Subprime mortgage lending: recognising its potential and managing its risks

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                                         HOUSING MORTGAGE
                                                   SUBPRIME
                                                          & MORTGAGE
                                                            HOUSING TRANSACTION
                                                                      LENDING   IN CHINA

              Subprime mortgage lending: recognising its
                   potential and managing its risks
                        By Edoardo Turano, Experian – Scorex’s Business Consultant,
                                            Experian - Scorex

          Risks and opportunities in subprime              for example, by their credit history) and that   and collecting the loans) compared to prime
          mortgage lending                                 do not qualify therefore for the prime           loans. The difference [1] is generally in the
                                                           market. The availability of subprime             order of 3 to 4.5 per cent over the base rate.
          Subprime mortgage lending offers many            products is not limited to mortgages but it      Given the higher risk implied by such loans,
          opportunities for growth and profitability.      includes other typical retail products such      usually subprime lenders try to cover the
          While this market is already well developed      as personal loans and credit cards.              higher related costs through [1]:
          in the US and the UK, in the rest of Europe                                                       • frequent use of early redemption charges;
          there is still a low availability of non-        Considering mortgage products, subprime          • frequent requirement for Mortgage
          standard mortgage offers. However, recent        loans are offered to borrowers who                 Insurance;
          research suggests there is a significant         represent a higher level of risk with respect    • higher commission fees (with differences
          untapped demand for this type of product in      to standard mortgage underwriting                  compared to prime loans up to 1% of the
          Europe. Many lenders are therefore trying to     guidelines. These loans are characterised          credit facility).
          enter this market by expanding their             by interest rates (and fees) higher than the
          product offering to reach a wider customer       standard prime rate that is available in the     An overview of the European subprime
          base.                                            market at a given point in time. The most        mortgage market
                                                           common categories of applicants who fall
          To be successful in this market though,          into the subprime mortgage segment are:          Recent research [2] indicates that there is a
          lenders will need to address the issues of       - Borrowers with a poor credit history           significant demand in Europe for high risk
          funding and risk management. Many                  (previous credit problems);                    mortgage loans. This has been valued as
          lenders, in fact, underestimate the higher       - Borrowers asking for high Loan to Value        ranging from 400 billion euros to over 1,200
          risks in subprime lending and its proper           (LTV) mortgages;                               billion euros in the medium term. This
          management, ending up with losses. This          - Borrowers with a high Debt to Income           forecast growth depends on future house
          article presents an outline of a quantitative      ratio;                                         prices and on regulatory issues.
          approach to risk evaluation and risk based       - Borrowers who cannot document all of the
          pricing as an effective tool to deal with          underwriting information in their              Currently, the availability of high risk
          regulatory      compliance      and      risk      application.                                   products in Europe is fairly limited,
          management. This type of approach brings                                                          especially compared to the US and UK. For
          many benefits when correctly implemented,        Statistics show that loans to this type of       example, in most European countries it is
          although it does present some difficulties in    borrower are characterised by high default       very difficult for borrowers to succeed in
          its practical implementation especially to       rates (borrowers falling into arrears which      obtaining a mortgage with a loan to value
          entrants to the subprime mortgage market.        cannot be recovered) and high loss rates         higher than 80%. Other examples are loans
                                                           (lender’s loss after repossession compared       to people with poor credit histories, self-
          What are subprime mortgages?                     to original loan amount) and are therefore       certified income or for older age applicants.
                                                           considered as posing significant risk.           All of these products are generally not easily
          The term subprime (also called non-                                                               available although there is quite a difference
          conforming or non-standard) defines a            Subprime loans are offered with higher than      among countries with the UK being
          specific lending market sector where             standard interest rates, as the lender needs     recognised as the most developed
          borrowers are considered as posing a             to cover higher credit losses and overhead       European mortgage market. Estimates of
          higher than standard credit risk (as revealed,   costs (related to underwriting, servicing,       the subprime market in the UK indicate a

