Subprime mortgage lenders, look out: The next 12 months could be rough.

Competition, investor uncertainty, growing pains, and a murky economic future all could threaten the stability of the growing pool of lenders that cater to homeowners who can't get loans from banks.

"I don't think the carnage has quite begun," said Michael Durante, an analyst with Prudential Securities, New York, "but we're going to see a significant number of these companies fall by the wayside."

Subprime mortgage lenders have had two phenomenal years. They have made loans, and gone public, at breakneck speed. Wall Street, lured by higher returns, is providing what seems an unending stream of funds through securitization.

This liquidity has facilitated the swift growth, and outstripping last year's origination volume seems only to require finding a faster way to get the loans on the books.

Veteran companies, some of them previously little more than mom and pop shops, have ballooned into multiproduct, high-volume operations. And start-ups have watched originations double, triple, even quadruple in just a year.

These companies have made millions, specializing in the customers that banks won't touch: those who have gone through bankruptcies, or defaulted on loans, or who lack the annual income necessary to secure a bank loan, or new immigrants who don't have a banking history.

Even formerly conservative banks have tumbled all over themselves to find a way to get a piece of the pie, often by purchasing a subprime lender.

Current economic factors promise to funnel more consumers into the market. Credit-card delinquency rates are rising, bankruptcies are at record levels, and consumer spending has not slowed.

Although banks fear these signs of excess, nonconforming lenders cheer them. "Really, rising credit card delinquencies just mean more new customers for us," said the chief executive of a top-10 nonconforming lender.

As customers fall behind in their card payments, the logic goes, their credit reports suffer, denying them access to bank loans. Additionally, more homeowners are turning to the debt consolidation loans that lenders like the Money Store peddle. Credit card and mortgage debts are piled into one loan, secured by the home's value.

Consumers make one, lower, payment a month - and have credit cards freed up to charge more. The consumer has learned the lesson, and is not apt to pile up excessive debt again, insist lenders who make these loans

But this excess is spooking some economists. "We've got an extraordinary debt problem, especially in what should be glowing expansion," said David Levy, director of forecasting with the Jerome Levy Economic Institute, Mt. Kisco, N.Y.

The American population has polarized into an upper-income minority with a high level of assets, and a low- to middle-income majority that relies on an increasing level of credit to fuel its spending.

An inevitable recession, with a drop in real estate prices, would be fatal for the subprime sector, said David Olson, a Maryland-based consultant and publisher of Wholesale Access, a mortgage information resource.

But, the most immediate pain is being dealt from Wall Street, where the subprime party could already be over: Momentum investors, who fueled much of this sector's phenomenal stock growth, have grown leery.

The combination of several blowups in the subprime auto-loan market, a $19.8 million loss reported by Advanta Corp. because of credit card delinquencies, and a hike in interest rates have spooked these investors.

Stock prices for subprime mortgage loans have taken a nosedive since mid-January, with industry leaders losing as much as 40% of their value, often in a matter of weeks. The drop has made many companies sitting ducks for banks looking to get in, said Prudential's Mr. Durante.

So far, though, Wall Street hasn't completely turned its back - the securitization pipeline has not dried up. If it does, "this industry is as good as dead," said one analyst who covers the sector.

Some rating agencies have expressed concern over the way that these companies book profits. Gain-on-sale accounting, which allows lenders to book immediate profits, is the industry standard.

Competition continues to heat up, thinning the margins for wholesale loan purchases and driving lenders to reach farther and farther down the credit ladder.

In addition to start-up subprime specialists, the past year has also brought traditional lenders like KeyCorp and Countrywide Home Loans to the market. About 80% of traditional lenders make some sort of subprime loan, Wholesale Access reports.

Lurking on the horizon are the government-sponsored entities that rule the traditional mortgage market.

"Fannie and Freddie are going to eat your lunch," Mr. Olson said in addressing subprime executives at the industry's annual conference in Maui. "They're the single strongest lobby in Washington - they may not be here today, but they're a power to be reckoned with."

Freddie, with its Loan Prospector program, is the clear leader of the two on the issue. The agency has developed a credit scoring model that allows traditional lenders to get automatic underwriting on subprime loans and sell them to participating subprime conduits.

In addition, the threat of class actions is nipping at the heels of the sector. Compensation of mortgage brokers is an especially vulnerable area, given the vaguely defined rule that governs broker payments. More than a dozen class actions have been filed against lenders who pay brokers for securing higher-rate loans, a common practice among subprime lenders.

The suits come at a time when the number of mortgage brokers who make subprime loans has ballooned from 500 in 1985 to 20,000 in 1996, Wholesale Access reports. The slump in loan volume starting in 1994, after the refinancing boom ended, drove conventional brokers onto the subprime side, Wholesale's Mr. Olsen says.

If several of the high-profile suits are decided in favor of the borrower, subprime lenders may be forced to radically rethink the way they originate loans, or face millions in class action settlement costs.

Despite all the negatives, most subprime lenders say they are confident that their future is bright.

"At the end of the day," said Robert Grosser, chief executive of Cityscape, "the fundamentals will always prevail. If you're a serious subprime originator who knows and understands this business, you will survive."

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