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The secured lending landscape has changed significantly since the global financial crisis. 

Institutional investors such as hedge funds, sovereigns and pension funds are now actively engaged in areas once considered the stronghold of banks, notably after the latter were forced to de-risk and reduce their balance sheets to meet stringent regulatory requirements on capital structure and liquidity. For institutional investors, this has offered a potentially exciting opportunity, but have they been seduced into the mortgage market by the promise of high yields and low volatility without considering the risks?

A recent report on the assets managed by the world’s largest 100 alternatives managers found cash invested in illiquid credit strategies – which include commercial and residential loans – hit $360bn in 2017.

As asset owners continue to search for fixed income yields, and pour more and more money into loans, asset managers are finding they have to deploy capital increasingly quickly, in a safe and competitive manner. But mortgage lending requires a very specific skillset, and new lenders are starting to appreciate the difficulties of juggling product pricing, credit risk, sales, distribution and asset monitoring. On top of these commercial considerations, they must meet the required lending rules of domestic regulators, such as the Financial Conduct Authority and the Prudential Regulation Authority.

A need for speed and attention to detail

Given the need to deploy capital quickly, and with many critical variables to assess, new loan originators can find accessing the market a challenge.  For some, using a servicing company to help manage the process, improve speed to market and bolster key competencies is the easiest option.

In fact, an external servicing business can assist with the entire end to end process, including supporting the distribution process, assessing credit risk, managing data and its analysis, as well as performing due diligence if required. A good servicer can also help with product testing during the implementation phase and challenge the design where necessary, providing an invaluable initial quality control function.

Risk profiling is an essential, but complex, element of lending and one that is often underestimated. For new originators, a lending market may look appealing from an initial top down analysis, but loaded with concealed risks when picked apart in detail.

For example, a lender may build a successful relationship with a key distribution channel early, only to find that they suffer from geographic concentration, or some other covenant breach, up until that time when a portfolio achieves scale and diversifies.

This ‘concentration risk’ is one of many considerations an originator may need guidance on. It is here that servicers can add value, potentially assisting all parties in defining covenants in the lending documentation that are both realistic and achievable over time, and as the book matures.

Harnessing expertise

For funders and originators, the role of the servicing agent goes beyond simply servicing the loans once completed. Servicers have a unique perspective of the lifecycle of secured, real estate backed loans. For example, they can monitor the quality of underwriting throughout the life of a product, providing report data that aids in risk management monitoring, while supporting the trading of loan portfolios in the future, should an investor wish to trade.

For example, left unmonitored, errors in the initial documentation from brokers, at the time of origination, can create huge problems later on. The time and costs of due diligence to correct those mistakes is far greater when an investor comes to selling a loan portfolio, than if caught and rectified early in the lifecycle.

Choosing a servicer

For those who have decided to employ the expertise of an asset servicer, vendor evaluation is critical. A lender requires a partner with experience operating in all market environments and can demonstrate an exemplary track record of servicing capabilities.  They should be able to identify and help manage all applicable credit and operational risks.  Given the challenges and dynamics of this market, the servicer should have a pedigree of proven knowledge and integrity.  A strong leadership team who understands the market, its numerous complexities, with the skills and resources to meet all of the lender’s current and future needs should be a pre-requisite.

Link Asset Services is proud of its reputation and wants its clients to be able to secure the best possible performance from their portfolios. This is not just applicable to the day-to-day borrower interaction and reporting, but also when it comes to strategic events and decisions investors have to make during the financial cycle. Our mantra is to maximise the return from the loans managed, for the least inconvenience to all stakeholders through the lifecycle.

Lenders must ensure they have made every effort to protect client capital. By assessing the track record of the servicer, ensuring they work collectively to safeguard the interests of all parties, only then can a lender feel secure in knowing they have started to manage the risks involved with this opportunity.