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                                         HOUSING MORTGAGE
                                                   SUBPRIME
                                                          & MORTGAGE
                                                            HOUSING TRANSACTION
                                                                      LENDING   IN CHINA

          share in the order of 10% of total mortgage      credit history [1]. In the UK, the most         loss-on-default rates involved with subprime
          market value [3]. In the US instead, the         developed European mortgage market, the         lending, as well as the higher overhead
          market share of subprime loan originations       corresponding percentage is much lower.         costs. Moreover, they frequently lacked the
          was approximately 20% of the total               Furthermore, in the US there is wider           management expertise, business planning
          mortgage market in 2004, and subprime            availability of historical data on subprime     processes, and risk management processes
          mortgages originations have been growing         loans on which robust quantitative analysis     necessary to manage these risks in a safe
          at an average annual rate equal to 25% from      can be based. Regarding analysis,               and sound manner.”
          1994 to 2003 [4].                                European lenders have obviously learned
                                                           from the US business model in terms of risk     Pricing is the key to a successful
          There are however many factors that justify      management. However, many lenders still         subprime lending business
          expectations for a likely expansion of the       lack the necessary know-how and expertise
          European subprime mortgage market. First         to develop sophisticated pricing models         It is evident then that the most crucial
          of all, a general widespread growth in credit    necessary to handle the risk in subprime        element for a sub-prime lender is the
          use (not limited to mortgages) is evident.       mortgages.                                      assessment and the pricing of risk. This
          The demand for mortgage credit has been                                                          includes both a careful evaluation of the
          increasing in particular among non-              The high risk in subprime mortgages             customer’s riskiness at application and
          traditional borrowers. A typical example of                                                      effective methods of dealing with loans that
          this class of borrower is immigrants, whose      The increased risk in subprime lending          start to fall into arrears. An objective
          share of the European population is              needs to be carefully assessed and              assessment of risk at application allows the
          becoming more and more substantial.              managed. Clearly, a lender who decides to       lender to reject applicants whose higher risk
          Immigrants are generally considered as           enter the subprime mortgage market has to       cannot be offset by higher interest rates
          subprime borrowers as they are                   be prepared to deal with higher delinquency     (considering obvious practical and legal
          characterised by limited credit histories, low   rates than those relative to standard prime     constraints) and that are profitable only for
          incomes and are likely to apply for high loan    mortgages. An analysis of a real portfolio      lenders engaged in equity lending.
          to value mortgages. Moreover, the growth in      showed that for subprime loans serious          Accepted applicants are then assigned an
          self-employment or in flexible working           delinquency rates [4] can be 20 times higher    interest rate that reflect their risk.
          arrangements (with less certain and regular      than for prime loans. Apart from high
          income streams) has also somehow                 delinquency rates, lenders should also          Although all subprime lenders have a
          modified the “traditional” consumer              expect higher than average loss rates from      methodology to adjust the price on the
          landscape, pushing further the demand for        their subprime portfolio. The combination of    basis of the borrower’s risk, there are clearly
          innovative mortgage products that do not         high delinquency rates and high loss rates      different levels of sophistication. Many
          rely on standard underwriting practices.         may result in risk that could be                lenders, in fact, employ a fairly basic
                                                           unmanageable. This is why within the            calculation, based on a coarse risk
          Another driver of subprime loans growth          subprime segment it is necessary to             segmentation of their subprime customers,
          worth highlighting is the increasing             distinguish among different classes of          denoted by letters such as A- (the least risky
          popularity in Europe of mortgage insurance.      customers in terms of risk. These range         category), B, C, or D (the riskiest category).
          This allows the lender to transfer part of the   from lower risk customers (near prime),         Borrowers within each category are
          risk to the insurer. If the borrower defaults    through medium risk, and to high risk           generally charged the same interest rate
          on his payments and the loan is                  customers. While the majority of lenders will   with minor differences among borrowers in
          subsequently written off, part of the lender’s   only target the first two groups, the highest   the same risk group due to the negotiating
          loss is covered by the insurance                 risk group is generally the target of           ability of the borrower or the mortgage
          underwriter. With mortgage insurance,            specialized lenders, prepared to cope with      broker, and certain risk indicators such as
          many lenders are willing to offer higher risk    the greater risks implied by such loans or      property type or ability to document
          products. In Italy for example, mortgages        who aim to profit through the repossession      income. The risk segmentation, however, is
          with a loan to value up to 100% are              of the collateral (equity lending).             often based on a limited set of risk drivers
          becoming popular thanks to mortgage                                                              (eg LTV) that may not result in risk being
          insurance, as generally regulatory               The reality is that many lenders try to enter   homogeneous among each class. This
          requirements would not allow banks to offer      the subprime market without the necessary       causes lower risk customers within a class
          housing loans with an LTV higher than 80%.       requisites. As recognised by the US             to be overcharged, effectively subsidising
                                                           Comptroller of the Currency [5]: “A number      the higher risk customers within the same
          Two important aspects in which European          of institutions have incurred significant       class who are being undercharged.
          mortgage lenders are lagging behind their        losses and other problems because of
          US counterparts regard data capture and          poorly structured subprime lending              The segmentation may also be the result of
          analysis. In the US, credit-scoring agencies     programs. Generally, these institutions         expert judgment that, although it is an
          can access 80–90 per cent of people’s            underestimated the higher default rates and     important element in all business decisions,

