Trade in whole mortgage loans is brisk in the UK, while Germany and the Netherlands show potential, but the booming European market’s main player is American. Michael Marray reports.

The whole loan market in the European mortgage sector is booming, with a growing number of mortgage originators using whole loan sales as a quick and efficient way to raise funding and move assets off their balance sheets.

Many of the whole loan buyers already have their own origination but are acquiring additional portfolios to diversify the mix of assets on their balance sheets, or perhaps to reach critical mass for a securitisation.

In addition, specialised mortgage investors – some without their own origination capabilities – are also buying whole loan products to push through their securitisation vehicles, perhaps holding onto the lowest rated junior tranche that pays a high return.

“European mortgage lenders are seeking diversified capital market funding sources, providing an impetus for significant growth in the whole loan sales market,” comments Brian Kane, director of European residential mortgage-backed securities (RMBS) at Standard & Poor’s (S&P) in London.

“Whereas whole loan trading is the primary driver of RMBS origination in the US, the European market has only recently reached a level of structuring sophistication and an understanding of the fundamentals of the credit risk, liquidity and relative value pricing to embrace the whole loan sales market,” says Mr Kane. “A vigorous whole loan sales market is likely to generate even higher levels of residential mortgage loan securitisations in Europe.”

Inga Smolyar, director at Fitch Ratings in London, says: “The whole loan market gives established mortgage lenders another exit strategy and funding source, while new entrants to the market may find it easier to purchase whole loan portfolios and securitise them, instead of setting up their own origination shops.

“Recently some RMBS portfolios have had some portion of their collateral acquired in the whole loan market. The Bluestone transactions, however, are an example of an RMBS deal backed 100% by mortgages purchased in the whole loan market, and we expect this to become a trend in 2006,” says Ms Smolyar.

There have been two offerings out of the Bluestone securitisation programme, which issues on behalf of Redstone Mortgages. Redstone, part of the HVB Group, does not originate mortgages itself but buys loans in the secondary market and repackages them for securitisation. Its debut RMBS offering last December was backed by a pool of non-conforming mortgages, and it followed this up with a second deal in July.

Many other securitisations now feature some whole loan sale collateral. For example, in early October, Leek Finance was launching a £960m RMBS, with most of the mortgages originated by Platform Funding, a subsidiary of Britannia Building Society. In addition, there was also some collateral acquired from Kensington Mortgage Company in the pool.

Tracking specialists

One of the developments that is making things simpler for secondary market purchasing of residential mortgage loans is the emergence of third-party servicers. These companies have software systems to handle the time-consuming tasks of tracking direct debit payments, and the specialised skills of chasing late payments from call centres.

With a sizeable number of these firms to choose from, buyers of mortgage loan portfolios now find it easier to cross national boundaries, whereas in the past cultural and language barriers might have dissuaded investors from taking on something as cumbersome and granular as a residential mortgage loan portfolio.

When a portfolio is sold, the servicing contract may be allotted to a new company but often the service remains in place. It carves out the loans being sold from the overall portfolio, re-badges them and keeps on top of the cashflows and late payment calls. The buyer can thus focus on relative value and pricing without having to worry about the servicing.

Rapid growth

The servicers have grown rapidly with the RMBS market but are now doing more business with whole loan purchasers. One of the largest players is Homeloan Management, a subsidiary of Skipton Building Society.

“The whole loan market has continued to grow at a fast pace during 2005,” says Steve Haggerty, managing director at Homeloan Management. “There are plenty of whole loan buyers at the moment, since in the UK mortgage lending market there is overcapacity, with too many lenders chasing too few borrowers. As a result some traditional lenders are struggling to originate enough loans, and are topping up in the whole loan market.

“Regular securitisers, such as GMAC-RFC or Kensington, run whole loan programmes alongside their securitisation programmes as an alternative outlet to move assets off balance sheet. But now we are also seeing non-securitisers originating mortgages with the express intent of selling them into the whole loan market,” says Mr Haggerty.

One example of a mortgage lender that does not securitise is Freedom Lending, which instead uses the whole loan market to move loans off balance sheet. In April, Freedom sold a £100m portfolio to Mortgages plc.

An advantage of whole loan trades is that they can be very small, whereas the fees associated with a securitisation make deals of less than £200m a rarity, and most are much larger. In contrast, small whole loan sales of £20m to £30m are quite common, as well as large £400m to £500m disposals by big players.

American trailblazer

Given that the mortgage whole loan market has been highly developed in the US for many years, it is no surprise that a US company has been the trailblazer in Europe. General Motors subsidiary GMAC has become a major residential mortgage lender in the UK. It recycles its capital by either selling large whole loan portfolios or offering RMBS via its RMAC programme. As an expert trader of portfolios, GMAC is also sometimes seen on the buy side in the whole loan market.

According to S&P, GMAC-RFC sales this year include a £150m portfolio to Amber Homeloans, a £250m portfolio to Britannia Building Society and a £251m portfolio to Mortgage Express, a subsidiary of Bradford & Bingley.

Mortgage Express is a regular buyer of GMAC-RFC products, and GMAC has programmes that put together portfolios of assets that specifically match the requirements of the buyer. Thus buyers have some ability to place orders for a particular type of product, although the rating agencies would always want to make sure that individual portfolios are not cherry picked but are cut from a large portfolio.

“One dynamic in the whole loan market is that some originators are underwriting mortgage pools to be sold in whole under pre-approved criteria,” says Alexander Batchvarov, managing director in structured finance research at Merrill Lynch. “The buyer may, for example, not want loan-to-values above 85%, or not want self-certified mortgages or interest only mortgages, and will buy whatever is originated within these parameters.

“And some regional building societies are buying whole loans to build a mortgage pool across the whole country, as opposed to the regions in which they originate,” he adds.

Increasing risk

In addition to getting away from regional concentration, analysts note that buyers may wish to put some higher yielding sub-prime products alongside lower yielding prime mortgage assets. When traditional lenders buy whole loans, they tend to buy a bit further out along the risk curve, analysts say.

But some buyers are also playing a numbers game, and temporarily bulking up their balance sheet (often prior to securitisation), both as a way to create some profit from extra deal flow and to look bigger.

“A highly competitive lending market currently exists in the UK, and it can be hard for building societies to originate enough new mortgages,” says one analyst. “It may be something of an outmoded measure but at the end of each year, the league tables are produced and building societies tend to be measured by the size of their balance sheets – and they don’t want to be seen to be shrinking.”

The UK has the largest and fastest developing market for whole mortgage loan sales, although there is also increasing activity in the Netherlands. Recent legislative changes in Germany have made it easier for assets to be transferred, as part of the development of a true sale asset-backed securities market, and Germany is viewed as having strong potential as a whole loan market.

The Netherlands already has an active whole loan market and major buyers include the insurance companies. The market benefits from a well-established, centralised credit-scoring system that tracks borrower performance.

Stateside dominance

S&P identifies the existence of widely accepted credit scoring mechanisms as a key advantage that the US market has over many European countries. Credit scores are provided by Fair, Isaac and Company and are developed from five categories of data: payment history, amounts owed, length of credit history, new credit and types of credit used.

Fair Isaac started working on credit scoring in the 1950s and lenders view its scores as reliable measures of credit evaluation. In contrast, certain features of the European market present difficulties, in particular the fact that data availability and standardisation vary significantly across European countries, and even across originators in the same country.

In spite of the more limited data availability relative to the US, European originators are increasingly becoming more sophisticated. Continued development of risk-based pricing platforms and credit scoring models are providing the market with the quantitative tools necessary to determine quickly the value of portfolios of loans, which should further boost the whole loan market in Europe.

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