Paradise Island, Bahamas - The roster of departures from the home-equity and subprime sectors this past year has made the sector smaller, but has given the survivors more room to do business, and that might be a good thing, according to sources interviewed at the Fabozzi/Information Management Network Asset Securitization 2000 conference in the Bahamas last week.
"The years 1996 and 1997 were the inflating of the business, and now the air is out of the balloon," said Mark Adelson, managing director of residential mortgages/home-equity at Moody's Investors Service. "The players in the market are saying, Now we can do business without killing each other.'"
The bloodbath that occurred in the industry, beginning with the liquidity crisis of 1998 and ending with the exit of several major players over the last few months, has given way to a cleansing period that finally seems to be coming to an end.
"There is always a lagging effect coming out of a cleansing period, and the only question is whether it will be slow or fast," Adelson said. "Although volume is down from last year, I believe there is the possibility to sustain good issuance and I am positive about the future."
At a conference session entitled Dynamics of the Subprime Mortgage ABS Market: Recent Events, Origination, Servicing and Securitization, panelists discussed how consolidation in the sector will affect future performance.
"I think that with deeper corporate pockets, there will be more scrutiny and control, and it will be better overall," said Glenn Tso, managing director and co-head of the residential mortgage group at FSA.
"It's easier to get talent with consolidation," added Jay Bray, CFO of Centex Home Equity Corp. "That makes it easier for the company to grow at a steady pace."
"It is as competitive as it ever has been with fewer players," said William O'Neill of Option One Mortgage.
Furthermore, investors who had typically looked only at conventional mortgage product are now looking at mortgage-related ABS as they see less value in conforming paper.
"The traditional lines have been blurred," said Moody's Adelson. "Investors are looking more broadly, beyond just jumbo paper. Now they are looking at Alt-A paper, and other mortgage-related bonds."
Prepayment Models
But what is even more interesting is a topic which Adelson says speakers at the conference should talk about, but probably won't: reliance on quantitative models.
"Nobody will address the potential for a shift in the economic climate and how that will bear on the reliability of quantitative tools that people use in this business," Adelson said.
In the past, fancy models used to predict prepayments for loans neglected to take into consideration "unquantifiable" factors in the home-equity sector that were perhaps difficult to include in a model though completely evident to most people.
"Models had predicted that prepayments would be slow, and the best and the brightest were blessing them," Adelson said. "But there were factors that sped up prepayments, such as the fact that consumers had more access to finance - but that was difficult to fit into a model."
"This is a pretty common theme now," said Andrew Davidson, founder and president of Andrew Davidson & Co. "As the new data is coming in and prepayments are slower on this product than they were two years ago, everyone's looking around to try and understand what's been causing those shifts in prepayments. The market is aware of the issues and I'm not sure we have the solutions yet."
Additionally, Davidson noted that the structure of the industry has changed dramatically, so whether or not the borrowers change their behavior, the nature of the providers of home-equity loans has changed dramatically. That should have an effect on prepayment speeds and losses and what kind of new loans people can have.
Since members of the industry build so much out of quantitative models, Adelson added that there needs to be more circumspection and questioning of models, which sometimes either overemphasize recent data, don't look broadly enough, or neglect to provide stress tests for bad situations.
"Let's hope that [our ability to rely on prepayment models] lasts, but we have to keep up our guard in case it doesn't," Adelson said
