PRA statement on the regulatory treatment of retail residential mortgage loans under the Mortgage Guarantee Scheme

The PRA is updating a previous statement from 2013 to clarify the treatment of the 2021 HM Treasury’s Mortgage Guarantee Scheme (MGS).^{footnote [1]} The purpose of this statement is to provide information on capital, notification, disclosure, and reporting requirements for loans under the MGS as set out in the relevant UK legislation.^{footnote [2]} The PRA’s approach to capital, as described below, would be applicable to mortgage insurance schemes with similar contractual features to MGS, but the approach to reporting, notification, and disclosure only applies to MGS and not to other securitisation programmes.

This statement does not provide an exhaustive commentary of the regulatory requirements for MGS loans: firms should review the relevant legislation and, as necessary, seek independent advice to satisfy themselves that they meet all applicable requirements. In particular, the UK Capital Requirements Regulation (UK CRR) requires firms to obtain a legal opinion on the effectiveness and enforceability of credit protection afforded by a guarantee such as MGS.^{footnote [3]} The PRA considers this requirement to be capable of being satisfied on the basis of a legal opinion obtained jointly by firms.

Under MGS, the Government guarantees a portion of the first losses (net of recoveries) on retail residential mortgage loans eligible for the scheme. As a result of the first loss guarantee, the following securitisation positions are created:

• the guaranteed portion of an MGS loan generates an exposure to the Government as guarantor of the first loss on the loan;
• and the remaining part of an MGS loan is an exposure to the borrower, the risks of which are retained by the participating lender.

The tranching of the credit risk of an MGS loan into these two positions will result in firms calculating Risk Weighted Exposure Amounts (RWEA) in accordance with Article 234 and Chapter 5 of Title II of the UK CRR, and the definitions of securitisation and synthetic securitisation in Articles 4(61) and 242(14) of the UK CRR. Because the guaranteed portion of the first loss is provided on individual loans, each MGS loan will itself be treated as a pair of securitisation positions.

The approach a firm uses for credit risk purposes for its UK retail residential mortgage loans – the Standardised Approach (SA) or the Internal Ratings Based Approach (IRB Approach) – will determine how a firm calculates capital requirements for MGS loans.

Firms using the SA to credit risk for the underlying mortgage loans

For a firm using the SA approach for UK retail residential mortgage loans, Article 245 of the UK CRR allows a firm, subject to meeting the significant risk transfer (SRT) test, to calculate the risk weights to be applied to the retained securitisation positions in accordance with Article 261 of the UK CRR.

The guaranteed portion of the loan would be treated as an exposure to the UK Government.

In cases where firms choose not to recognise the guarantee for the purpose of calculating capital requirements or where the SRT test is not met, firms should calculate capital requirements as if the guarantee did not exist, and as if the underlying loan exposure had not been securitised as per Article 247(2) of UK CRR. 

Firms using the IRB approach to credit risk for the underlying mortgage loans

For a firm using the IRB approach for UK retail residential mortgage loans, Article 245 of the UK CRR allows a firm, subject to meeting the SRT test and conditions set out in Article 258 of the UK CRR, to calculate the risk weights to be applied to the retained securitisation positions in accordance with Article 259 of the UK CRR.

When applying the Securitisation Internal Ratings Based Approach (SEC-IRBA), firms should calculate the IRB capital requirements for each individual MGS mortgage loan as though it had not been securitised as an input into the SEC-IRBA equation KIRB in accordance with Article 255 of the UK CRR. Where the PRA has applied floors or adjustments to a firm’s IRB parameters, or underlying elements of those parameters, those floors or adjustments should be applied also for the purposes of calculating KIRB. This would include the 10% floor to the exposure-weighted average loss given default (LGD) of exposures that applies to retail residential mortgage loans under Article 164(4) of the UK CRR.

The guaranteed portion of the loan would be treated as an exposure to the UK Government.

