After watching investment banks reap big profits by securitizing subprime mortgages, two of the biggest banking companies are jumping into the business.
Chase Manhattan Corp.'s investment banking arm, Chase Securities Inc., quietly began to buy pools of subprime mortgages and home equity loans for securitization in July.
And NationsBank Corp. has reportedly been gearing up to securitize home equity loans-both those originated by its finance company subsidiary, NationsCredit, and those bought in bulk from other lenders.
The moves are yet another way for the banking companies to participate in the booming subprime market, where they had already been lending. Making loans to people with tainted credit histories increased more than 25%, to about $100 billion, from 1994 to 1996 and continues to expand at a rapid rate, according to Wholesale Access, a Columbia, Md., consultancy.
Some observers said the banks would be taking a calculated gamble. While securitizing subprime loans can be highly profitable, it can also carry above-average risk. A few packagers have had losses recently when they had to supply additional capital to shore up deteriorating loan pools.
The packagers' ability to service these loans will determine how they do in the market, said Hedi Katz, a director at Fitch Investors Service who specializes in home equity lending.
Collecting timely payments from credit-impaired borrowers requires a hands-on approach that traditional lenders sometimes find difficult to master, said Ms. Katz.
Subprime mortgage lending is "a market that banks have not historically been in," she said, "but they're being forced to open their eyes now," despite the potential for problems.
Profit margins are just too good, Ms. Katz said, and the "market is huge right now."
Ron Kripalani, managing director at Chase Securities' mortgage securities group, said he agrees. Investors are clamoring for high-yield products like subprime-mortgage securities, he said, so "there are opportunities."
Chase Securities is buying pools of closed loans from small retail loan originators and from its sister division, Chase Manhattan Mortgage, which originates about $70 million a month of subprime mortgage loans.
So far, Chase Securities has amassed less than $100 million of such loans, but Mr. Kripalani is hoping to increase volume to about $100 million a month, he said. That's the minimum that can be securitized to make the transaction cost-effective, most bankers said.
NationsBank executives were not available to comment on their reported interest, but lenders, rating agencies, and analysts have indicated that the Charlotte, N.C., banking company is exploring the market.
The home equity and subprime-mortgage-backed securities market has mushroomed in recent years, from $10.4 billion in 1995 to a projected $78 billion this year, according to Moody's Investors Service.
Investment banks Prudential Securities, Credit Suisse First Boston, and Lehman Brothers led the home equity securitization market last year on the underwriting side. Large publicly owned subprime mortgage originators like Contifinancial, New York, and Money Store, Union, N.J., are also major players.
Many large publicly owned subprime mortgage originators have complained that margins have been compressed in recent months, especially in the bulk purchase arena. One large lender, Aames Financial Corp., Los Angeles, even announced at the end of April that it would virtually eliminate its bulk purchase operations because competition had driven prices so high.
But commercial banks that enter the market are unlikely to feel the squeeze because they have cheaper capital available, said John Hess, an investor relations executive at United Companies, a Baton Rouge, La., subprime lender.
Despite this cheaper capital, Mr. Hess said he is not worried about the competition. "Where they make up for cost of capital on the front end, on the back end it may cost them more to service these loans," he said.
Commercial banks that already securitize these loans have stepped up volume as well. First Union Capital Markets, First Union's investment arm, originated $500 million of B and C home equity loans in 1996 and has already originated about that many such loans this year.
Margins have been compressed, said K. Wesley M. Jones, managing director of First Union's mortgage finance department, but "there still is a nice profit margin."