Last week the research group at UBS Warburg examined current home-equity pool collateral characteristics, finding subtle but meaningful differences between today's market and the 1998 heyday-blowout that left so many lenders in the gutter.

At issue is whether lenders today are more conservatively pricing their loans. Warburg finds that the weighted average coupon in today's fixed-rate pools is nearly identical to 1998 pools, though a pure WAC comparison fails to recognize the expanded use of prepayment penalties, the researchers note. A borrower that takes a prepayment penalty receives a rate discount of between 50 basis points and 100 basis points, said Tom Zimmerman, of Warburg's ABS research group.

Factoring in this rate reduction, Zimmerman argues that lenders are in essence pricing more conservatively. Also, since the penalty equates to about five months of interest, which is passed through the waterfall, it essentially adds padding on the back end, theoretically recouping rate differential should the borrower prepay.

Interestingly, prepayment characteristics in fixed-rate home-equity pools have not changed dramatically, particularly during refinancing cycles, despite the greater use of prepayment penalties that began in 1998. What has changed, however, is the home-equity lender's profitability, as the penalties help to offset revenue loss from portfolio run-off.

On the ARM side, because home-equity pools can include so many different products, such as 2/28s and 3/27s, the prepayment analysis is tricky, but there is a notable spike following the two-year reset, and a more subtle spike at the three year, Zimmerman said. He noted the substantial shift to ARMs, estimating that about 75% of the current home-equity market is floating-rate, attributable to a spread widening between the ARM rates and Libor. This widening has also contributed to the flurry of net-interest margin (NIM) securitizations seen over the last year or so.

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