Subprime mortgage loans are helping banks reinvigorate lending programs challenged by lackluster margins.

The products, also called B and C loans, are made to borrowers with tarnished credit histories. The loans typically carry higher rates and fees and offer bankers better margins.

B and C loans accounted for $90 billion of the $796 billion of mortgages originated in 1995, according to David Olson Research, Columbia, Md.

That figure is expected to rise as more lenders embrace the products.

B and C loans "are probably the most rapidly growing sector of all mortgages," said Christine Clifford, analyst with David Olson Research.

"A lot of mortgage companies are looking to this sector to help sagging profits," Ms. Clifford said.

Indeed, large and small banks are getting into the business. Just this year, Fleet Mortgage set up a B and C unit after years of focusing on conventional loans.

And Poughkeepsie Savings Bank is on the verge of entering the market through a program with a wholesaler.

The savings bank will first conduct special training to make sure its loan officers are clear about the differences between conventional and subprime loans, said Joel A. Brotman, senior vice president.

With the program, the Poughkeepsie, N.Y., savings bank will add to its arsenal of products. "This may provide us with additional originations and profits," Mr. Brotman said.

Industry experts say it's best to operate a subprime program as a separate lending unit because of differences between A-quality loans and B and C borrowers. Strong appraisal and collection efforts are said to be crucial to subprime programs.

"Whether they do it as a separate unit or within the mortgage banking unit, B and C lending should be a separate program," said Andrew B. Jones, vice president in charge of the mortgage securities group at Duff & Phelps Credit Rating Co.

The programs also require a commitment from top management, observers say.

"It can't be a side project," Mr. Jones said. "To be successful it has to be a primary focus."

B and C loans are seen by some as door openers to cross-selling opportunities.

"The link between traditional lending and B and C lending is there," said David Lereah, chief economist of the Mortgage Bankers Association of America.

"You can go to a window and talk to a loan officer of a mortgage company and if you don't qualify for the standard residential mortgage, you can be referred to a fellow subsidiary for B and C lending," Mr. Lereah said. "You don't want to lose that business."

Mellon Bank is among lenders that act quickly if a borrower doesn't qualify for a conventional loan, industry observers say.

"They trace their B and C client," said Allen Hardester, a Columbia, Md., mortgage consultant.

"The bank doesn't wait for him to be refused or denied on a grade-A loan," Mr. Hardester said. "They have signs saying if you have bad credit, we have programs for you.

"They go right into the B and C pitch," Mr. Hardester said. "It has been extraordinarily successful."

Most mortgage banks that originate B and C loans get them off their books by selling them to a conduit. Companies like Delta Funding, Woodbury, N.Y., package the loans, obtain ratings, then offer them to Wall Street.

Banks "should be looking to originate the products even if they don't keep them on their books," said Hugh Miller, president of Delta Funding, adding that the products supply a necessary competitive edge.

Instead of relying on conduits, some larger mortgage banks handle the securitizations themselves.

First Union Corp., for instance, has set up a program to process B and C loans from origination to securitization.

The Charlotte, N.C., banking company's home-equity unit writes the loans, then works with the capital-markets group to turn them into securities.

The program, which sold its first loans on Wall Street last year, should see increased business in 1996, First Union executives said.

"We've created an effective and efficient program, and we're very happy with the productivity," J.C. Faulkner, vice president in First Union's Home Equity Bank, said in an interview recently.

Unlike conventional loans, there are no set criteria or standards to define what constitutes B, C and even D loans. This has led to confusion, and at times borderline borrowers have been classified as B or C credits, subject to higher rates than A-quality borrowers.

"One of the things you look at when you find so-called A, B, C lending marketing materials is that virtually every one of them has a definition of what's A, B and C," said Donna Callejon, a senior vice president with the Federal National Mortgage Association.

Moving to set even clearer standards, Standard & Poor's Corp. last year established guidelines for B and C loans and how banks can reduce their risks of originating and servicing them.

S&P took the step in response to banks' inquiries about B and C products, said Frank Raiter, managing director with the rating agency's structured-finance group.

As banks seek ratings for their loans, S&P will judge the products against the standards. A positive rating by S&P would make it easier for banks to sell their loans on the secondary market.

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