion) of notes, showing a quarter-on-quarter growth of over 150%. This additional supply coupled with the end of low-for-long rate environment is expected to result in coupon rates widening.
Also, an increase in borrowing costs is expected to affect prime credit demand. In an attempt to counteract the potential softening of the origination momentum, institutions may start looking at relaxing their underwriting criteria. In addition, an increase in base rate is expected to reduce prepayment rates and therefore limiting the institutions ability to reprice the assets. This constraint coupled with an increase in cost of funding and higher credit premium will result in additional pressure on portfolio profitability.
In anticipation of the above aforementioned scenarios, it is likely that a number of financial institutions will look to analyse potential disposal options for their stock portfolios to ease said pressures.