The sale of whole mortgage loan portfolios is a relatively new concept in the UK and the rest of Europe. Investment banks are increasingly acquiring portfolios from originators to securitise through their own programmes and this is driving an increased interest in whole loan sales. Ideally, many banks would like to create or acquire their own originators but entering the market is difficult and there are few acquisition opportunities.The situation in the more sophisticated US market is different. Whole loan sales constitute the main feedstock for residential mortgage-backed securitisations. By contrast, in the UK, a mortgage originator has traditionally securitised the mortgage assets through its own programme. Whole loan sales have several advantages over securitisations and, from a seller’s perspective, offer an alternative source of revenue. Sales will yield an immediate income for a seller rather than a return over a prolonged period of time. Sales will remove loans from a seller’s balance sheet and will often generate a profit, as loans are sold at premium over the face value of the aggregate of the loans. Under the IAS 39 accounting rules introduced in January this year, most securitisations fail to qualify for so-called derecognition and must be retained on an originator’s balance sheet. This is because a portion of the risks and benefits of ownership remain with the originator in most cases. Whole loan sales will remove such assets from the balance sheet in their entirety. Many whole loan sales transactions now take the form of white-labelling whereby mortgages are originated according to a buyer’s specifications. Agreements detailing a buyer’s demand for certain products and the overall value and quantity of loans required for the coming year help provide certainty for originator and buyer. The benefits to buyers of portfolios vary depending on the nature of their business and their commercial aims. An investment bank might buy a portfolio with a view to securitisation or possibly restructuring and repackaging to improve fee income as fees from the traditional agency role have declined. It may also consolidate smaller portfolios into a package large enough for securitisation. For many lenders that wish to hold mortgage assets, whole loan purchases provide a way quickly to increase market share. One of the prime factors behind the immaturity of the markets in the UK and Europe is lack of uniformity. The range of mortgage products available to UK borrowers is wider than in the US, increasing the complexity and cost of mortgage sale transactions. Representations and warranties on whole loan sale tend to be less onerous than those given on a securitisation. As these warranties are not the same as the warranties required by rating agencies on securitisation, a buyer under a whole loan sale who then securitises the mortgages may have to take on additional warranty risk which can be difficult to ascertain. There is also no standardised credit scoring system in the UK. Providers such as Equifax run sophisticated operations but the use made of data varies significantly from originator to originator. And the availability of data is not as good as in the US. Underlying property valuation is also difficult without easy access to information. Some are tackling the problem by using computerised valuation models. These standard criteria generate consistent valuations. But in the absence of a single system to value properties that are the subject of mortgage loans, or the credit risks that buyers are undertaking, the market will not be able to develop fully. Separate from the above commercial concerns about the availability of accurate information is the legal framework. The regulatory scheme underlying mortgage lending has undergone a substantial upheaval in the past 12 months. Until Mortgage Day, the Council of Mortgage Lenders provided the Mortgage Code that drove voluntary regulation of the mortgage sector, with the Office of Fair Trading providing limited regulation under the Consumer Credit Act. Since M-Day, the Mortgage Code no longer applies but its main provisions have been incorporated into the Financial Services Authority’s regulatory regime. The withdrawal of the Mortgage Code means members no longer give any representation to potential customers that they comply with the CML’s Statement of practice on transfers. This means packages of mortgages originated after M-Day can be sold free from the onerous arrears provisions, thereby simplifying the documentation required. Residential mortgage lending is now regulated by the Financial Services Authority on the basis of the Financial Services and Markets Act 2000 and the rules set out in the FSA Handbook. Buyers will now be concerned at the risk of mortgages being unenforceable under the 2000 Act. For example, if a lender does not have the necessary permission. Although compliance with the Mortgage Conduct of Business rules as set out in the Handbook provides a source of concern for both sellers and buyers, non-compliance does not make the mortgage unenforceable. The FSA enforces the Unfair Terms in Consumer Contracts Regulations. It produced a Statement of Good Practice on Fairness of terms in consumer contracts in May 2005. This covers interest rate variation clauses but is less prescriptive than the guidance previously produced by the OFT. So as the advantages of whole loan mortgage sales are becoming increasingly clear to the big players, improvements in the availability of information to buyers and more sophisticated use of this data, will galvanise the appeal of whole loan sale transactions.
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