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                                          HOUSING MORTGAGE
                                                    SUBPRIME
                                                           & MORTGAGE
                                                             HOUSING TRANSACTION
                                                                       LENDING   IN CHINA

          lacks the objectivity and consistency of            the probability of a future event. Credit           PD is the likelihood that a client will default
          quantitative analysis. As for the correct           scoring is an instrument widely used by             on his repayments in a given timeframe. The
          pricing for each level of perceived risk, this      companies for the internal processes of             EAD is the value of the bank’s exposure at
          is a task that requires a significant effort in     portfolio     risk      measurement       and       the time of the borrower’s default. This can
          terms of data collection and analysis. Many         management. It allows a lender to estimate          be expressed either in absolute terms or in
          lenders employing simplified pricing criteria       the probability of future insolvency of a           terms of a percentage of the loan exposure
          find themselves incurring higher than               person requesting credit or of an existing          at origination. The LGD is the loss on a
          expected losses.                                    customer. The profile is calculated on the          credit instrument after the borrower has
                                                              basis of the information available at the           defaulted. It is therefore a percentage of the
          The most advanced lenders rely on                   moment of the decision. Application scoring         exposure at default that takes into account
          automated underwriting systems and on               estimates, at the moment of the request, the        not only the amounts recovered but also the
          quantitative analysis for price setting.            level of risk associated with each                  associated direct and indirect costs. By
          Automated underwriting systems evaluate             application before it is effectively approved.      building scoring models for each of these
          applications using algorithms based on              In practice, credit scoring results in the          three parameters, a lender is able to have an
          statistical analyses of historical data             definition of a table listing the                   objective and accurate estimation of the
          containing        previous       applicants’        characteristics that provide the most               expected loss of a prospective client at the
          characteristics and their performance in            predictive information, together with the           application stage. An example of the
          terms of debt repayment. This is generally          associated attributes and weightings. A             estimation of the expected loss using
          referred to as credit scoring. Credit scoring       total score is obtained as the sum of the           scoring models is given in the figure below.
          techniques are recognised as being more             points in each characteristic. The total score      A given applicant would be associated to a
          accurate and consistent than manual                 corresponds to an estimate of the                   different level of PD, LGD and EAD
          underwriting in determining the riskiness of        probability of default.                             (expressed as a percentage of the original
          individual loan applications. An accurate                                                               exposure) using the output of three scoring
          estimation of risk allows a more                    Even though scoring models have                     models. The product of the resulting values
          sophisticated quantitative approach to              traditionally been used only to assess the          of these three parameters with the
          pricing to be taken, which in turn allows a         default probability of a client, the true risk of   requested loan amount results in the
          lender to define clear and objective goals          a loan is given by its expected loss. Not           estimate of the expected losses.
          such as profit maximisation or volume               every client with the same default
          increase.                                           probability has the same potential loss. Two
                                                              clients with the same default probability can
          An objective risk evaluation of subprime            react differently to collection procedures
          borrowers                                           and generate very different losses for the
                                                              lender. The product of three different
          Scoring can be defined in general as a              elements gives the expected loss:
          statistical technique to predict, at a specific     probability of default (PD), loss given default
          point in ti.me with the available information,      (LGD) and exposure at default (EAD). The

