Two years ago, high loan-to-value (LTV) lending was the Gold Rush of mortgage banking. FirstPlus Financial Corp. of Dallas, the market leader, was still a darling of Wall Street and dominated the business of lending consumers money based not on what their house was worth, but their ability to pay.

For a while, high LTV--mostly a second lien product--looked like the greatest thing to come down the mortgage turnpike since, well, the creation of the adjustable-rate mortgage. But alas, the high LTV boom--a $10 billion-a-year, high-profit-margin niche-- didn't last, virtually collapsing with the bond market turmoil and subsequent flight to quality in the fall of 1998. FirstPlus has since filed for bankruptcy (see "A Comet Falls, An Industry Shifts," August 1999).

And all the while, while FirstPlus was rocketing, then reeling, Residential Funding Corp. of Bloomington, Minn., was studying the high LTV market, waiting for the right moment to take the plunge. And plunge it did.

Now, more than a year after the bond market crackup, RFC--which is ultimately owned by General Motors Corp.--is the high LTV market. And if all goes according to plan, RFC, a sister company to GMAC Mortgage, should wind up purchasing and securitizing close to $2 billion worth of high LTV loans in 1999. Not bad for a company that's only been in the market for a little more than a year.

To understand how RFC has come to dominate high LTV, you first have to understand that RFC is a non-depository, owned by a Big Three automaker. Its forte in mortgage banking has always been jumbo, or what used to be called "non-conforming," loans. (These days the term non-conforming applies to just about any mortgage that isn't purchased by Fannie Mae and Freddie Mac.) These days, a "jumbo" mortgage is $240,000 or larger.

Profit margins on jumbo loans are higher because the product is not prone to the commoditized pricing that affects conventional residential loans. RFC likes higher profit margins, even if the risk is greater. When it saw the boom in high LTV gathering steam in 1997, it watched from the sidelines, even through 1998, because it was uncomfortable with the underwriting standards lenders were using.

To hear RFC managing director Jeff Detwiler tell it, RFC absolutely loved the product. It saw it as high-yielding and non-conforming, and believed that if originated properly, it would be a great addition to RFC's stable of products. Unfortunately, RFC felt that increasingly, originators' underwriting standards were too risky.

By nature, high LTV is a catch-all phrase for any mortgage where the loan-to-value ratio is north of 97%. But the loans FirstPlus and other once-soaring producers were making during the 1996-98 boom had LTVs of 112% or even higher. The FICO (credit scoring) numbers on approved borrowers also were too high for RFC's liking.

So RFC watched and waited. Then, when the bond market went into its tailspin, high LTV securitizations dried up and all the non-depository players (which made up most of the sector) got creamed. Suddenly, producers had loans to get rid of but no place to dispose of them because Wall Street either wouldn't securitize them or wanted more money, making the whole process unprofitable. RFC then jumped in and began buying at fire sale prices. And it bought selectively, but always at bargain prices, market participants noted at the time.

To RFC the crackup in the high LTV market had to occur before it would jump in. "We knew what happened last year would happen," Detweiler said in a recent interview. "The market is now purged." The way he views it, the sector's collapse came about because the firms that were hurt most, like FirstPlus, had foolishly paid premium prices and were none too careful about how they valued the HLTV-backed securities they kept on their books.

If RFC reaches its goal of securitizing $2 billion in HLTV loans, it will have a market share of 25% to 35% of the business, according to the Database Product Group's new 2000 Home Equity Lending Directory. RFC also services the underlying loans and the resulting mortgage-backed securities. Its currently has $2 billion in HLTV servicing, second only to the bankrupt FirstPlus, which has shifted its $6 billion portfolio to an affiliate.

Detwiler feels RFC has succeeded in HLTV where others have failed because it has been careful not to overpay for the closed loans it buys, but more importantly it has strict loan standards and is unwilling to sacrifice quality for volume. The average FICO score on most of the product RFC buys is 680--substantially TK than average-- Detweiler says, adding that the typical RFC high LTV customer is "Joe Middle America" who makes $70,000 a year and has a $150,000 house. The average LTV on these "home equity" loans is 108% to 109%.

"These are mostly debt-consolidation loans," he says. "The people we underwrite do not have a history of going out and running up the credit cards again after they get the loan." RFC buys closed loans, which means it doesn't have a direct interface with the consumer filling out the loan application. "Our originators [that sell to RFC] are small players," he says. "To tell you the truth, we'd rather be dealing with them than the mega-originators. The mega-lenders would rather do things their way, and we'd rather do things our way."

RFC re-underwrites all of the HLTV loans it buys, he notes, adding that during the go-go years of HLTV, 15% to 20% of the loans being produced were of questionable quality and would never have been purchased by his company. "That's one reason why we stayed out of this market for so long," he adds. "Now, all the craziness is gone." Most high LTV mortgage professionals agree that RFC is the largest investor in the market.

"RFC got in at the right time, and they had what everyone else didn't have at the time--plenty of capital," notes high LTV consultant Gordon Monsen, a former PaineWebber managing director who helped shepherd the development of the high LTV securitzation market.But Monsen wonders why no one else in the mortgage market has attempted to compete against RFC. "I really can't explain why Associates [First Capital, Irving, Tex.] and Household [Inc., Prospect Heights, Ill.] haven't joined in. They could do it in a heartbeat." Both are large, well-respected, publicly traded non-depositories with the ability to both portfolio and securitize loans.

After RFC, the largest buyer of high LTV loans is U.S. Bancorp, Minneapolis. Some banks like high LTV mortgage paper because the yield can be anywhere from 300 to 600 basis points over conventional rates. But bank and thrift regulators have frowned on the product and made it more difficult for institutions to hold the loans in portfolio.

The recent failure of First Keystone National Bank of West Virginia, once a large high LTV and Title One (a government-insured HLTV loan) securitizer, hasn't helped. Keystone is missing about $500 million in assets, and high LTV/Title One looks like the chief cause of its problems--along with fraud. As long as regulators continue to fret over high LTV, depositories aren't likely to become large participants. That leaves RFC at the top of the heap--at least for time being.

Besides being a contributing editor to U.S. Banker, Paul Muolo is executive editor of National Mortgage News. He can be e-mailed at: Paul Muolo

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