Tentative signs are emerging that the mortgage market may be once again starting to move in the right direction.
Following the initial disruption, the London InterBank Offered Rate has become more stable, trading at between 50 and 60 basis points above Bank of England Base Rate – a rather wider spread than has been the case historically, but much less than the 120 basis points seen in the second week of September.
Institutional investors who pulled back from UK mortgage-backed assets are now finding themselves flush with cash and continue to look for safe homes with attractive yields for their funds.
While the securitisation market is not yet revitalised, a few transactions have become public in recent weeks. They were not of the size of pre-credit crunch deals, when they were typically several hundred million pounds or more, but the return of activity is nonetheless of symbolic importance.
On the other hand, there have been a number of whole loan deals, some of them achieving a discounted pricing as compared with the above par cost of such assets just a couple of months ago.
Intertesting times ahead
Looking forward, future activity among whole loan traders will be interesting to follow: some deals will have been pre-agreed and will continue to flow, presumably at pre-agreed rates; however, some lenders will have to offload assets sooner or later in order to maintain funding levels and the rates paid will give an indication as to lenders’ appetite for assets.
Changes emerging
As time passes, other changes may emerge. The ‘originate and sell’ – immediately – model may not hit the spot. This has been the traditional way of doing business in the US, with originators typically writing business and packaging it up for sale as quickly as they can.
The argument goes, originators had less incentive to worry about credit quality, as they took no principal position in loans that were sold on so quickly. Obviously where the originator is obliged to ‘buy back’ the non-performing asset as seen in some arrangements, the quality of the lending and thus the performance of the loan, should be better.
As the market picks up, mortgages need to be of higher quality and to be seen as such by investors. If a loan has remained on the balance sheet of the originator for longer, it may give investors a higher degree of confidence in its quality, reducing the likelihood of default or equity erosion. Of course, this ‘seasoning’ of mortgages gives no absolute guarantee that some loans won’t go bad over time, but it does help weed out those where the borrower defaults almost immediately and the lender moves towards repossession proceedings rapidly.
Warehouse funding
Where loans are seasoned on the originator’s balance sheet, this has an impact on the warehouse lines they need – the means by which they fund such assets until they are sold on either as a whole loan trade or part of a securitisation. Warehouse funding is, of course, a business critical issue for lenders, particularly specialist lenders that don’t have ready access to more traditional forms of funding.
Will lenders be able to afford to hold assets on balance sheet while the seasoning of assets takes place? Is a warehouse funder’s collateral inherently more risky if the asset is not being securitised or sold as part of a whole loan trade until much later in the cycle of the loan?
The willingness of warehouse funders to provide lines to lenders that originate mortgages does presuppose that their position is secure in terms of both the creditworthiness of the assets taken in security, and the robustness of the servicing that is in place.
Whether servicing is performed in-house or outsourced to a third party servicer, the warehouse provider needs to check the contractual arrangements in place – including both primary and back-up servicing – to ensure they are adequately protected in all eventualities. The market takes considerable reassurance from having either servicing or back-up servicing provided by an independent, rated provider. In short, it’s not just a question of credit quality, but also servicing quality.
Building a return of confidence
With latest Council of Mortgage Lenders' figures showing a significant dip in mortgage lending between August and September, the general consensus is that business volumes will remain muted, at least until the New Year. Having said that, the building blocks are there for a return of confidence, among both investors and consumers, come 2008.
Investors continue to have the funds to invest, and as they come to recognise the underlying creditworthiness of UK mortgage assets, and the opportunity to command a higher price than they did three months ago, they will return. Not quite out of the woods, but getting there.
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