Home Equity: As in Subprime Auto Game,Some Equity SpecialistsSeen

Jerry Robinson says he can't help being skeptical about home equity stocks.

"I'd like to be bullish-I'm an optimist," the Stephens Inc. analyst said. But Mr. Robinson, who's been following both kinds of finance companies for the past 14 months, notes "eerie parallels" between home equity and the subprime auto sector, which crashed early this year.

Accounting standards vary widely in the high-margin business of lending to homeowners with poor credit, and credit scoring practices are nonexistent, he said. What's more, a ready supply of cash, in the form of securitizations, has placed a high priority on loan volume.

"Some of these companies will continue to do well," he said of the home equity lenders he follows. "But one of them is going to walk off a cliff."

Faced with the comparison to auto lenders, home equity lenders insist that borrowers are less likely to walk away from their homes than from their cars, and that will keep delinquencies in check. But Mr. Robinson is not convinced.

He said the securitization market for the loans is like a college that allows students to grade themselves. Subprime mortgage companies rate their own loan pools on a subjective scale from A to D, leading to "significant grade inflation," he said. In asset securitization, as in college, he said, "you have to get a C or you fail."

The industry's use of gain-on-sale accounting, which allows companies to claim profits in their earnings that they won't book until the distant future-opens the door to more problems, Mr. Robinson said.

"There are a lot of moving parts on the accounting side," he said. "The quality of earnings is suspect."

Heavy competition for loan volume is another problem: "You have to wonder at what point companies are capturing loans, and at what point they're cannibalizing their own business."

Mr. Robinson said there is money to be made from the sector-but not necessarily by investing in lenders.

The steady stream of securitizations has brought a windfall of business to accounting firms, he said. "If you do deals every quarter, they have to be audited."

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