Securitization of home equity loans has come of age, helping fuel rapid growth at a number of finance companies, says Len Blum, managing director of Prudential Securities' mortgage and asset finance group. Last year, issuance of home equity securities hit $10 billion, up from $6.6 billion in 1993, according to Asset Sales Report, an American Banker newsletter. Mr. Blum discussed the market's development in a recent interview.

Q.: What's behind the growth?

BLUM: Most recently, with the rally in the bond market we saw a lot of investors get hurt in traditional mortgage-backed securities. Those investors look to home equities as a safe haven, and that has brought a new breed of investors to the market. Another factor has been the relative wider spreads available in the home equity debt market. We have also seen investors grow more comfortable as they have bought home equity securities and seen them perform well.

Q.: Who are today's issuers?

BLUM: Issuers fall into a number of groups. You have your frequent issuers who are in the market pretty much every quarter. In that group you would include the Money Store, United Companies Financial, Aames Financial, Equicredit, and Advanta and several others.

Then you have sort of your conduit-type issuers like ContiMortgage, which comes to the market from time to time. We are also seeing issuers who are less frequent and the market is receptive to all three groups.

The largest issuers are the finance companies, but we have seen some bank participants, such as CoreStates.

Q.: How does bank paper differ from finance company paper?

BLUM: Banks will target the most creditworthy borrowers. Finance companies will go after the next segment. Bank borrowers tend to use more formulaic and credit-scoring driven underwriting criteria. Finance companies tend to be more flexible in their approach to underwriting credit.

The more high-quality borrowers are also more interest rate sensitive in their prepayment behavior. That means that in terms of prepayments, a finance company borrower would generally be more stable than a bank borrower. Finance company borrowers are much more driven by what their monthly payment is. They are not as motivated to refinance when interest rates lower.

Q.: Have the structures of home equity securities been changing much?

BLUM: We have learned how to slice and dice these securities into pieces that really make sense for specific investors. So an investor can come to us and say I want a security with such and such average life and such and such principal window. We can structure that. We can cut those cash flows out of the overall bond and give that investor exactly what they want. That makes the market much more attractive for investors.

Q.: Would you give an example of one the innovations?

BLUM: The prefunding account. At closing the issuer can issue a larger amount of bonds than it delivers collateral for. Let's say your transaction closes Jan. 15; it is a $300 million offering. At closing the issuer only has to deliver $150 million of mortgages. The difference between $300 million and $150 million is held in cash with a trustee; the issuer then has a prefunding period over which time the issuer can deliver additional collateral to the trustee and get cash from the trustee.

Q.: Why is that technique useful to lenders?

BLUM: It allows them to hedge. It allows them to issue bonds and lock at a rate for their future originations. It allows the issuer to know what his funding costs are at the time when he originates the mortgages themselves.

Q.: How has securitization changed the home equity market?

BLUM: Securitization has made it much easier for a finance company to grow. We are seeing a lot of home equity originators turn into growth stories because they can turn over their capital much quicker with securitization - and they get a much better deal than they do by selling the loans as whole loans.

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