Nonconforming loans are losing their stigma as the ugly stepchildren of the mortgage family, according to speakers at a conference on subprime lending sponsored by the National Real Estate Development Center.
Many times, the 150 lenders at the conference were told mortgages with lower credit quality, known as B and C loans, would soon become commodities. The commoditizing of mortgages with the highest credit quality, known as A loans, has already shrunk profit margins for traditional lenders.
The supply of the lower-quality loans should increase 25% in the next year, said Anthony Lembke, director of mortgage securities research at Salomon Brothers, New York.
Mortgage originations are increasingly sensitive to rates, Mr. Lembke said. If the rate on a 30-year fixed mortgage declines just 50 basis points - half a percentage point - there will be another refinance boom.
Conversely, if rates increase 50 basis points, volume for prime mortgages will slow down, which will in turn spark interest and competition in B and C loans, Mr. Lembke said.
But while much of the B and C market is still untapped, Mr. Lembke warned against an increase in competitive pricing and higher loan-to-value ratios, which are being offered by lenders that are trying to keep volume up. The higher the loan-to-value ratio, the more loans go into default, he said.
An industry veteran, Gregory Bowcott, told newcomers to nonconforming lending that they should slowly ease into the amount of risk they take.
First, recent entrants should, at the retail level, accept borrowers who have just missed qualifying for conforming loans. When they are comfortable making those loans, Mr. Bowcott said, these lenders should enter the wholesale arena and add riskier products to their menu. Finally, Mr. Bowcott suggested new B and C lenders could eventually add direct-to- consumer sales, using telemarketing and direct mail.
While technology will assist B and C lenders with their underwriting decisions, Mr. Bowcott said artificial intelligence should not be the only method of loan approval.
"We still have to look inside the loan file for the story," Mr. Bowcott said, "but automated underwriting can be used for 80% of the decisions."
