Banks and thrifts are poised to pick up the pieces now that the leaders in one of the fastest-growing, most controversial consumer finance sectors have hit a wall.
Sovereign Bancorp, First Union Corp., and U.S. Bancorp are among the companies already piloting high-loan-to-value home equity programs. The specialty finance companies that dominate the field have run into a liquidity crunch, but demand from consumers is strong.
This year homeowners have been eagerly snapping up high-loan-to-value mortgages-which allow them to borrow as much as 150% of their home's value- and using the excess cash to consolidate high-rate credit card debt, make home improvements, even go on vacation.
Originations of high-LTV loans are on track to exceed $12 billion in 1998, according to most estimates, and the potential market has been estimated at up to $200 billion.
But this month's restructuring of FirstPlus Financial Group, Dallas-by far the largest company in the business-combined with recent snags in the asset-backed-securities market and investment banks' newfound reluctance to lend in untested sectors, has put the brakes on growth of this new product.
"We're going to see a significant reduction in volume next year," said Glenn Costello, analyst with Fitch Investors Services. Large originators and buyers of these loans, including FirstPlus, DiTech Funding Corp., and Empire Funding Corp. have stopped buying such loans on the open market, because they can't securitize or fund purchases.
The high-LTV sector is not the only lending opportunity to open up to banks as a result of the liquidity crunch in the securities market. Several banks have said they are pushing into commercial real estate finance now that real estate investment trusts and investment banks are pulling back.
"Like other ABS markets," the high-LTV market is a victim of circumstances, Mr. Costello said. "Even though the product has done well, these companies have been caught in a liquidity crunch that no one expected."
In fact, high-LTV volume could decrease more than 50% in 1999, according to PaineWebber estimates.
Capital-rich banks, some of which appeared marginally interested in the product in the past, are now it a great position to buy up the highest- quality loans at discounted prices, observers say. Some banks have started pilot programs to take advantage of the market.
Banks can "create some very, very handsome assets" by toughening credit- score and debt-to-income requirements, said Champ Meyercord, a former Greenwich Capital investment banker who is now chief executive of Mego Mortgage Corp., Atlanta.
Several banks, including First Union, Sovereign Bancorp, and U.S. Bancorp are buying high LTV loans and keeping them in portfolios.
Sovereign, based in Wyomissing, Pa., has contracts to buy high LTV loans from a "couple of high-quality shops," said Jerry Cunnane, executive vice president, portfolio lending. The loans "make sense" only if lenders are sure they are buying high quality paper, Mr. Cunnane said.
The company does extensive due diligence before funding the loans and spot appraisals afterward, Mr. Cunnane said. In return, it gets a higher return on assets and return on equity that with traditional mortgage products.
Nonetheless, Sovereign's high-LTV volume is "very insignificant," compared with its asset size, Mr. Cunnane said.
For U.S. Bancorp, which recently purchases a stake in the subprime lender New Century Financial Corp., high-LTV loan volume is less than 1% of a $55 billion portfolio, a spokeswoman said.
The collapse of the market comes just as the highly debated but relatively untested product was becoming the focus of government agencies.
Most recently, the General Accounting Office issued a report in September deeming high-LTV lending beneficial to some consumers.
On the other hand, thrifts are being discouraged by the Office of Thrift Supervision from leaping in, said the agency's director, Ellen Seidman.
"This is a tricky and in large quantities questionable product," Ms. Seidman said.
Ms. Seidman said the OTS is looking at four issues when it examines thrifts that are dabbling in the high LTV business-underwriting quality, servicing method, performance monitoring, and consumer disclosure.
The OTS has never been keen on the high-LTV product. In August the agency issued a report warning lenders that these loans could be risky.
There has always been a "question mark" around these loans, said Tom Zimmerman, senior vice president at PaineWebber, because there was "not enough data on losses." Uncertainty is leading to "panic on the investor side," Mr. Zimmerman said.
DiTech Funding, an Irvine, Calif. lender with both conventional and high-LTV divisions, stopped funding high-LTV loans on Oct. 23, said president Scott Carnahan. "We are slowing down, because the financing for that product is slowing down," he said.
Regardless, the high-LTV the market isn't going to disapear, said Peter Rubinstein, vice president, Chase Securities. In fact, the setback to the specialty firms is "actually healthy for the market," he said, because it will tighten credit standards and issuer quality.
"The bottom line is you will never see a loan that performs reasonably and has huge consumer demand go away," said Gordon Monson, chief executive of Westmont Capital Corp., a start-up high-LTV company.