Contents:

CHAPTER 1 EXECUTIVE SUMMARY 3 Introduction 3 Overview and Historical Background 3 The UK RMBS Market in 2004 6 Objectives of RM Securitisation 8 Alternative Methods of Funding 10 Outlook for the UK RMBS Market in the Future 12 CHAPTER 2 INTRODUCTION 24 What is this report about? 24 Who is the target reader? 24 How to use this report 24 CHAPTER 3 OVERVIEW AND HISTORICAL BACKGROUND 26 Introduction 26 What is mortgage securitisation? 26 The process of mortgage securitisation explained 27 Securitisation can bring a number of advantages to all parties concerned 30 But there are also some drawbacks 31 The birth of phenomenon – the RMBS market in the USA 33 A number of factors have combined to create a favorable climate for securitisation in the USA 35 Securitisation in Europe – a brief overview 36 Booming house markets are partly to blame for the growing popularity of securitisation in Europe 38 Brief overviews of the selected European RMBS markets 38 The development of the RMBS market in the UK 41 The historical background to the UK market 41 CHAPTER 4 THE UK RMBS MARKET IN 2004 43 Introduction 43 Statistics for the UK RMBS market 43 Macroeconomic drivers of the UK RMBS market 44 House prices have been a strong driver behind the growth of the RMBS market 45 The UK mortgage market has flourished in the environment of low base rates 46 Investor demand for mortgage-backed securities has been strong 48 Microeconomic drivers of the UK RMBS market 49 The development of the non-standard mortgage sector has made securitisation a common funding method 49 Stagnating retail deposits and increasing competition in the mortgage market caused providers to look elsewhere for funding options 50 In the current Basel 1 environment providers have many incentives to securitise 51 CHAPTER 5 OBJECTIVES OF RM SECURITISATION 52 Introduction 52 Securitisation as the main method of funding 52 Overview 52 Competitors 53 Costs and issues 54 Securitisation as a method of funding diversification 57 Overview 57 Competitors 57 Costs and issues 58 Securitisation as a method of risk transfer 59 Overview 59 Competitors 60 Costs and issues 62 Securitisation as a method of balance sheet management 63 Overview 63 Competitors 63 Costs and issues 65 CHAPTER 6 ALTERNATIVE METHODS OF FUNDING 66 Introduction 66 Whole loan sales 66 Overview 66 Competitors 67 WLS vs securitisation 67 What do lenders think about WLS? 68 Covered mortgage bonds 69 Overview 69 Competitors 70 Covered bonds vs securitisation 71 CHAPTER 7 OUTLOOK FOR THE UK RMBS MARKET IN THE FUTURE 73 Introduction 73 Regulatory initiatives such as Basel ll will have a considerable impact on the UK RMSB market 73 Basel ll standards will link capital adequacy requirements for banks more directly to risk 73 Consolidation and fragmentation of provision are two mortgage sector trends which are likely to affect the RMBS market in the future 77 Consolidation in the non-conforming sector can affect lenders’ securitisation strategies 77 Fragmentation of mortgage provision 81 Macroeconomic factors and the state of the mortgage market will be an important determinant of how the RMBS market will perform in the future 83 What is going to happen to UK house prices? 83 What impact will the environment of rising base rates have on the affordability of mortgage debt and house prices? 85 Forecasts for the mortgage market reflect the current level of uncertainty 87 Conclusion 89 CHAPTER 8 APPENDIX 90 Supplementary data tables 90 Further Information 92 Definitions 92 Useful links 96 The retail banking team 99 LIST OF TABLES Table 1: European RMBS issuance comparison, 2003-2004 37 Table 2: Securitisation accounted for 10.6 per cent of total mortgage loans outstanding, Q3 2004 43 Table 3: New risk weights (standardized approach), according to Basel ll 74 Table 4: Recent competitive developments within the non-standard mortgage market 79 Table 5: Economic forecasts used in neutral scenario forecast for the UK mortgage market, 2004-2009f 87 Table 6: European 2005 YTD supply by asset class, February 2005 90 Table 7: Average house price in the UK, 1995-2004e 91 Table 8: The growth of total mortgage balances outstanding, 1995-2004e 91 Table 9: Total mortgage gross advances, forecasted to 2009 according to the our neutral scenario, 1994-2009f 92 LIST OF FIGURES Figure 1: Typical RM securitisation structure 4 Figure 2: HBOS dominates the UK market, with EUR 20.8 billion of RMBS issuance as of 2004 6 Figure 3: Total mortgage gross advances are forecasted to fall to £263.6 billion by 2007 before returning to growth, 1994-2009f 15 Figure 4: Typical RM securitisation structure 27 Figure 5: A typical rating scale 28 Figure 6: The US RMBS market is dominated by the three GSEs 34 Figure 7: RMBS accounted for 75 per cent of the total European asset-backed securities as of February 2005 37 Figure 8: HBOS dominates the UK market, with EUR 20.8 billion of RMBS issuance as of 2004 44 Figure 9: The price of an average house in the UK has increased by 145 per cent over the last ten years, 1995-2004e 45 Figure 10: While approvals fell in 2004, average loan sizes continued to grow strongly, 2000-2004e 46 Figure 11: Total mortgage receivables have increased by 124.6 per cent since 1995, 1995-2004e 47 Figure 12: While interest rates have risen five times since 2003, they remain at a sufficiently low level to continue making borrowing attractive for consumers, 1995-2004 48 Figure 13: Relationship between originator and counterparty in Bristol & West’s synthetic securitisation transaction, June 2000 61 Figure 14: The mechanics of the mortgage bond issuance 70 Figure 15: Halifax reported monthly declines in house prices towards the end of 2004, January 1994 to November 2004 84 Figure 16: Despite house price growth, average mortgage repayments as a proportion of take-home pay remain relatively low, 1980-2004 85 Figure 17: Total mortgage gross advances are forecasted to fall to £263.6 billion by 2007 before returning to growth, 1994-2009f 88