Asset Managers Improving Yields With Resi Whole Loans
An unmistakable transformation is underway among asset managers and insurance companies with respect to whole loan investments. Whereas residential mortgage loan investing has historically been the exclusive province of commercial banks, a growing number of other institutional investors – notably life insurance companies and third-party asset managers – have shifted their attention toward this often-overlooked asset class.
Life companies and other asset managers with primarily long-term, risk-sensitive objectives are no strangers to residential mortgages. Their exposure, however, has traditionally been in the form of mortgage-backed securities, generally taking refuge in the highest-rated bonds. Investors accustomed to the AAA and AA tranches may understandably be leery of whole-loan credit exposure. Infrastructure investments necessary for managing a loan portfolio and the related credit-focused surveillance can also seem burdensome. But a new generation of tech is alleviating more of the burden than ever before and making this less familiar and sometimes misunderstood asset class increasingly accessible to a growing cadre of investors.
Maximizing Yield
Following a period of low interest rates, life companies and other investment managers are increasingly embracing residential whole-loan mortgages as they seek assets with higher returns relative to traditional fixed-income investments (see chart below). As highlighted in the chart below, residential mortgage portfolios, on a loss-adjusted basis, consistently outperform other investments, such as corporate bonds, and look increasingly attractive relative to private-label residential mortgage-backed securities as well.
Nearly one-third of the $12 trillion in U.S. residential mortgage debt outstanding is currently held in the form of loans.
And while most whole loans continue to be held in commercial bank portfolios, a growing number of third-party asset managers have entered the fray as well, often on behalf of their life insurance company clients.
Investing in loans introduces a dimension of credit risk that investors do need to understand and manage through thoughtful surveillance practices. As the chart below (generated using RiskSpan’s Edge Platform) highlights, when evaluating yields on a loss-adjusted basis, resi whole loans routinely generate yield.
In addition to higher yields, whole loans investments offer investors other key advantages over securities. Notably:
Data Transparency
Although transparency into private label RMBS has improved dramatically since the 2008 crisis, nothing compares to the degree of loan-level detail afforded whole-loan investors. Loan investors typically have access to complete loan files and therefore complete loan-level datasets. This allows for running analytics based on virtually any borrower, property, or loan characteristic and contributes to a better risk management environment overall. The deeper analysis enabled by loan-level and property-specific information also permits investors to delve into ESG matters and better assess climate risk.
Daily Servicer Updates
Advancements in investor reporting are increasingly granting whole loan investors access to daily updates on their portfolio performance. Daily updating provides investors near real-time updates on prepayments and curtailments as well as details regarding problem loans that are seriously delinquent or in foreclosure and loss mitigation strategies. Eliminating the various “middlemen” between primary servicers and investors (many of the additional costs of securitization outlined below—master servicers, trustees, various deal and data “agents,” etc.—have the added negative effect of adding layers between security investors and the underlying loans) is one of the things that makes daily updates possible.
Lower Transaction Costs
Driven largely by a lack of trust in the system and lack of transparency into the underlying loan collateral, private-label securities investments incur a series of yield-eroding transactions costs that whole-loan investors can largely avoid. Consider the following transaction costs in a typical securitization:
- Loan Data Agent costs: The concept of a loan data agent is unique to securitization. Data agents function essentially as middlemen responsible for validating the performance of other vendors (such as the Trustee). The fee for this service is avoided entirely by whole loan investors, which generally do not require an intermediary to get regularly updated loan-level data from servicers.
- Securities Administrator/Custodian/Trustee costs: These roles present yet another layer of intermediary costs between the borrower/servicer and securities investors that are not incurred in whole loan investing.
- Deal Agent costs: Deal agents are third party vendors typically charged with enhancing transparency in a mortgage security and ensuring that all parties’ interests are protected. The deal agent typically performs a surveillance role and charges investors ongoing annual fees plus additional fees for individual loan file reviews. These costs are not borne by whole loan investors.
- Due diligence costs: While due diligence costs factor into loan and security investments alike, the additional layers of review required for agency ratings tends to drive these costs higher for securities. While individual file reviews are also required for both types of investments, purchasing loans only from trusted originators allows investors to get comfortable with reviewing a smaller sample of new loans. This can push due diligence costs on loan portfolios to much lower levels when compared to securities.
- Servicing costs: Mortgage servicing costs are largely unavoidable regardless of how the asset is held. Loan investors, however, tend to have more options at their disposal. Servicing fees for securities vary from transaction to transaction with little negotiating power by the security investors. Further, securities investors incur master servicing fees which is generally not a required function for managing whole loan investments.
