Contifinancial Corp., which has a reputation for novel investment vehicles and trendsetting business strategies, may have scored again.
The New York subprime mortgage lender recently placed $99.7 million of Contimortgage Net Interest Margin Notes with private investors.
The notes are backed by home equity loan certificates, which are supported by excess spread and residuals from subprime mortgage securitizations.
To put it simply, purchasers are investing in assumptions Contifinancial is making on loan performance.
"You're betting that their track record is going to repeat itself," said Reilly Tierney, analyst with Fox Pitt Kelton, New York.
Gain-on-sale accounting makes this investment vehicle possible. Home equity lenders make loans, then book expected profits before the loans are repaid by homeowners.
"What we've done is transformed excess receivables into cash," said Contifinancial chief executive Jim Moore.
Taken to its extreme, the note structure could allow lenders to sell off all the risk that gain on sale accounting carries. Contifinancial, though, is retaining some of the first risk position.
Detractors have criticized home equity lenders as unstable investments because gain-on-sale accounting relies on a company's presumptions and allows most lenders a lack of cash on hand.Mr. Moore, who structured the note, has been credited with the creation of several of Conti's other novel debt instruments.
"The idea," Mr. Moore said, "is to create a new market." Several other home equity lenders are reportedly eyeing the securitization structure, and are expected to issue their own net interest margin notes.
Observers mentioned Money Store as a possible participant in the new market. A company spokesman said Money Store was keeping its options open, but would not comment on any specific security.
The net interest margin notes "create a cash-positive environment," said Mr. Moore. Ultimately, he said, "the home equity portfolio becomes self- sustaining."
But don't expect an immediate sea change in the home equity industry, Mr. Tierney said.
"The markets are not going to buy these from just anyone," he warned. Lenders will need a "long track record."
Mr. Moore agreed. The notes will only work for companies that "have two to three years of experience and can live with the ratings agencies."
Contifinanicial has, in fact, privately issued similar notes before, but this is the first time it took the transaction to the street. "We were approached by a number of investment bankers," Mr. Moore said.
The only similar investment-in-assumption vehicle available is issued by Green Tree Financial Corp., St. Paul.
Green Tree offers net interest margin trusts securitized by manufactured-housing loans, which have a much longer performance history than subprime mortgage loans.
