ORLANDO - In the Middle Ages, alchemists tried to turn lesser metals into to gold. Today, lenders are attempting to change securitized loans of lesser credit quality into triple-A pools in much the same fashion, says an expert in the field.
Speaking at the National Home Equity Mortgage Association's southeastern conference here, Glen Stein, vice president of asset-backed securities for Prudential Securities Inc., said people are trying to turn B and C securities - the lower-credit-quality securities, into pools whose credit is rated much higher, at triple-A.
In a session titled "Untapped Potential in the Home Equity Market," Mr. Stein explained the appeal of nonconforming loan pools to the 150 lenders and wholesalers in attendance.
Investors should concentrate on maximizing the unique potential that nonconforming loan pools carry, he said, instead of trying to reconcile the differences between the two types of loans.
"We are not as concerned about credit issues," Mr. Stein said. "Investors should think about timing involved in recouping principal, rather than whether they will get it back at all."
B and C loans, made to people with damaged credit, have several advantages over traditional high-credit-quality loans, Mr. Stein said.
One edge is the lower refinance index of these loans, which can be half that of traditional loans. People with damaged credit are more concerned with making payments than on getting the best interest rates, Mr. Stein said. Additionally, they often can't afford the up-front costs of refinancing.
For investors, that means that loan pools perform predictably despite interest rate fluctuations.
At Prudential, Mr. Stein reassures investors about prepayment stability by using a "home equity prepayment" model. Normally, nonconforming loan refinances trend up for the first 10 months before leveling off, he said.
Putting B and C loan pools in bonds will get them an automatic triple-A rating, making them more attractive to investors, Mr. Stein asserted. Once a bonding agency guarantees a loan pool, the responsibility for the bonds lies with the bonding agency. And for large originators, the basis-point cost of bonding is very low, often in the teens, Mr. Stein said - well worth the price to encourage potential investors.
Large nonconforming loan pools are ready for segmentation, another reassuring quality investors like about these pools. With segmentation, investors can pick and choose the level of risk and commitment they feel comfortable with. And companies like Prudential can create specialty packages for these investors at a profit.
"Like Frank Perdue, we realized that we can sell the parts for more that the whole," Mr. Stein said, referring to the man whose company sells prime chicken parts.
Large pools of nonconforming loans tend to be more attractive than small ones when making deals, he said, adding that investors are assured that there are other interested investors out there - and segmentation can be more precise.
Low-income loans have much higher yield than conforming loans - an obvious attraction to investors. In today's low-interest-rate environment, that means more attractive profit margins than from traditional loans.
In fact, nonconforming loan pools are so attractive that pricing has gone "through the roof," one wholesaler reported. Secondary marketers are reaching to pick up the very volume Mr. Stein addressed, leaving the pricing environment unstable.