Self-securitization eases a switch to adjustables.

THE HIGHLY COMPETITIVE mortgage market in California is often the spawning ground for new kinds of lending businesses. One of the latest examples: adjustable-rate mortgages to people with less-than-immaculate credit histories at rates that float high above the London interbank offered rate.

With credit enhancement, such loans can be packaged into triple-A issues that carry market rates to investors but leave the lender with net servicing spreads that can run as high as 5%.

Dewey Consulting Group, Long Beach, Calif., specializes in helping lenders to securitize their own loans, known as B, C, and D credits, to borrowers with substandard credentials.

American Banker's Edward Kulkosky talked to the group's principal, John D. Dewey, about how he helped one client, First Alliance Mortgage Co. of Orange, Calif., a home equity lender, to convert to originating and securitizing premium-rate first mortgages.

Q.: Why did First Alliance decide to make a change?

DEWEY: They were basically responding to competitive pressures that were pushing rates down, and also to impending regulatory pressures that have been focused extensively over last two years on the home equity business.

The company had focused on home equity loans to weak credit. They had sold all of their production as whole loans and retained the servicing at spreads of 150 to 200 basis points.

Q.: A pretty lucrative business?

DEWEY: It was. But the pressure was on. Early last year, we did the first securitization, getting a rating of triple-A on the senior piece, and single-A on the B piece. The weighted average coupon rate was about 14% on the fixed-rate loans. The weighted average cost of funds when we sold the securities was 6%. Then we completed a second securitization, using a surety bond from MBIA Inc.

Q.: When was the shift to adjustable rates made?

DEWEY: In the second half of last year. Rates were coming down nationally and we found our marketing costs for fixed-rate loans were going up. And refi mania was taking share away from First Alliance.

Q.: So First Alliance really had to reshape its whole approach?

DEWEY: We launched the program into our wholesale division first, then into our retail branch system in mid-August. In April, First Alliance funded about $10 million in fixed-rate product, but as the system developed a comfort level with adjustable products, they originated $39 million in October, a 380% increase. And 70% of originations in October were in Libor-based adjustables.

The net result is that First Alliance has gone from originating $100 million a year of fixed-rate second mortgages to $400 million of first-mortgage adjustables in less than a year.

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