The news keeps on coming! More companies closing, or giving bad news in earning reports and industry outlook. Wall Street continues to pay low premiums for subprime loans, and if you believe the news reports, the industry is on the verge of collapse…. If you look a bit deeper though, there is more to see. While Wall Street gives a grim outlook on our industry, they are also spending a lot of money buying firms who produce these loans. Morgan Stanley, Merrill Lynch, Deutsche Bank, Lehman Brothers, Credit Suisse, Ing, FBR, and others all have wholesale subprime mortgage subsidiaries, most of these being recent acquisitions.
While we are still in for a rough time, the entrance into the market by these firms shows that some of the smartest financial minds anywhere believe there is money to be had in this industry, and a lot of it. This said there are still some things that need to be taken care of to make our return to profitability. Most loans now are made on a matrix basis, instead of a repayment basis. While this is necessary to create uniformity, and to allow for efficient growth, many of the people making exception decisions have never been involved in the trading or collecting of loans. This becomes important as it creates a lack of foundation for making important decisions. Anyone who has collected on loans, or has been involved in the disposition of problem loans gains insight into which loans typically perform, over what a matrix will tell you.
As we have seen, many of the companies who have gone to business have done so due to a failure to focus on quality. I don’t believe that any of these were malicious attempts to take advantage of the investors; however there easily may have been severe cases of neglect. For the past few years it was almost too easy – volumes were on the rise, and outpaced all the delinquencies. Now that volumes have declined, the delinquencies (which trail by 6-18 months) are still climbing. The rigorous quality controls that have been put in place over the past 6-12 months will not really impact the quality of portfolios for the same time frame. An interesting side note – Alt-A has become all the rage, and is currently the darling of the industry with everyone wanting a share. They are currently doing many of the products that the subprime industry has moved away from for quality reasons, and doing so at better pricing. While they have a much higher average FICO band, their WAC is also much lower and does not allow for near the delinquency that a subprime portfolio is built to support.
- Brett Reall
