Since refinancing has come to an abrupt halt, first-mortgage lenders are turning increasingly to "B" and C" lending as areas of potential growth.
But lending to those with "less-than-perfect" credit histories is a crowded, competitive niche. As many as 22 companies want the business, with more likely to join in - stiff competition has prompted some lenders to ease their underwriting standards.
This market may not be what first mortgage lenders want, said a panel of market participants who spoke on B and C lending last month in New York. The occasion was a conference on "Whole Loan CMOs," sponsored by Frank J. Fabozzi Associates and Information Management Network.
Two rating agency analysts and an investment banker gave overviews of the market for B and C loans, which include anything from home equity loans and second mortgages to "hard money" loans based almost solely on the value of the collateral.
These loans are made to those with less than the best credit histories - typically with more than one loan delinquency on record in the last 12 months. To compensate lenders for the risk, the coupons are high - between 10% and 13% - and to protect against losses, originators usually require loan-to-value ratios below 80%, with securitized pool ratios averaging around 60-65%.
Andrew Jones, vice president at Duff & Phelps, explained that loans to "A" borrowers are made mainly on the basis of the borrowers' ability to repay. Below that grade - B, C and D - the value of the collateral that secures the loan becomes increasingly important.
There are many lenders that specialize in B and C lending, noted Bill Cherry, managing director at Kidder Peabody, including such established players as Chrysler Financial Corp., Beneficial Corp., Old Stone Credit, The Money Store and Advanta Corp. Most originate fixed-rate second mortgages, which are held or securitized in insured transactions, he added.
A new tier of players has entered the market recently, Cherry observed, including: Long Beach Savings Bank, Southern Pacific, Resource Mortgage, American Residential, Equicon (Cargill), Independent Mortgage of Florida, Alliance Funding and Quality Mortgage. The latest is Prudential Home Mortgage, a unit of Prudential Insurance Co. of America, the nation's second-biggest mortgage lender.
The new players tend to originate adjustable-rate mortgages based on six month Libor rates.
"It's a crowded field," Cherry said. "Is it the saving grace of mortgage banking?" With up to 22 conduits already operating, "We don't know how big the market really is."
He noted that some lenders ascribe to a "white-collar recession" theory, which holds that new B and C borrowers are springing up as a result of layoffs and cost cutting at big companies. "I don't know if that's true," he said.
Jones of Duff & Phelps concurred. "There's been a lot of talk about B and C lending at the end of the re-fi boom," he said. "But it's unlikely that this will be the answer."
Jones stressed that servicing is "dramatically different" between A lending and B and C lending. "This is very important for A lenders moving into B and C lending."
Servicing the lower-rated loans is "much more aggressive," he added. Servicers often contact borrowers even before the first payment is due and provide budgeting help. Once a payment is missed, contact must be made with the customer within five to 10 days. Chronic late payers must be tracked, and foreclosures should be prompt, generally within 45 days of nonpayment. A backup servicer must also be available on a securitized transaction, Jones said.
Guardian Savings,a California thrift whose securitized B and C loans experienced high default rates several years ago, had a replacement servicer that was "really an A-quality servicer," Jones pointed out. As a result, the loans were not worked out properly and the thrift's deals were downgraded. However, Guardian also did "back-to-back seconds," he added.
Mary Sue Lundy, vice president at Fitch Investors Service, said, "It's hard to know how much the market can take of this product."
Despite uncertainty over the size of the potential market, many first mortgage lenders plan to enter the fray. The nation's largest, Countrywide Funding plans to offer home equity loans.
The increased competition does not bode well for underwriting standards, conference participants said.
"What is for sure is that the competition may force originators to lower their standards," Cherry predicted. "We've already seen one lender raise its LTV to 85%."