Even as the global financial markets try to stem the bleeding and lick their wounds, some in the securitization industry are predicting not only that the subprime mortgage industry will recover, but also that it will actually grow.
In a sector that has seen an increasing number of defaults, foreclosures, layoffs and shuttered firms, this may seem like a bold, even reckless, prediction.
But the message last week from some of the speakers at Information Management Network's third annual Subprime ABS: Where Are We Heading? conference in Las Vegas was that news of the subprime mortgage industry's demise has been greatly exaggerated.
"We are going to see a major expansion of the subprime market," said Richard Benson, president of Specialty Finance Group.
Driving this expansion, Benson argued, will be the readjustment of prime borrowers into subprime borrowers as the smoke clears. "If you dig deep and look at their credit, these aren't prime loans, they're subprime loans," he said. "These people do not have the credit to be prime borrowers."
Benson went even further: "Three million people who call themselves homeowners shouldn't be homeowners," he said. "They have no equity. They have to improve their financial standing."
To be sure, Benson has not exactly been the most optimistic observer of the subprime market. In fact, at last year's Subprime ABS conference, he was one of the only speakers who actually predicted pending doom for the market.
Benson was not alone in forecasting the subprime mortgage industry's expansion. Both Jason Stewart, portfolio manager for investment adviser Barrier Investments, and Bobby Lazenby, president of risk management firm Lazenby & Associates, also predicted growth opportunities for
the industry.
"There is going to be a much larger subprime market than we have had before," Lazenby said. He sees the market turning back the clock to a time in which subprime borrowers weren't necessarily borrowers with a history of credit problems. "In the late-'80s, the subprime borrower was someone who had been divorced or had a medical difficulty and was no longer able to make all his or her payments," he said. "They weren't chronically bad payers on all their credit across the board."
Not everyone, however, was on board with this prediction. "The subprime market is going to be substantially smaller than it is today," said Mark Adelson, an independent consultant.
However, with the era of no down payments and no-doc lending heading into the sunset, Adelson sees a shrinking market that might be better off in the end. "It will be a smaller but much stronger market," he said. "It will be like it was before this period of crazy lending." While he agrees with Benson that a number of homeowners today really shouldn't be homeowners, he doesn't see the fallout as a boon for the subprime industry. "A lot of homeowners will go back to being renters," he said.
Lazenby conceded that lending will be lower in the short term, but he defended his forecast for a growing subprime market in which lenders will have to dig deeper and consider a borrower's credit history. "This is going to open a whole new market for us, and we're just going to have to take it on a loan-by-loan basis," he said.
Adelson, however, foresees a return to more traditional loan deals for prospective homebuyers, rather than prime borrowers converting to subprime borrowers. This shift will include an increase in Federal Housing Administration loans. "They've already begun trying to grab a bigger share of the market," he said.
If borrowers begin seeking out more traditional loans, it could coincide with a return to more modest expectations with home buying. "Everyone wants their $600,000 dream home right now, when what they really should be getting is a $200,000 starter home," he said.
While Benson believes the subprime mortgage industry will experience expansion, he does see changes ahead for the market. "We need to go back to a balance-sheet model," he said. "Simply relying on FICO scores and nothing else is proving dangerous." Benson added that "securitization morphed from a wonderful financing tool into a business model." The involvement of hedge funds, some of which have been hurt by betting on credit derivative options, will also change. In fact, Adelson went so far as to say the "ABS CDO market will not come back."
Looking beyond just the potential increase in subprime mortgages, Benson also addressed the role of the much-maligned rating agencies. Although these firms became complacent in assigning scores to subprime loans, they could still play a crucial role for investors in the future. "Like them or hate them, we are going to need rating agencies more and more, because we need the transparency," he said.
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