Two high-profile predatory lending cases - coupled with Congress' watchful eye on the subprime lending industry - have left many investors wondering what would happen to the credit quality of outstanding mortgage-backed securities pools consisting of home-equity loans.
Moody's Investors Service published a report on this issue, with Moody's and market observers agreeing that minimal impact will be felt in those pools.
According to Keith Wofford, vice president and senior analyst for structured finance at Moody's - and author of the report - the goal of the report was to focus investors' attention to the securities, rather than the originators or allegations themselves. "The implications are potentially very different obviously for the originators than they are for the bonds," he said. "Sustained bad publicity is never good from the perspective of a shareholder, but that's not where the investors are."
The two originators in question are First Alliance Mortgage Co. and Delta Funding Corp. However, according to Wofford, only Delta's bonds have been placed on watch, and it all depends on the outcome of the case as to how those watching the bonds will react.
"The question is whether the litigation is widespread enough against a particular originator that the number of loans in a particular pool that has been securitized might be affected," he said, noting that litigation is likely to impact the pools more so than legislation.
"If somebody went through the whole list of deals and said you've got five loans we categorize as predatory lending, you have to void those loans," added a market observer. "It's not going to have any major impact. I think that by and large, most of the companies involved in this industry may have a little bit of that, but it's so small, it's not an issue."
Those bonds most at risk of credit downgrading are those with a senior-subordinate structure, especially at the subordinate level. "The worst of it has to get a senior-sub structure, where you have deep subordinated bonds where they might be at risk of loss or if there are enough people within one of these deals who were able to have their loans voided," said one MBS researcher.
With all the attention currently focused on First Alliance and Delta, the possibility for other issuers to face similar consequences exists, though no one particular company sticks out. "Are there others out there who could have predatory lending problems at the end of the day? Yes," said a market observer. "Do I have any that stick out in my mind as having kind of unusual-looking patterns such that I would say, Uh-oh, that could be trouble?' No."
"I don't know anyone in particular who would fall into that category," said another source, adding that those with a corporate philosophy leaning toward predatory practices would be those who are targeted, rather than companies whose predatory loans are "on the fringes."
As for how the government is handling the situation, some market participants believe that Congress does not know how the subprime industry operates. "I think some of these senators and congressmen who are looking at this thing right now, I don't think they have any idea of what it takes to try to run a business when you're lending money to people who don't typically pay you back," said a Street subprime specialist.
Other observers agree that if high-profile law suits and legislation against predatory lending is to continue, C- and D-rated borrowers are likely to be left out of the picture altogether. "People who have in the past serviced a broad range of the subprime market A-minus, B-plus, all the way down, may simply decide it's not worth the headline risk or the regulatory risk to lend to people with really tarnished credit," the observer said.
"So I think what's going to happen is that part of the market is going to cease to be."