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Lenders must master art of flexibility

As the mortgage market matures, funding methods for lenders are becoming more sophisticated.<

Lenders have to make sure that they remain flexible to react to market conditions. Getting funding at the best price while ensuring sufficient liquidity is important for efficiency. But funding and portfolio decisions are also crucial in terms of risk management, especially in the sub-prime sector. The art of staying flexible is not easy to master but it is one lenders must strive towards.

The lesson I will concentrate on here is ensuring diversity in funding sources and mortgage portfolio. An important weapon in achieving this is portfolio trading – a market that has become more mainstream and will continue to develop.

Lenders overly reliant on one funding channel will find that difficulties in this channel will severely hurt their business. A mixed strategy is important to maximise returns and reduce risk. Ensuring balance means some mortgages are bundled together and securitised, others are sold off as part of whole loan sales and the rest are simply kept within the lenders’ portfolio.

All these options have advantages and disadvantages in terms of returns, liquidity and risk. But ensuring a balance with a reasonable degree of diversity is crucial. A lender should not become overly dependent on any one option as this will impede its ability to react to changing conditions in both the primary and secondary mortgage markets. Similarly, those lenders whose mortgage portfolios are overly-dominated by a particular variety of mortgage are exposed to unnecessary risk.

It is at this point we turn to the weapon of portfolio trading. The expansion in whole loan trading is helping drive more sophistication in funding. Some lenders are finding they can achieve better execution through whole loan sales than through securitisation. They can get a better price and immediate profits. But perhaps more important, lenders are realising that through buying and selling mortgage pools they can help mitigate the risks they face.

The whole loan trading market will continue to develop. More transparency is needed so risks can be properly analysed and contracts must become more standardised so negotiations between buyers and sellers can be more time and cost efficient. These changes are underway and are making the market more attractive. At the moment it takes months to facilitate a whole loan trade but this will come down to weeks, if not days.

Lenders that develop their use of portfolio trading will have an advantage. It is an important weapon in ensuring diversity in funding and portfolio structures. And its deployment is crucial to mastering the art of flexibility.michael culhane is chief executive of The Oakwood Group

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