The process of origination and securitization of Home Equity Loans (HELs) is currently undergoing a structural shift that may have implications for liquidity going forward. The top originators (which include RFC and Countrywide) have increased their market share and overall production volume of loans, strengthening their commitment to the product. Furthermore, investment banking firms have recently begun establishing new securitization shelves, which enable them to purchase and package HEL whole loans from smaller originators. Lehman, which operates the SASCO shelf, has engaged in this type of trading and securitization activity for a number of years.
There has been no shortage of news stories on the problematic path that the overall market for these loans has taken in recent months. Several prominent originators of HELs from the past few years (e.g., The Money Store, UCFC) have either shut down, been sold, or have scaled back production significantly. Other, smaller originators have been unable to compete in a difficult marketplace. Aggressive gain-on-sale accounting practices, poor pricing, and a general dependence on securitization for capital access by smaller originators have been the most obvious culprits. Additionally, recent scrutiny of originators' alleged use of predatory lending practices has weighed heavily on the market. However, in the wake of these negative trends, the stronger players have flourished.
Issuers such as Countrywide, RFC and SASCO have seen their HEL volumes grow significantly in an otherwise declining private label mortgage market. (Note that we define HEL as including both B- and C-rated first liens as well as A-rated 2nd lien mortgages.) For example, Countrywide's private label mortgage production volume for the first six months of 2000 has been flat to that of the first six months of 1999. However, the firm's HEL production is up nearly 160% over last year's originations for the same period. Similar increases have been recorded for the other big names.
Traditionally, Wall Street firms have been the providers of liquidity for the ABS markets. Mortgage-related ABSs generally suffer from a liquidity give-up relative to Credit Card and Auto securities. Additionally, since the credit crisis in late 1998, the willingness of the dealer community to make markets in ABSs has diminished, most notably in lesser-name issues. However, investment banks have typically been committed to making markets on securities issued off of their own shelf. With smaller originators struggling to stay liquid in a market where the execution on their securities has suffered substantially, Wall Street has stepped in by purchasing whole loans and packaging them in deals bearing their own names. Morgan Stanley and DLJ recently established their own labels and have each issued their first deal in the past two months.
To be sure, the question of the quality of the collateral and servicer on each new conduit transaction remains. However, the endorsement of the collateral via the application of the underwriter's name probably carries some meaningful weight (i.e., underwriters should theoretically perform more thorough due diligence when their own names could hit the headlines). The replacement of "off-the-run" issuers with Wall Street dealer nameplate transactions should, in our opinion, add to the perceived liquidity in the sector.
Perception often tends to become reality in the world of ABS. That said, it remains to be seen whether the dealer community will remain committed to this new conduit business. If they don't, the improvement in liquidity will be a short-term phenomenon.
The notion of "tiering" amongst securities issuers has been a topic that has received attention in recent years. With both the shake-out of weaker players that came to market sporadically, as well as the growth among the bigger, high quality names, the tiers has been reshuffled. As the larger, more frequent securitizers have grown, and with Wall Street firms adding their names to the product, HEL securities should benefit from a better defined and more organized marketplace. We expect the tiers to develop as follows:
1. The major issuers;
2. Wall-Street-sponsored conduits;
3. Small, infrequent issuers.
However, the perceived gap between major issuers and the conduits will not be as great as the chasm between major and small issuers that existed previously. It will be interesting to see whether a separate tier structure develops amongst the dealer conduits. However, we expect these changes to greatly benefit the HEL market, if the street maintains its commitment to supporting its conduits.
