UK government creates £50 billion ABS fund

The UK government outlined further plans today to try to stabilise the economy and encourage banks to lend more.

UK prime minister Gordon Brown and Alistair Darling, chancellor of the exchequer, explained at a press conference in London this morning that the new measures were being introduced because, while UK banks had maintained lending levels, they were struggling to fill a gap in credit provision left by the retreat of foreign firms and non-bank lenders.

Brown said: "These are comprehensive measures focused on one purpose - increasing the amount of lending that is available to families and to the businesses that are the backbone of our country and who want to invest and create jobs."

The news included the creation of a £50 billion asset purchase facility, which will start operations on February 2. This involves the Treasury authorising the Bank of England to purchase high-quality private sector assets, including paper issued under the UK government's capital guarantee scheme (designed to reduce the risks on lending between banks), corporate bonds, commercial paper, syndicated loans and a limited range of asset-backed securities created in viable securitisation structures.

This fund will be financed by issuing Treasury bills, and the Treasury will indemnify the Bank of England. Further details of this will be announced by the end of January.

The government also revealed an asset protection scheme, designed to protect financial institutions against exposure to exceptional future credit losses on certain portfolios of assets. The Treasury, in return for a fee, will protect against the major portion of credit losses that exceed the "first loss" amounts, which banks will bear. The eligible assets for this scheme include portfolios of residential and commercial property loans, structured credit assets, corporate and leveraged loans, and any closely related hedges held by the participating institution as at December 31, 2008. This scheme is expected to last less than five years.

The government will extend the drawdown window of its capital guarantee scheme, which was announced last October, from April 9, 2009 to December 31, 2009, subject to state aid approval. All other aspects of the scheme will remain the same, including the final maturity date of April 9, 2014. During the drawdown window, banks can issue more debt, and once it has been issued, they can keep rolling it over once the window closes (all of it until April 13, 2012 and up to one-third of the total until April 9, 2014).

Brown said the government will negotiate lending responsibility agreements with participating banks in order to maintain and improve the supply of credit to the wider economy. These agreements will have specific and quantified lending commitments, which will be binding and externally audited.

The government is also considering further ways of addressing the loss of mortgage lending capacity. As a first step, it confirmed that Northern Rock, the mortgage lender nationalised in February 2008 after struggling to raise money market and capital market funding, is no longer actively pursuing a policy of rapidly reducing its existing mortgage book. The original objective of the bank's scheme was to encourage customers to remortgage to other lenders in order for the institution to pay back its government loan.

"This has been very effective and has enabled the company to reduce the government loan well ahead of the business plan," said Northern Rock in a statement today.

Reflecting this, and in order to support government policy to increase mortgage lending capacity in the market, the bank said it is slowing down the rate of mortgage redemptions. This means more mortgage customers will be able to stay with Northern Rock, but also means the repayment of the loan will be slower.

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Northern Rock fallout continues