Wall Street is quietly moving to standardize loans to home borrowers with checkered credit, an initiative that could reduce rates on subprime home loans the same way rates were lowered on mainstream mortgages in the early 1980s.
The initiative, spearheaded by Standard & Poor's Corp., would redefine credit standards for the booming subprime mortgage business by instituting a uniform evaluation system.
Such a step to replace the current patchwork approach could cut rates by several percentage points, industry experts said.
"Standardized judging will help a lot" to bring down subprime loan rates, some of which are now in the low to mid teens, said Peter Rubinstein, senior vice president with Donaldson, Lufkin & Jenrette, New York.
The reductions in rates would narrow the presently large distinction between prime and subprime loans and could expand the market for so-called B, C, and D products by making them more affordable to borrowers.
Although the initiative is still in its early stages, Standard & Poor's is finding a favorable reception from investors, bankers, and underwriters. The giant ratings agency is talking to them about adopting a single set of rating criteria for the scores of approaches used by individual lenders.
The rationale is that investors, armed with more accurate and comprehensive information about subprime securities, would be willing to bid more for the products because they would be less of a gamble. The securities' correspondingly lower yields would be passed along to borrowers in the form of reduced interest rates, industry experts said.
That's what led to the downward adjustment in mainstream mortgage rates more than a decade ago, when Fannie Mae, Freddie Mac, and Wall Street joined forces.
"They dramatically reduced interest rates for homebuyers" by establishing standard judging criteria for loan quality and creating a big market for trading, Mr. Rubinstein said.
Conventional loan rates, adjusted for normal market fluctuations, are at least three percentage points lower than they were before securitization standards were set, industry experts say.
The move toward uniform standards is gaining steam as more lenders enter the market. More than $40 billion of these loans were made last year, compared with about $27 billion in 1995, according to industry estimates.
At the same time, the industry has been striving to make clearer distinctions between prime loans that Freddie Mac and Fannie Mae can purchase and securitize and subprime loans that private conduits turn into securities. Indeed, Freddie Mac said it has been finding that many of the loans submitted to its automated underwriting system as subprime actually qualify as prime credits.
To set uniform standards, S&P would rely largely on credit and mortgage scoring and rate loans by risk grades that range from 1 to 7. The approach would "help spot problems before they happen" in large pools of subprime securities, said S&P managing director Frank L. Raiter.
S&P has taken its proposal on the road, holding meetings this winter with investors, bankers, and underwriters. Many industry executives are warm to the idea, saying a uniform approach would remove investors' uncertainty about what they were buying.
"There really isn't a standard legend with respect to what is B, C, or D," said Jim Svinth, senior vice president of Norwest Mortgage's capital markets group.
Investors are also interested in the approach. Although subprime bond buyers would receive a somewhat lower return, there would be much less a chance of the securities souring, said Michael A. Mastobuoni, manager with Coast Partners Securities, a Jersey City, brokerage that buys on behalf of institutional investors.
"The proposal would create a much more precise way to judge these loans," Mr. Mastobuoni said.