                                                            Figure 1 – Calculation of expected losses
                                                                   Loan and applicant characteristics

                            PD scoring model                               EAD scoring model                              LGD scoring model

                           Quantile PD         %                   Quantile EAD     %                      Quantile EAD                       %
                               1                5                       1           50                           1                            10
                               2               10                       2           58                           2                            30
                               3               12                       3           65                           3                            40
                               4               15                       4           68                           4                            42
                               5               20                       5           70                           5                            48
                               6               25                       6           72                           6                            57
                               7               30                       7           74                           7                            60
                               8               35                       8           78                           8                            68
                               9               40                       9           80                           9                            73
                                                                 Loan amount = $100,000
                                      Expected Loss = PD x EAD x LGD x Loan Amount = 0.12 x 0.58 x $100,000 = $3,967

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          There are three main drivers of risk for          while retaining all the evidence available in         Cost of funding                  4.50%
          mortgages: LTV (there is in fact significant      the existing portfolio (for example regarding
          evidence that default rates rise sharply          the correlation between the variables).               Operating costs                  1.25%
          when the LTV is higher than 80%), debt to
                                                                                                                  Expected loss allowance          2.50%
          income ratios (DTI, measuring the ratio           Another issue which affects the estimation
          between instalment and monthly income)            of risk for mortgages in general is that              Desired return                   2.00%
          and credit bureau scores (accounting for          collateral risk can have a greater impact on
          experiences with other institutions for a         loss than default risk. Credit risk estimation        Final price                     10.25%
          more comprehensive assessment of the              techniques are limited by the difficulty in
          applicants’ creditworthiness). These              forecasting changes in collateral values,           Figure 2 – Cost model for interest
          variables represent the key information used      regardless of their accuracy in assessing the       rate determination
          by credit scoring models to assess the PD         creditworthiness of individual borrowers.
          and the LGD. Socio-demographic                    Experience shows that collateral risk is            This cost model incorporates all the items
          information (age, residential status, etc) of     difficult to measure [6] and, even more so, it      that should be taken into consideration in
          the applicant is also used to increase the        is difficult to forecast over the typical life of   determining the price:
          accuracy of the models. As for the EAD, the       a mortgage.
          main driver is the maturity of the loan. It is                                                        a) Cost of funds: the interest rate at which
          very rare for borrowers to default soon after     Some lenders, while recognising that credit            the lender can borrow money;
          they have received credit (unless fraud is        scoring is a valuable tool, do not think that it    b) Operating costs: rate increase to include
          involved) and when they have nearly               can be applied to subprime lending. This is            costs to originate, service and terminate
          completed the repayments. Estimating the          because the risk in subprime mortgages is              the loan;
          time of default and knowing the repayment         driven by many qualitative factors.                 c) Expected Loss Allowance: rate increase
          amount enables the lender to estimate the         Therefore it is argued that an individual              to take into account the expected loss
          exposure at the time of default.                  approach to underwriting is necessary.                 rate (PD x EAD x LGD) that can be
                                                            However qualitative evaluation criteria can            estimated using scoring models as
          New entrants to the subprime segment are          always be combined to the results of the               described above;
          likely to have some difficulties in developing    quantitative evaluation performed by the            d) Desired return: takes into account the
          scoring models. Scoring models allow              scoring model to increase the quality of the           target return on the investment and
          accurate predictions when they are                risk estimation. This approach is also taken           should be such as to adequately
          developed on the basis of historical data         for the credit risk assessment of small                remunerate the cost of the economic
