A once-bullish home equity analyst downgraded three companies in the sector Monday, citing ever-increasing prepayment rates, continued stiff competition, and in one case management turnover.

Delta Financial Corp., Woodbury, N.Y., First Alliance Corp., Irvine, Calif., and Southern Pacific Funding Corp., Lake Oswego, Ore., were downgraded from "buy" to "hold" by Jennifer S. Scutti, a Prudential Securities analyst.

Prepayment rates, which have already forced several in the sector to readjust their earnings, continue to grow, Ms. Scutti said. Most publicly traded home equity lenders use gain-on-sale accounting, which requires them to make assumptions about future loan performance. Any changes to those assumptions affect earnings.

Competition and the rate of loan refinancing are not slowing down as hoped, she said.

"If you looked at prepayment speeds during the first quarter, they were still rising, but the rate was slowing down," Ms. Scutti said. "But in May and June they have just shot up."

Borrowers are prepaying loans faster because the current competitive, low-interest rate environment has spawned a Catch-22, she said. Lenders who watched competitors take away borrowers by offering lower rates have stepped up marketing efforts to put volume back on their books-ultimately increasing prepayment rates industrywide.

Delta Financial, which up until now has emerged unscathed by negative factors, may need to take a charge to its second-quarter earnings, Ms. Scutti said.

Prepayment rates in some of the company's pools are "going through the roof," she said. Adjustable-rate mortgages are prepaying in some pools at rates of up to 70%, and in addition, many balloon mortgages are coming due.

The company has since stopped making these loans but can do nothing about previous securitizations, she said.

Ms. Scutti said the necessary charge will be 25 to 30 cents a share, and she has readjusted 1998 estimates from $2.38 to $2.10.

First Alliance, meanwhile, is being downgraded because of recent management and employee turnover, Ms. Scutti said. Its chief financial officer, Mark Mason, left in May, and his expected successor, John Mitchel, in June, when the company announced it would have to take a $4.5 million writedown.

The company is due to report earnings next week, requiring Francisco Nebot, the newly hired chief financial officer, to "hit the ground running," Ms. Scutti said.

First Alliance has also been losing seasoned loan officers and managers to higher-paying competition recently, which could lead to less productivity, she said.

Southern Pacific, which has often been the subject of takeover rumors in recent months, was the most difficult to downgrade, Ms. Scutti said. Although the company has diversified its management, investments, and distribution channels in the past year, it still may not have "enough meat to make it a valuable franchise," Ms. Scutti said.

The company has reportedly hired Morgan Stanley to help it find a buyer.

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