A price war has broken out in adjustable-rate mortgages - and thrifts are doing most of the shooting.
More than a dozen thrifts are touting one-year adjustables with start rates below 4%, according to a recent survey by HSH Associates, and scores are offering rates below 5%. That compares With a fixed-rate market that is pricing loans at around 8.4%.
"It's kamikaze pricing," said Sam Cooper, head of portfolio management for Chase Manhattan Mortgage Corp.
In fact, the pricing is so low that traders call it "beneath the screen." Translation: The loans are offered at rates that are as much as 150 basis points below where they could be sold profitably on the secondary market.
Effect of Higher Rates
The aggressiveness marks a big change for the thrift industry, which spent the past few years licking its wounds from credit problems. The industry also was hurt by low interest rates, which boosted the popularity of fixed-rate mortgages, the specialty of mortgage banks.
In recent weeks, however, rising rates have caused more consumers to consider adjustables, which carry lower initial rates and long have been the favored product of thrifts.
Moreover, thrifts once again have the capacity to lend.
Appetite for Loans
"Asset quality has turned around," said Gary Gordon, a thrift watcher at PaineWebber Inc. "They haven't grown for three years and have bolstered capital" - all factors that give the lenders an appetite for loans.
A typical participant in the new aggressiveness is Nutmeg Federal Savings and Loan, a small Danbury, Conn., lender that until last Friday was offering a one year ARM with a starting rate of 3.5%. That rate has since been increased to 4%.
William D. Starbuck, executive vice president at Nutmeg, is blunt about his intentions: "It's a relationship business and we are buying market share."
He added that Nutmeg and others are "saddled with a lot of liquidity. We can buy Treasuries or invest in a loss leader, maybe losing some money in the short run but making it up long term."
None of which appeases thrifts' critics.
"I can't compete profitably with a loan like that," said a loan buyer who sells into the secondary market.
Part of the reason savings and loan associations can underprice the competition is that their adjustables currently enjoy a structural advantage. Many thrifts write adjustables that are pegged to the industry's cost of funds.
Because the average cost of funds moves slowly - and is reported with a lag - the rates on the adjustables do not rise and fall as rapidly as other rates.
One commonly used cost of funds index, based on the average cost at western thrifts, now stands at 3.629. By contrast, one-year Treasury securities now yield 5.23%.
"The fixed-rate has ground to a halt," said Charles Rinehart, chairman of Home Savings of America, the nation's largest thrift. "We're satisfied that [the cost-of-funds adjustable] is the best product, the most stable."
This type of a market is making it tough for mortgage banks, which must sell all the mortgages they originate. They are having trouble keeping pace with pricing and usually have fewer types of adjustables to offer.
Many mortgage banks, realizing that the secondary market may not be the best alternative, are trying to team up with thrifts. "I've had calls from five mortgage bankers who want to originate loans for me," said Mr. Starbuck.
Thrifts, meanwhile, are using a variety of loan products to try to bring mortgages in the door.
Making a comeback, especially on the West Coast, are negatively amortizing adjustables. "Neg ams," as the industry calls them, are loans where the interest rate is adjusted more frequently than the payment.
Principal May Increase
Typically, the rate is adjusted every month while the payment is only changed after a year. If rates rise, the borrower can find that the principal amount has increased.
Some negatively amortizing loans are now being offered at rates as low as 2.25%, according to Sam Lyons, senior vice president of mortgage banking at Great Western Bank.
Analysts say these loans can perform well if property values increase. But if home prices go south, a lender can experience a high rate of default.
"People are taking out loans that could be long-term problems," said Tom O'Donnell, an analyst at Smith Barney Shearson.