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Funding a bank in a liquidity crisis Back  
Ulster Bank’s funding strategy had a buoyant start to the year, as the bank completed the largest securitisation of residential mortgages ever undertaken by an Irish bank. However, while the bank continues to attract significant amounts of liquidity, the credit crisis during the summer has meant that the cost of that liquidity has increased, writes Donal Corbett, who expects that the liquidity crunch will continue for a number of months.
Ulster Bank Group’s funding strategy over the past number of years has been to broaden the funding mechanisms available to us whilst continuing to focus on liability gathering from our retail and corporate customers. Ulster Bank Group is funded from a number of sources namely, retail deposits, corporate deposits, mortgage backed promissory notes, certificates of deposit through Ulster Bank Northern Ireland, the inter-bank money markets, European commercial paper, floating rate notes, securitisation, and as a core subsidiary of the Royal Bank of Scotland Group (RBS) we fund an element of our balance sheet directly from RBS.

2007 in review
We entered 2007 in a very strong position buoyed up by the completion in December 2006 of the largest securitisation of residential mortgages ever undertaken by an Irish bank and indeed one of the largest funding transactions ever undertaken by an Irish institution, namely a €3.9 billion transaction.

In early 2007 we set about completing a number of debt capital markets transactions. In April we increased the size of our ECP programme from €5 billion to €8 billion and added a new dealer to the programme. That was quickly followed in May by a 3- year €1.5 billion public floating rate note. The transaction was launched at 8am and within two hours the orders stood in excess of ?2 billion. The orders were closed shortly after midday on the same day and the transaction was significantly oversubscribed settling at Euribor plus 6 basis points.

In June, we completed a €1.95 billion securitisation of First Active mortgages, which included the re-financing of four previous securitisation deals which were completed in 1998 and 1999. The deal was the twelfth mortgage-backed securitisation for the Ulster Bank Group and achieved the tightest ever pricing for the Celtic programme. All tranches were comfortably oversubscribed at, or inside the initial price guidance levels, despite significant amounts of competing ABS supply and an increased element of caution about the residential housing market at that time when interest rates were increasing.

As part of The Royal Bank of Scotland Group, all of our capital injections come from our parent and we carried out a number of capital transactions throughout the year. The new liquidity rules introduced by the Irish Financial Regulator in mid-year, where Irish banks moved away from a stock liquidity to a matched liquidity approach, ensured that we increased our funding with a maturity of greater than one month in the run up to the introduction of those rules. This liquidity approach stood us in good stead when liquidity in the debt capital markets came under pressure from July onwards. Ulster Bank is the highest rated full service Irish clearing bank having the highest possible short term ratings from S&P, Moody’s and Fitch whilst having strong double ‘A’ long-term ratings from each of those agencies also. These strong ratings have been a significant benefit to us during the uncertain times since the beginning of the third quarter. Consequently we continue to attract short dated funds and in September we increased the size of our ECP programme from €8 billion to €12 billion. We also continue to attract significant funding through our interbank money market operation.

We are currently implementing a €5 billion certificate of deposit programme into Ulster Bank Republic of Ireland and we are extending our mortgage backed promissory note programme, already in place in First Active for a number of years, to Ulster Bank to further diversify funding options.

Funding outlook
In recent times we have diversified the funding mechanisms available to us and we are set to continue with that process as we head into 2008. Given the strength of our ratings we are currently evaluating the implementation of a US$ commercial paper programme and a medium term note programme. While in the short term the FRN and securitisation markets are relatively unattractive compared with the wide range of alternatives to which we have access, they will remain a core part of our diversified funding strategy in the medium term.

Whilst we continue to attract significant amounts of liquidity, the cost to our business of that liquidity has increased. Some of our mortgage business is priced at ECB plus a margin yet it is funded at Euribor plus a margin. The ECB has not moved rates since June 2007 yet Euribor has increased significantly since June, particularly in the 3- month maturity term. My personal view is that the liquidity crunch is set to continue for a number of months. I think we will have to go through the 2007 year end audited accounts reporting season across the financial system to bring increased transparency and confidence back into the debt capital markets.

The US housing market is a crucial piece in the jigsaw also. If defaults continue in the sub-prime sector, with subsequent losses being realised as those foreclosures work their way through, then confidence will continue to be dented in the entire market given the wide distribution of the bonds backed by those sub-prime assets. In the securitisation market, which has seen massive rates of growth over the last few years, a significant investor base i.e. Structured Investment Vehicles, have effectively been removed from the market. This is due to SIVs experiencing funding difficulties, together with uncertainties around being able to get a realistic market price for their investment books. The SIV arbitrage between funding short and lending long is being severely tested at present so it may take some time for them to be any sort of a force again and this will reduce demand going into 2008.

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