Emerging technology is streamlining the process of data cleansing, normalization and aggregation, greatly reducing the operational burden of these processes, particularly for whole loan investors, who can cut out many of these intermediary parties entirely.
Overcoming Operational Hurdles
Much of investor reluctance to delve into loans has historically stemmed from the operational challenges (real and perceived) associated with having to manage and make sense of the underlying mountain of loan, borrower, and property data tied to each individual loan. But forward-thinking asset managers are increasingly finding it possible to offload and outsource much of this burden to cloud-native solutions purpose built to store, manage, and provide analytics on loan-level mortgage data, such as RiskSpan’s Edge Platform supporting loan data management and analytics. RiskSpan solutions make it easy to mine available loan portfolios for profitable sub-cohorts, spot risky loans for exclusion, apply a host of credit and prepay scenario analyses, and parse static and performance data in any way imaginable.
At an increasing number of institutions, demonstrating the power of analytical tools and the feasibility of applying them to the operational and risk management challenges at hand will solve many if not most of the hurdles standing in the way of obtaining asset class approval for mortgage loans. The barriers to access are coming down, and the future is brighter than ever for this fascinating, dynamic and profitable asset class.
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RS Edge Platform Implementation Streamlined Processes Reducing Client Resource Support Needs by 46%-VERSION 2
PROBLEM
An asset manager sought to replace an inflexible risk system provided by a Wall Street dealer. The portfolio was diverse, with a sizable concentration in structured securities and mortgage assets.
The legacy analytics system was rigid with no flexibility to vary scenarios or critical investor and regulatory reporting.
CHALLENGE
Lacked a single-solution
Data integrity issues
Inflexible locally installed risk management system
No direct connectivity to downstream systems
Models + Data management = End-to-end Managed Process
HIGHLIGHTS
5 Vendors → Single Platform
32% Annual Cost Savings
Increased Flexibility
Additional
RS Edge Platform Implementation Streamlined Processes Reducing Client Resource Support Needs by 46%-VERSION 1
AT-A-GLANCE
An asset manager sought to replace an inflexible risk system provided by a Wall Street dealer. The portfolio was diverse, with a sizable concentration in structured securities and mortgage assets.
The legacy analytics system was rigid with no flexibility to vary scenarios or critical investor and regulatory reporting.
5 Vendors → Single Platform
32% Annual Cost Savings
Increased Flexibility
Additional Ad-hoc Analytics
”Our existing daily process for calculating, validating, and reporting on key market and credit risk metrics required significant manual work… [Edge] gets us to the answers faster, putting us in a better position to identify exposures and address potential problems.”
— Managing Director, Securitized Products
Models + Data management = End-to-end Managed Process
RiskSpan Chosen “Best Company for Diversity and Inclusion” Category Winner in WatersTechnology’s Women In Technology & Data Awards 2022 Rankings
RiskSpan Chosen “Best Company for Diversity and Inclusion” by WatersTechnology Women In Technology & Data Awards 2022
RiskSpan’s Diversity, Equity & Inclusion Initiative
RSOne Vision
Diversity, Equity & Inclusion has been a recent focus of RiskSpan as of early 2021, and Managing Director Christabel James has led the effort. She works closely with RiskSpan’s executive team to initiate and build out RSOne DEI strategies. Christabel has established a mentoring program and organized a number of team building events. She is also active in coordinating and attending events geared towards women in finance.
Formal Mentorship Programs
- Open to all employees companywide
- One on one conversations with team members to understand their personal and career aspirations and match them to a mentor
- Guide executive and management team on mentorship community
- Heavily promote reverse mentoring
- Created and shared guides with both mentors and mentees providing guidance on the program
Engagement
- Implement DEI Images for laptop screensavers
- Host competitions with the goal of raising awareness
- Initiate and share results of survey along with action items
Observances
- Established Juneteenth as a corporate holiday
- Regular companywide communication drawing attention to a DEI resources
Women’s Employee Resource Group (ERG)
- Established ERG to support and encourage the women in the firm
- Established a women’s forum and schedule individual conversations with junior staff
- Hosted female’s get together which included women at all levels from associate analysts to CEO
Industry DEI Committees and Events
- RiskSpan is an active contributor to the Structured Finance Association’s DEI Toolkit Initiative, which provides guidance and resources on best practices related to DEI. SFA’s Toolkit includes a combination of video interviews, member-written blogs, articles, podcasts, and member-firm submitted resources centered around diversity recruitment.
- Participated in the Virtual National Diversity and Leadership Conference 2021
Training Framework
- Available to anyone seeking assistance with certifications and customized training programs
- Built a framework for team to take advantage of courses included as part of memberships for free or a reduced cost
- RS Portal integration was initiated