In cases where firms choose not to recognise the guarantee for the purpose of calculating capital requirements or where the SRT test is not met, firms should calculate capital requirements as if the guarantee did not exist and as if the underlying loan exposure had not been securitised as per Article 247(2) of UK CRR. As a result, firms using the IRB approach should not reflect the effect of the guarantee in parameter estimates in this case.

5% vertical slice

Under MGS, participating firms are exposed to 5% of the first loss on a MGS loan. Given that firms retain the whole of the senior part of the loan, the PRA considers this to be equivalent to the firm holding a 5% ‘vertical slice’ of the underlying mortgage loan outside of the guarantee structure. Firms should calculate the capital requirements for that part of an MGS loan as an exposure to the underlying mortgage loan using the IRB approach or SA, as applicable.

The 5% vertical slice of each MGS loan outside the guarantee should be included in the calculation of the 10% LGD floor set out in Article 164(4) of the UK CRR.

Maturity mismatch

Article 252 of the UK CRR sets out the requirements for adjusting RWEAs for synthetic securitisation under the Securitisation Standardised Approach (SEC-SA) and SEC-IRBA approaches where there is a mismatch between the maturity of credit protection (the guarantee) and the securitised exposures.

Significant Risk Transfer Notification

Rule 3.1 of the Credit Risk Part of the PRA Rulebook requires firms to post-notify each individual transfer of significant credit risk. The PRA recognises that firms may find applying this notification requirement to each MGS loan to be unduly burdensome. In this case, firms should consider applying for a modification by consent in accordance with section 138A FSMA to notify the PRA only once (for the whole programme), following completion of the initial MGS loan securitisation transaction. The PRA’s direction, which can be found on the PRA’s waivers and modifications webpage, modifies the relevant PRA rule to require a single notification within one month of underwriting loans under the MGS programme.^{footnote [4]} The PRA may periodically seek information on a firm’s overall use of MGS to satisfy itself that commensurate risk transfer is achieved. The PRA draws firms’ attention to the expectations it has set out in Supervisory Statement 9/13 ‘Securitisation – Significant Risk Transfer’.^{footnote [5]}

Private Securitisation Notification to the PRA

Article 7 of the Securitisation Regulation requires the originator, sponsor, and securitisation special purpose entity (SSPE) of a securitisation to make available certain information to the PRA and Financial Conduct Authority with regard to each individual securitisation. In line with Regulation 25 of The Securitisation Regulations 2018^{footnote [6]}, the PRA hereby directs^{footnote [7]} that participating firms submit one notification with regard to MGS securitisations, detailing the estimated aggregate programme size. The PRA will reflect this modification as part of a broader update of the direction on its webpage^{footnote [8]} in due course.

Disclosure

The PRA notes the potentially disproportionate burden associated with the firm obligation to submit regulatory templates under the Disclosure Binding Technical Standards (BTS) when HM Treasury (the sole holder of the guaranteed position) has requested that information be submitted in another format to meet system requirements. In this case, the PRA is not minded to enforce the use of the regulatory disclosure templates if firms have provided to HM Treasury information which is substantively the same as that prescribed by the disclosure template(s). For example, where a firm decided to provide the information to HM Treasury using the BTS template(s) format but within a single template (i.e. all information within one template with rows for each loan) instead of one template per loan, the PRA is not minded to enforce.

Regulatory reporting

The PRA recognises that firms may consider that the burden associated with the reporting under the Common Reporting Framework (COREP) C14 and C14.1 for the MGS on a loan-by-loan basis is disproportionate in the firms circumstances. Exceptionally, with reference to this scheme only, the PRA is not minded to enforce where a firm reports C14 and C14.1 templates on an aggregated basis for MGS securitisations in respect of reporting dates that fall within 2021.

The PRA is currently consulting on proposed CRR rules on reporting to take effect from Saturday 1 January 2022. Subject to the outcome of the PRA’s consultation and the PRA making these rules, firms that wish to continue reporting on an aggregated basis will need to have secured a modification to the relevant CRR rule in the PRA Rulebook in accordance with section 138A FSMA.

The PRA will consider and may, where appropriate, publish a modification by consent direction in due course.