Since the mid 1990s the securitisation process has helped ensure that the supply of mortgage finance was not restricted to the deposit monies held from savers.
Without securitisations there would be a significant mismatch between market demand and the available supply of finance. The property market and mortgage lending has boomed, fuelled by the increasing availability of credit through wholesale finance and eventual securitisation.
This method of funding has enabled centralised lenders to originate volume lending without a balance sheet of deposits to call on, and helped many financial institutions manage their balance sheet and to lend in greater volume than their deposits would otherwise allow.
The number of transactions for residential mortgage backed securities (RMBS) has far outstripped the number of CMBS deals – ie, the commercial mortgage equivalent. This is clearly consistent with the size of the relevant markets and also the maturity of the residential sector.
To provide some context, during 2007 approximately 250bn euros of residential mortgages were securitised compared to 60bn euros of commercial mortgages.
Commercial mortgage securitisations differ significantly from residential programs. Residential deals are typically made up of a large number of individual mortgages with smaller loan sizes – offering a significant diversity or “granularity” as investors would normally refer to it.
In contrast, traditional commercial deals normally consist of much fewer but significantly larger loans on substantial property values, often dominated by investment loans.
It may surprise you to know that some commercial deals have in the past been made up of just eight very different loans – whereas a typical residential pool would include thousands of very similar properties and borrowers.
Turning to the current market conditions we are seeing interest rates rising and loan criteria being tightened across the board, a condition that stems from liquidity constraints in the wholesale finance markets and a shift in credit appetite – both sparked by widespread borrower defaults in the USA.
The effective closure of the securitisation market, which ultimately is the repayment vehicle for short term wholesale finance, lies at the heart of the problem.
This market pretty much closed in August 2007 as investors became nervous about the quality of the mortgage assets supporting the bonds as US non-conforming loans began to default against a backdrop of falling property prices.
The effect of this is being felt within the UK commercial mortgage market, as well as in the residential sector. Specialist commercial lenders will undoubtedly find their funding harder and more expensive to come by.
Many of these have established their business models around the capital markets, either here or in the US, and will face the prospect of warehouse funding at higher rates with more restrictive terms together with higher securitisation costs once volume is sufficient to complete a transaction.
We have already seen the withdrawal of two lenders from the market – and as with the whole mortgage industry these can be directly attributed to conditions in the wholesale finance markets.
Wholesale funding and securitisation are fundamental to the financial system and the UK mortgage industry. Conditions will improve and the markets will reopen, albeit the terms of doing business will be tougher and more expensive.
From an intermediaries perspective the upside during this disruption is that customers will find the provision of credit harder to come by and as a result find the services of a professional intermediary all the more necessary.