          that is representative of the characteristics     businesses (SME) and corporate clients                 capital (for example, as from Basel II
          of the target population. Therefore models        where there are a lot of qualitative aspects           advanced internal rating approach or
          developed for prime borrowers should not          (such as the quality of the management or              from any value at risk model) employed
          be used for risk assessment of subprime           the business perspective of the market                 by the financial institution (also known as
          borrowers. Institutions should instead build      sector where the company operates) used                the cost of risk).
          models on data representative of the              to integrate the quantitative risk evaluation.
          targeted subprime borrowers. However new                                                              In a more comprehensive view of the
          entrants to the subprime segments will not        A quantitative approach to risk based               approach, there are other items that can be
          have this data available, given that              pricing for subprime lending                        considered such as relationship and
          mortgage defaults appear generally several                                                            competition adjustments. Relationship
          years after origination. In this case it may be   Risk based pricing (RBP) is the practice of         adjustments take into account the
          possible for them to rely on external data. It    charging different interest rates depending         relationship and value of existing customers
          is also possible to infer the behaviour of        on the risk of the loan. A basic approach to        in terms, for example, of potential additional
          risky customers from an existing portfolio of     the determination of the interest rate is           revenues to the lender in the form of a
          prime customers by incorporating prior            based on identifying costs and then adding          purchase of additional products or the
          assumptions regarding the relationship            the required rate of return to determine            introduction of additional clients. More
          between risk and risk drivers. For example,       pricing. An example of this approach, in its        valuable customers can be offered a higher
          a portfolio of prime loans may not have           simplified version, is given in the following       discount. Competition adjustments allow
          customers with LTV > 80%. A possibility is        figure.                                             lenders to take into consideration existing
          then to assume a relationship between                                                                 market conditions with a price adjustment
          default rates and LTV for LTV values higher                                                           that makes sure that the final price is
          than 80%, using for example available                                                                 competitive. Whilst the latter is quite usual,
          evidence from the US market. This enables                                                             the former is more difficult to estimate given
          the subprime lender to build a scoring                                                                the several difficulties that have to be faced
          model for an extended range of LTV values                                                             when dealing with the estimation of future

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           cross- (or up-) selling opportunities or the                     Flat rate lenders could then face a significant        pricing strategy. With no differentiation, the
           evaluation of the value of new customers                         issue since, over a period of time, the profile        interest rate is independent of the risk of the
           potentially introduced by the applicant.                         of the portfolio could change with a lower             applicant (denoted in the figure as AAA for
                                                                            proportion of good quality customers and an            the less risky, to the more risky CCC). By
           Given that under a risk-based pricing                            altered risk profile, which can significantly          charging a lower interest rate to low risk
           framework the price is more sensitive to risk,                   change the financial exposure of the                   applicants it is possible to improve the
           financial institutions adopting it can avoid                     organisation (as offered prices would be in            volume of applications (maximisation of size)
           the adverse selection effect. Adverse                            fact more attractive to risky borrowers).              while still being profitable. A maximisation of
           selection can affect lenders not applying                                                                               risk adjusted returns results in a flat price for
           risk-based pricing in a market where other                       Another benefit of a quantitative RBP                  the lower risk grades and an increase in
           lenders are. Higher risk customers will be                       approach is that it allows for a differentiated        price for the higher risk applicants. A
           offered higher rates by lenders operating a                      set of strategies to be implemented. The               combination of the two previous approaches
           risk-based pricing strategy and will                             following figure illustrates three possible            results in a full price discrimination with a
           potentially migrate to those lenders offering                    strategies that can be adopted with a                  trade off between volume and profitability.
           a flat rate as this will offer them better value.                variable interest rate compared to a flat

