Some of the country's smallest banks are using Wall Street as their path into the turbulent specialty finance business.
The lenders are writing mortgages for up to 125% of a property's value and then packaging these highly leveraged loans into securities.
"This is the next step in our efforts to build profit-centers that generate noninterest income," said Randy Shaffer, executive vice president and chief financial officer at Community West Bancshares, Goleta, Calif.
The $98 million-asset bank is preparing its first securitization - a roughly $50 million package to be sold this spring. Until now, it would originate and service the loans, but would not earn securitization fees when making bulk sales of the loans to big finance companies.
While the potential for more income exists, the efforts must be taken carefully. High-loan-to-value and subprime mortgages caused meltdowns at big finance companies late last year because they failed to adequately gauge prepayment speeds and profit projections did not pan out.
Mr. Shaffer and other lenders at small banks say they have matters under control, especially on the accounting end, and are using conservative prepayment assumptions.
The bankers say they are using seasoned advisers to help craft the deals. Community West is working with a finance unit at Deloitte & Touche, and City Holding Co. chose PNC's mortgage securitization group for a $33.2 million package sold in December.
City Holding will use PNC later this year for a package that could reach $100 million, but City Holding is proceeding slowly, said its chief executive, Steven J. Day.
"We're handling things in an extremely conservative manner to avoid future writedown potential," he said.
The $1.3 billion-asset bank in Charleston, W.Va, is using high credit scores when choosing who to lend to. Loans are typically in the $30,000 to $40,000 range, equaling 125% of a property's value minus its outstanding mortgage.
Both City Holding and Community West have been making the loans since last year. The banks' executives say the business is not as complex as they initially believed and is similar in many ways to the Title 1 lending they had done for years.
By handling securitization of high-LTV loans, the banks can book thousands of dollars in fees for processing and other functions, industry experts said. Some of that income will be given up to the advisers, but there is still plenty of income coming to the bank, Mr. Shaffer said.
The loans typically carry interest rates in the mid-teens and are issued as securities with coupons, or rates, under 10%, providing plenty of spread income potential.
The banks are handling the deals as private transactions, meaning they do not have to go through comprehensive - and expensive - steps like registering the securities with regulators and preparing disclosure forms. The approach reduces the pool of available investors to only large institutions, but Mr. Day said City Holding had little trouble lining up buyers.
Securitization efforts by Community West, City Holding, and a handful of others, while not a trend, do signal that smaller lenders are warming to the idea of making mortgages in excess of a property's value, one industry observer said.
"It's the beginning of a turnaround by more mainstream lenders," said Gordon Monson, former director of high-LTV lending at PaineWebber and now a private consultant.
Indeed, many community banks and larger institutions continue to shun the loans, feeling they would be hard, if not impossible, to collect on if the borrower defaults.
In a potentially encouraging sign, Mr. Day said his bank has seen very little in the way of sluggish payments and has yet to experience its first writeoff.
