The subprime market's problems be damned. That appears to be the view of senior management at Austin, Tex.-based Empire Funding, a company whose loan volume has skyrocketed since 1996 and where-with typical Texas bravado-executives say there is no reason the good times cannot keep rolling.

As part of his strategy, Gary W. Bradford, the company's president and chief executive, is trying to shed Wall Street's view that Empire is indeed just another subprime lender. In its latest report, Empire, a privately held firm founded in 1987, says it is "one of the nation's leading consumer finance companies, specializing in the origination, purchasing, servicing, and securitization of consumer loans secured primarily by second liens on real property."

Says Mr. Bradford: "Let me share our view that what we're doing is not really what the subprime business does, which is dealing with consumers who start at one end of the spectrum, obtaining loans that can be sold to Fannie and Freddie, and who for one reason or another end up working with subprime lenders for credit reasons.

"Those loans are tied to real estate as collateral but we're not making real estate loans, we're making consumer loans that don't depend on someone's equity in a house but on his or her credit history.," he adds.

"In fact, we're looking at better borrowers today than we were two or three years ago, borrowers in our securitizations who are substantially better credits than you would find, say, in a securitization of credit card receivables. Eighty percent of what we lend them goes to paying off credit card and other high-interest debt. Despite this, we continue to be lumped in with other subprime lenders by Wall Street."

Indeed. In the past year or so, Empire has suffered the same indignities as all subprime lenders, closing all its correspondent offices as well as 14 home improvement lending offices, reducing head count from 850 to 459, halting marketing efforts-and standing by with hands thrown up as the securitization market closed its doors in the interim.

"We've spent the last quarter of 1998 and the first quarter of this year recovering," says Mark Otto, vice president of marketing. "But we've reconfigured the company and its product line, there are no longer as many competitors, and we'll be in a strong marketing mode in the second half of this year."

Ironically, the product Empire is counting on to guarantee its success is one that Wall Street analysts view as even riskier than the typical B and C loans made by subprime lenders-hence its enormous difficulty in shaking its image as just another one of the subprime pack.

That product? High-loan-to-value loans, which Empire markets as the Equalizer and which it introduced in the first quarter of 1997. The Equalizer allows qualified borrowers to combine debts of up to 125% of the value of their home. Today, Empire is the second-largest originator of high-LTV loans. The top share of the market has belonged to FirstPlus, with a smattering of other competitors. In 1997, about $8 billion of the product was securitized.

Unfortunately, Wall Street views high-LTV loans-while extraordinarily profitable for issuers-as very risky. These are "one of the newest and most controversial mortgage-related products in the market today," notes a report last August from Moody's Investors Service. "That is because the combined loan amount of the first lien mortgage loan and the high-LTV loan often exceeds the value of the home by up to 25%.

"There is little margin for error in this product," the report says. "If a lender makes a mistake in assessing a borrower's credit quality and the loan defaults, the lender is likely to suffer a complete loss."

Why? "Because the high-LTV loan generally is in a second lien position behind a large first mortgage loan," says the report. "In a foreclosure, sales proceeds would go first to pay off the first mortgage loan. Any remaining amounts would then be used to pay down the high-LTV loan. But the chances of having any monies left over after the first mortgage is satisfied are slim."

Clearly, that potential pitfall has not deterred Empire, precisely because it knows its customers well and therefore is less likely than others to make mistakes. Mr. Bradford says the company's success to date in securitizing $2 billion in loans speaks for itself. "We have three years of history on how loans perform and on the credit history of our borrowers," Mr. Bradford says. "Nobody has the volume or maturity that we do."

Helping the company is the fact that it services the vast majority of its own portfolio, about 110,000 customers in a portfolio worth between $3.1 billion and $3.2 billion. "Keeping and controlling our servicing is an absolute necessity in this market and one that's very profitable for us," says Mr. Bradford. "Anyone not doing it is asking for trouble."

Perhaps more important, however: in January, Empire raised its underwriting criteria for consumers. For instance, it has slowly raised its Fico score requirement from 620 to 660 and also increased its minimum disposable income requirements.

Results to date have been stellar. "We've implemented guidelines that focus on factors equally as important as Fico, (such as) disposable income, geographic limitations, and debt-to-income ratios," company material says. "The enhancements have eliminated 70% of historical defaults."

Mr. Bradford says the company has compared the performance of loans in older securitizations that do not meet its current underwriting standards (about 30%) with those that do in both older and newer securitizations. "Those meeting our current criteria are performing at a much higher standard," he notes.

If these steps are not enough to convince Wall Street that Empire is a winner, additional steps should. For instance, in April the company took greater control of its destiny by buying back the 40% interest that it had sold to Contifinancial Corp.

"Conti had been looking for capital for six or eight months (see accompanying graphic), and we thought it was an appropriate time to buy back their share so we wouldn't be encumbered by a shareholder trying to sell itself," says Mr. Bradford.

Finally, the company has vowed to diversify through the introduction of new products such as unsecured loans; shifted its sales strategy from one that revolves around correspondents to one that employs 3,000 brokers that will eliminate its former 4% payment to correspondents; and installed a front-end application system and has begun scanning all paper documents.

"Getting our product soundly positioned in the secondary market is our biggest challenge," says Mr. Bradford. "We're well on our way to accomplishing that."

Is Wall Street impressed? "Right now, they've survived, restructured themselves, and tried to make the case that they've identified a better set of criteria for selecting customers," says one credit officer at a ratings agency. "How successful they'll be I can't say. But they are doing something, and that seems impressive to me."

One note of caution: before the Asian bug hit last year, the company's tone about its future was just as optimistic-and its outlook no less promising. For instance, its loan production grew an astounding 353% over 1996-and the company had securitized $2 billion of its high-LTV loan product. In 1977, it originated $1.4 billion in loans, half of those conventional.

Its number of correspondents and brokers was growing in tandem. At yearend 1996, it had 139; a year later, the number had mushroomed to 824.

A company brochure said that "to the untrained eye," it may appear that Empire had a momentary growth spurt. "In retrospect, however, it's clear that the last few years represent more than a chance encounter with success for Empire Funding. To the contrary. We've listened hard to our customers."

According to Moody's, high-LTV loans in securitized pools tend to be, like Empire's, second lien loans, with average balances of $35,000 and terms ranging from 15 to 30 years. On a positive note-perhaps one speaking well for Empire's strategy-"we have seen a trend toward higher Fico score distributions in some newer high-LTV pools," the ratings agency says.

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