                                                Figure 3 – Implementation of different strategies for risk based pricing
                                            Now: market taker, no differentation                                             Maximisation of risk adjusted returns
                              2500                                                                        2500

                              2000                                                                        2000

                              1500                                                                        1500

                              1000                                                                        1000

                              500                                                                         500

                                0                                                                           0
                                     AAA   AA       A        BBB       BB          B   CCC                       AAA    AA          A        BBB        BB           B   CCC
       Y axis: basis points
       X axis: credit class
                                                    Maximisation of size                                                           Full price discrimination
                              2500                                                                        2500

                              2000                                                                        2000

                              1500                                                                        1500

                              1000                                                                        1000

                              500                                                                         500

                                0                                                                           0
                                     AAA   AA       A        BBB       BB          B   CCC                       AAA    AA          A        BBB       BB        B       CCC

           The adoption of risk-based pricing brings                        Some limitations of risk-based pricing arise           on interest rate, beyond which customers
           benefits not only to lenders but also to                         from constraints set by regulators. One                have to be declined.
           consumers. Lower risk consumers are                              example is the need to advertise interest
           rewarded for their good financial                                rates. In the UK, for example, lending                 Although the RBP practice is not without
           performance and can benefit from                                 organisations must give the advertised rate,           criticism, it allows lenders to set prices in an
           increased choice and competitive rates. For                      or a better rate, to 66% of applicants. This           objective and transparent manner. This is
           higher risk consumers, the gap between                           is simple when using a flat rate; however it           very important in the subprime market
           mainstream and alternative finance sources                       becomes much more difficult with risk-                 where there are many concerns regarding
           can be significant. Organisations that                           based pricing, where there needs to be                 fair lending. An objective assessment of
           previously would not have lent to these high                     accurate portfolio information to determine            client risk allows reputable lenders to offer
           risk consumers are now lending at an                             the advertised rate. Another example is                fairly priced product to individuals who
           appropriate price, so risk-based pricing                         caps on interest rates set by regulators. This         have difficulties in obtaining finance on
           brings more of the population into the                           means that if risk-based pricing is used               standard terms and conditions. Serious
           mainstream lending process.                                      there may need to be a cut-off level based             lenders can therefore differentiate

