Standard & Poor's predicts a sharp increase in the use of whole loan sale technology in Europe, offering mortgage originators a meaningful financing alternative to retail deposits or the costs of small-scale securitizations.
Whole loan sales drive the US residential mortgage-backed securitization origination process and Europe's fast-maturing mortgage sector has reached a level of sophistication and liquidity where the same technology can be deployed.
In the US, whole loan pool sales of $1 billion are a regular event, and can rise as high as $3 billion.
Mortgage originators in Europe, especially the UK, have now begun to pursue whole loan sales. The vendors are typically non-conforming originators who use their near prime assets for whole loan sales. Vendors have previously found the UK mutual building societies a useful source but they can rarely provide portfolios above £200 million ($364 million).
This is where the investment banks step in. Originators can immediately realize the value of assets sitting on the balance sheet at a profit – as the sale price is actually greater than face value. For investment banks, the process is driven either by the aim of extracting value by structuring or repacking the assets themselves in a securitization.
Careful nurturing
Lee Rochford, head of European ABS at CSFB, explains that the price paid is based on risk-based models underpinned by methodologies that rating agencies use to analyse portfolios for securitization. But this sector needs careful nurturing to expand to its full potential. "If this market is going to become liquid, sellers of portfolios are going to have to give a better standard of representations and warranties," he says.
Complete representations and warranties allow purchasers to fund themselves more easily in the securitization market. An unwillingness to recognize this point, unlike in the US, will impact on values and thus hold back the trading of larger pools," Rochford argues.
For example, HVB has purchased two home loan portfolios on its Bluestone platform. In June, the German firm marketed Series 2005-1, originated by Platform, a Britannia subsidiary. Fitch said this pool suffered from limited representations and warranties and requested extra credit enhancement.
Securitization has proved a godsend for originators constrained by a low retail deposit base over the past five years. Nevertheless 60% of the European mortgages are still financed by retail deposits. whereas in the US this percentage is close to zero. Agency debt and securitization is the refinancing route for the vast majority of mortgage originators.
If the same process was to take place in Europe it would be nothing short of a revolution in mortgage funding and provide a massive new opportunity for investment banks operating in the region.
Two issues
According to S&P there are two factors that might support the nascent European whole loan sector. First, while IAS39 will allow the complete and clean removal of assets from the balance sheet if conducted via a whole loan sale, securitization will not. On-balance-sheet recognition is a feature of the new accounting regulations.
The second issue is scale. The largest mortgage originators are at an advantage vis-à-vis smaller operators because they can sell very large transactions and extract a liquidity premium. Furthermore, securitization is a relatively expensive process; whole loan sales could help to level the playing field for smaller mortgage originators.