The post-economic crisis market is providing a catalyst for investors to re-think their strategies. One area to come under the spotlight in a recovering economic environment is the residential mortgage market. In particular, as banks increasingly look to deleverage their non-core units, investors are identifying opportunities to purchase mortgage portfolios as they search for higher yields. However, for investors to realise the returns, they must tackle a number of challenges throughout the process.
As with all investments, there needs to be a careful balance between risk and reward. The residential mortgage market is no exception so investors must ensure they analyse the risks from the outset as well as plan in advance for how they intend to service the portfolios. This requires them to apply the right analytics tools pre-acquisition and source the necessary expertise and servicing capabilities post-acquisition.
Many of the risks associated with mortgage portfolios result from a number of shifting macroeconomic factors. While in the UK, the Bank of England is keeping the base rate low in the short-term, it is perhaps inevitable that this will increase if the market sees strong recovery and continued growth. The resulting mortgage rate hikes will in turn have a clear impact on borrowers’ finances, jeopardising their ability to repay the loans. However, if the economy experiences another downturn, the risk is that rising unemployment will impact arrears rates.
The problem is that many of these risks will not always be apparent in the early bidding stages. To gain this crucial insight, investors need perform stringent affordability analysis and stress testing to assess the risk profiles of individual borrowers. These should consider each of the macroeconomic factors, including interest rate or inflation increases, to determine their impact on the overall performance of the portfolio. To achieve this, it is essential for investors to access historical data to build up a clear picture of how various mortgages are affected throughout their lifecycle.
Another important consideration is due diligence on the portfolios. In particular, investors should complete their due diligence pre-acquisition to ascertain whether the charge over the individual property is enforceable, in addition to obtaining an updated value for the property. While it is often not possible to complete full valuations, desktop research and land registry checks are viable ways to gather a significant amount of intelligence.
Once investors purchase a portfolio, they will need to service the loans effectively. This is a crucial requirement, as mismanagement could result in poor portfolio performance and unwanted attention from regulators if they fall short of regulatory requirements. This would put the investment fund’s reputation at risk, especially if they need to publically communicate their foreclosure and collections procedures to the authorities.
The challenge is that many investors will not have existing expertise or capabilities to service the loans, nor the inclination to develop these in house. Therefore, many are seeing outsourcing this task to a third party administrator as the best approach. As the European servicing market becomes more sophisticated, specialist servicing organisations are able to offer valuable expertise that was not always previously available. This puts investors in a strong position, enabling them to access the necessary tools and resources in order to minimise default rates, ensure regulatory compliance and optimise forbearance procedures.
With the right approach, investors have much to gain from the residential mortgage market, with portfolios providing an opportunity to secure risk adjusted yields of between six and ten percent. However, the risks cannot be ignored and it is clear that investors must pay close attention to pre-acquisition analysis and ongoing portfolio management. Those that make use of the maturing and evolving servicing ecosystem will stand the best chance of mitigating the risks and delivering on profits. ?
Alex Maddox is director of business origination and development at Acenden. He is based in London.