A more conservative underwriting strategy at Amresco Inc.'s home equity unit got a positive review this week from Moody's Investors Service.
Under a joint venture announced in late July between Amresco and Lehman ALI Inc., a new entity, Finance America LLC, would originate, buy, sell, and securitize subprime residential and home equity loans. All of Amresco Residential Mortgage Corp.'s origination activity is expected to go through Finance America by the first quarter. Brian L. Libman, a 13-year veteran at Lehman Brothers and former managing director, was named chairman and chief executive of the newly formed company.
Moody's rates Amresco Residential Mortgage Corp.'s loans as average for the subprime market. But it said the Dallas-based lender's move away from bulk and correspondent lending will probably lead to better credit quality.
Henry Engelken, a Moody's analyst, said it is difficult to monitor the quality of loans acquired in bulk, particularly when loans are not completely reunderwritten, as was the case at Amresco.
"When you have broker or retail originations, where every single loan is underwritten by the company doing the originations, you're looking at each loan," Mr. Engelken said. "That may be a better way to go than buying bulk packages of thousands of loans and trying to reunderwrite loans that have already been made."
Though adopting this strategy results in decreased volume and a higher cost to fund loans, specialty lenders who adhere to it would be closer to the loans and better able to assess risk, he said.
"The process of buying bulk acquisitions and not doing the level of scrutiny that's required are in the days of yesteryear," Mr. Libman said. "Going forward, I anticipate that you are going to have fewer, larger players who really do control the channels of risk. Over the last few years the definition of subprime has changed to cover an enormous span, so capturing good-quality data to assess risk has been very difficult for the entire industry."
Bulk lending become more expensive in the fourth quarter as cash dried up in the capital markets and investors were scarce. When more yield had to be paid on securities, Amresco Residential decided to focus on wholesale and retail lending.
Correspondent lending "ate up a lot of their cash, and they immediately had to sell off a lot of their assets," Mr. Engelken said.
"It became a capital issue," said Amresco Residential's president, Peter J. Levasseur. "The bulk and correspondent business generated a lot of volume for us, but at the same time it's a heavy capital requirement to stay in the securitization business. It was a business we really couldn't continue to pursue."
Amresco is waiting for the move to pay off. Its $19.6 million of revenue for the quarter ended June 30 was off from $54.4 million the year earlier, primarily due to the discontinuance of the capital markets operation. Furthermore, for the six months ended June 30, Amresco suffered a $60.8 million drop in interest income and $7.9 million decline in gains on sale, due to the discontinuation of the capital markets business.
Mr. Libman said that Lehman Brothers has an undisclosed equity and management interest in Finance America but that it would not be very active in the venture.