The term “run-off ” is appearing more and more frequently in the mortgage world, but it is a phrase which has a fairly ambiguous definition.
Broadly speaking, when mortgages are classified as “in run-off “, they are part of a mortgage portfolio which lenders no longer wish to build or add to.
Why would you not want to add to a portfolio? Well, many investment banks have mortgage books they either originated through subsidiaries or purchased in the secondary market, and they have little interest in increasing the size of these books.
And building societies that purchased mortgage assets from other originators are highly unlikely to add to these while the recession is still a threat.
The majority of these loans were specialist mortgages, typically funded via securitisation,
and that market simply collapsed two years ago.
The number of mortgages in run-off is surprisingly large. Estimates suggest the
value of mortgages in run-off is well north of £150bn – in other words, about 12% of
the entire UK residential mortgage stock.
In the boom years, access to mortgage funding was plentiful and much of the
growth in the mortgage market was funded by recycling cash through securitisations or
selling loans to third parties. This freed up capital that could then be used to originate
new loans. In the summer of 2007 we all know that capital markets across the globe
seized up completely, cutting off the supply of funding.
Many organisations were left holding large stocks of mortgages without the old
exit route supplied by securitisation and whole loan sales. For the first 12 months
after the shock, many of these organisations continued to try to sell the assets in
the secondary markets but as it became clear we were entering a global recession
the value of these mortgages as assets started to slide. The result was that trading
mortgages on the secondary markets became unattractive.
Faced with this reality, the only viable option for lenders was to put the assets into a run-off strategy – in other words to hold the assets until maturity or until a viable secondary market
returns.
There is no universal set of strategies that can be put into play to deal with a
mortgage book in run-off. Expertise in, and extensive knowledge of, the nature of risk
inherent within such books is essential, to determining the right strategies that are
applicable for each mortgage book.
Exact provides such expertise and understanding, and has been extremely active in this market since its launch 12 months ago. We have worked on £4.2bn of run-off assets and whilst this may be a relatively small percentage of the market it is very significant in formulating strategies to address the situation.
It is important first to establish the strategic goals. Is the objective to make
the book smaller in order to recapitalise the balance sheet? Is it more important
to de-risk the book? Or is a mixture of the two objectives more desirable? Once this
core strategy is set, it is imperative to assess what you have – the credit quality of the
borrower and the value of the underlying property acting as collateral is critical.
The amount and nature of risk within a mortgage book has significant implications
regarding what actions are possible and desirable, so understanding that risk from a
multi-dimensional point is essential. Once armed with this intelligence a number of
analytical models can be used to establish the cost of owning these loans out to maturity
against the current market value of the loans. This will require detailed analytics to
establish a base figure for arrears propensity and ultimately the loss severity on any
loans that go into possession.
The key determinant in reducing the size of a mortgage portfolio is the rate at
which borrowers redeem their mortgages. This is normally defined by borrower-driven
events such as the need or desire to move house, often as a result of a life event such
as a birth, death or divorce.
Remortgages have been the predominant reason for redemption over the past decade, however, as the market has inverted, creating a scenario where revert rates are actually better than new business deals, the number of redemptions through remortgaging has declined drastically.
Of course, the good old capital and interest repayment mortgage will reduce balances, but dependant on the make-up of the book this may be the minority segment. The reality is that over the last 12 months or so the redemption curve has flattened out and any lender
relying on pure redemptions to run the book off is in for a long wait.
Stand by for action Once all of the intelligence has been gathered we enter the action phase. One option can be to find ways to speed up the redemption process and, rather than relying solely on borrower-driven events, lender created events can be deployed. Many examples of this strategy can be observed in the form of borrower incentives, such as waving early redemption charges.
Whichever tactics are deployed, the mortgage servicer – whether in-house or third-party – needs to employ pro-active, intelligent servicing strategies. Its processes must be integrated from both a technology and people standpoint to ensure smooth running of the operational strategy. A proactive servicing team who understand the objective and have the right systems at their fingertips will achieve a much better outcome not just for the lender but also, and most importantly, for the borrower.
Treating Customers Fairly (TCF) must be at the top of the agenda for asset owners and servicers when deploying run-off strategies. This starts with treating each customer individually according to their circumstances and working with the customer as far as possible to find the best solution. Our intelligent approach can help to minimise arrears, identify loan modification initiatives that have a high chance of success and target redemption initiatives.
The bedrock of TCF, however, is the quality and experience of the staff who engage with the customers to ensure that any actions suggested are explained clearly to the borrower. Ultimately, there is no substitute for experience in customerfacing staff.
Finally, the servicer must have a robust strategy for the administration of the
remaining mortgages in the portfolio. Due to the economic climate, mortgages are less
fluid than they used to be.
The likelihood is that modelling assumptions will need to be based on a life cycle more typical in the 1980s, when mortgages tended to redeem every seven years on average, rather than every three as we saw during the boom.
With double-digit house price growth looking unlikely, an organisation’s servicing strategy becomes even more important, as lenders cannot rely on increasing property values to reduce losses. Regulation has become broader in the aftermath of the credit crunch and
this will have implications for decades to come. A significant investment in technology and people in the credit and collections departments is therefore vital. Unfortunately, this coincides with a two year period where lenders have sustained losses equivalent to the last 10 years’ profits.
