Despite the liquidity crisis of 1998, which most agree was responsible for last year's decline in home-equity issuance, the subprime home-equity sector is coming on strong, promising more action this year, analysts said - granted interest rates don't lull origination.
"Certainly [the subprime industry] is in a lot better shape than it was a year ago, in the sense of having resolved some of the headline risk issues and some of the capitilization risk," said Tom Zimmerman, an ABS analyst in PaineWebber's mortgage strategy group.
"It's a situation where we have - and it's not just in B&C lending, but in all consumer areas - the banks have a lot of capital to put to work, and they're aggressively trying to expand their presence in this area," he said. "And I think that means that you will have pretty stiff competition for market share."
Such competition may lead to slightly lower credit quality, as banks try to maintain volumes, Zimmerman said.
An important issue going into this year is prepayment rates, and what will influence them most. There are two major factors expected to effect prepayment rates.
First, Zimmerman said, increased competition may speed up the rates, as competing banks offer better refinance opportunities.
However, the pending interest rate hikes will likely play a counter role, especially in the agency mortgage market.
"In both your agency and home equity markets, a lot of the speed story relies on people who are refinancing their old loans," said Zimmerman. "And if interest rates back up, it makes it less attractive to do so. And this has a real dramatic impact on the agency markets. It just slams volumes down dramatically, and slows speeds down. In the home-equity, it slows them down as well, though not as dramatically."
As opposed to refinancing, where a consumer would shoot for a better interest rate, consumers are likely to maintain slow repayment on their existing loans in an rising interest rate environment.
This combined with competition among banks creates a push and pull situation with regards to prepayment rates. In the larger picture, however, Zimmerman speculates that rising rates will win over competitive lending, and prepayment speeds will slow a bit throughout the year.
Other Interest Rate Impacts
Assuming a rising interest rate environment makes it more difficult for the banks to originate loans, overall profitability could slide, Zimmerman said.
"We've restructured the industry and it's on a much stronger footing, but the negative is that we're now facing an economy which is finally getting around to pushing interest rates up," Zimmerman said. "If they were to go a lot higher, it could have a significant impact on originations."
Though interest rates would effect other consumer sectors, none would be hit like mortgage-related product, Zimmerman explained, due to the larger loan volumes involved.
Among other effects, interest rates could potentially cause a shift towards the B&C subprime markets on account of increased second lien borrowing, Zimmerman said.
"People may need to get access to cash some way, and if it no longer makes economic sense to refinance, they may turn to taking out a second lien on their house," Zimmerman explained. "The B&C market could see more second liens than it has the last couple years."
In such a way, the mortgage market might more closely resemble the mortgage market in the early 90's, where second liens were more dominant due to heightened interest rates.
"I'm not saying it's going to go back, but I think that it could move in that direction somewhat and that we'll see more second liens."