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          themselves from predatory lenders [1] who         must assess all costs needed to service          [2] Mortgage Insurance Trade Association
          instead attempt to make a profit in the           these assets and the expected losses that        and Mercer Oliver and Wyman News
          subprime segment by:                              will impact on profits. Some subprime            Release (2005) Untapped mortgage
          a) marketing loans explicitly at those in         lenders, in fact, charge borrowers high up-      demand tops 3500 billion across Europe
              debt;                                         front fees that allow them to originate a high
          b) offering loans with limited or no enquiries    volume of loans that include very high risk      [3] Financial Times (2006). Fears over surge
              about income;                                 customers, and this can put purchasers at a      in high risk mortgage
          c) being interested in the value of the           disadvantage. Furthermore, subprime
              collateral rather than the borrower’s         loans, especially those purchased from           [4] Inside B&C Lending, Vol. 10, Issue 4,
              credit- worthiness (‘equity lending’);        outside the institution’s lending area, are      February 14, 2005, p 1.
          d) charging high brokers’ or other advance        particularly at risk of fraud or
              fees;                                         misrepresentation (ie, the quality of the loan   [5] OCC bulletin 99-10 (1999) Interagency
          e) charging very high interest rates not          may be lower than the loan documents             Guidance on Subprime Lending
              commensurate with the real risk of the        indicate).
              applicant;                                                                                     [6] Temkin, K., Johnson, J.E.H and Levy, D.
          f) charging increasing interest when a loan is    One issue not to be overlooked regards the       (2002) Subprime markets, the role of GSEs
             in arrears.                                    impact of an economic downturn. Adverse          and Risk Based Pricing. The Urban Institute
                                                            macro economic conditions have a
          A key issue for the development of the            particularly relevant impact on the less         [7] Bradley, E., Kane, B. (2005) Europe's
          subprime loan market is funding. While            financially stable subprime borrowers.           Whole Loan Sales Market Burgeoning As
          banks can raise money from savers to offer        However, mortgage products have                  Mortgage Credit Market Comes Of Age.
          mortgage loans, smaller players, who may          developed considerably in the last decade,       Standard & Poor’s Structured Finance
          have no branch network, cannot rely on            without related risks being tested in times of
          deposits to finance their lending. These          economic stress. The need for stress testing     [8] Cataldi, G. (2003) Profitability
          institutions can raise funds for further          required in the Basel II framework is            Optimisation: The use of Risk Adjusted
          lending by selling part of their loans (their     therefore particularly relevant for subprime     Performance Measures. Experian-Scorex
          assets) to institutional investors. This          lenders who should test the effect of            White Paper
          practice, called securitisation, is becoming      economic         downturns        on      the
          more widely used for subprime lending. The        creditworthiness of their portfolio.             [9] Putt, J. (2006) A profit driven approach to
          credit risks are passed from the original                                                          risk based pricing. Experian-Scorex White
          lender to the institutional investor while the    Conclusions                                      Paper
          originator retains the loan servicing rights.
          An objective and consistent assessment of         There is a growing demand in Europe for          [10] White, A.M. (2004) Risk-Based
          risk through quantitative analysis is             higher risk mortgage products. This market       Mortgage Pricing; Present and Future
          therefore a key aspect of these                   offers many opportunities for profitability      Research. Housing Policy Debate Vol 15
          transactions. This is particularly critical for   but it also involves considerable risk. Some     Issue 3.
          the whole loan sale market. In a whole loan       prime and near prime lenders have already
          sale, an originator will sell a pool of loans     approached the market directly or through        [11] Lax, H., Manti, M. , Raca, P. and Zorn,
          directly to another institution, rather than      other companies they control or with which       P. (2004) Subprime Lending: An
          through securitisation. The buyer pays an         they have ad hoc agreements for the sale of      Investigation of Economic Efficiency.
          originator face value plus a premium for this     subprime credit products. A quantitative         Housing Policy Debate Vol 15 Issue 3.
          pool. While in the US this type of fund           approach to risk evaluation and more
          raising is widespread, the European market        tailored pricing strategies can provide the      [12] Collins, M., Belsky, E., and Case K.E.,
          has only recently reached a level of              competitive edge that will enable the first      (2004) Exploring the Welfare of Risk-Based
          structuring       sophistication    and     an    movers to acquire a dominant position in         Pricing in the Subprime Mortgage Market.
          understanding of fundamentals of the credit       these markets.                                   BABC 04-8
          risk, liquidity, and relative value pricing to
          embrace the whole loan sales market [7]. A        References                                       [13] International Convergence of Capital
          strong whole loan sales market is likely to                                                        Measurement and Capital Standards. A
          be a key driver of growth for the European        [1] Munro, M., Ford, J., Leishman, C. and        Revised Framework (2004). Bank for
          subprime mortgage market.                         Kofi Karley, N. (2005) Lending to higher risk    International Settlements
                                                            borrowers:      Sub-prime     credit    and
          The evaluation of risk is a critical task for     sustainable home ownership. Joseph               [14] Crews Cuts, A. and Van Order, R.A.
          institutions purchasing subprime loans            Rowntree Foundation                              (2003) On the economics of subprime
          securities from other lenders. Purchasers                                                          lending. Freddie Mac

          42                                     HOUSING FINANCE INTERNATIONAL – September 2006
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