It's business as usual at Saxon Mortgage Inc., as the company preps its first deal of the year, likely to price next week, said Brad Adams, senior vice president of capital markets at Saxon.

The pending $475 million deal will be backed by a 60/40 mix of fixed- and floating-rate home-equity loans. Prudential Securities Inc. will act as lead manager and the transaction will have a senior/subordinate structure.

A typical deal, Adams said.

"We'll probably start pre-marketing the week of the 14th, and then price maybe the 17th, that Thursday," he added.

With 14 deals since 1996, and proceeds nearing $7 billion, Saxon has become an established, consistent, top-tier player in the subprime/non-prime home-equity market, with successful executions through the years, despite periods of market volatility that literally wiped out a whole slew of Saxon's competitors.

So what's the secret?

"There are some big differences between us and the issuers of a year ago," Adams said. "But they're all gone. The people who are left pretty much know how to do this business well."

Saxon Takes It Slow

Virginia-based Saxon was formed in 1992 as a subsidiary of Resource Mortgage Capital, now Dynex Capital. For nearly four years, Saxon primarily originated jumbo mortgages and alt-A product, until it was purchased in 1996 by Dominion Capital, a subsidiary of Dominion Resources, parent company of Virginia Power, the state's sole provider of electricity, Adams said.

"In 1994, we began our wholesale subprime origination effort," Adams said. "Dominion bought Saxon specifically for its ability to originate and service subprime mortgages, so in May of 1996, we really started to accelerate our migration to subprime origination."

Though Saxon accelerated its originations, the idea is relative, as one of the companies overall strategies is "steady and measured growth," with just 15% portfolio expansion each year.

"We may increase our rate of growth just because there are fewer players," he said. "It's an opportunity to increase market share, when a lot of your competition goes away."

To grow at a phenomenal rate, a company must either price irrationally or loosen underwriting standards, neither of which Saxon is willing to do, Adams said.

"It just fits in with our underlying strategy, of prudent underwriting, prudent balance sheet management, aggressive servicing: just a real focus on credit management through the life of the loan," Adams said.

As an example, Saxon does not leverage its residuals.

With this strategy in mind, Saxon is careful when considering new markets and asset-classes, Adams said.

"This is our niche," he added. "We certainly have thought about other mortgage-related asset classes. If the economics we're right, we could branch out into alt-A, or even have a separate division to go back to our roots and do the jumbo stuff. But I don't know that we'll be doing that anytime soon."

In the past, Saxon had considered high loan-to-value origination, but decided against it.

Alternative Structures

In a rare example of a divergence in structure, during last fall's liquidity "worries" associated with Y2K, Saxon sold its floating- and fixed-rate loans as separate transactions.

"In that case we sold the floating-rate first through a reverse inquiry from the buyside, and then subsequently did the same thing with the fixed-rate," Adams explained.

"I think it was a trend in the third and fourth quarter because no one knew what was going to happen," he added. "In hindsight, the spreads we achieved by doing that weren't any better than if we had waited though. The certainty achieved by locking in spreads that early on and removing our hedges was worth quite bit to us."

In a strong market, Adams maintains it's best to issue competitively rather than identify an investor who wants to buy a large piece.

In terms of other structures and innovations, the company will look towards alternative credit enhancement this year, a move Saxon hasn't made since 1996.

"We're viewed as very prudent in terms of underwriting and servicing, so we've been able to sell subordinate bonds even in the worst of markets," Adams said. "I think it makes sense to have all options available going into a deal. We're probably going to cultivate relationships with the sureties this year."

Saxon is also considering a structure that would address basis risk. Nearly all the adjustable-rate loans Saxon originates are two-to-three year hybrid adjustable-rate mortgages, and in most cases, Saxon will sell floating-rate bonds off of those loans.

"In a situation where you're in a rising interest rate environment like we are now, that's especially risky," Adams said. "We're always looking at ways to mitigate some of that risk."

Harnessing the Risk

Credit risk management is Saxon's most apparent strategy as an asset-backed issuer and lender, Adams said. The company underwrites every single loan, even those included in a bulk purchase.

"In the past, a lot of the guys that buy loans through bulk purchases will underwrite a subset, like a 10% sample of the loans," Adams said. "We don't feel comfortable with that, so we actually bring our team in there, and take as long as it takes to re-underwrite every loan."

Additionally, Saxon, through its servicing company Meritech Mortgage Services Inc., uses an unusually aggressive servicing platform, and begins a foreclosure process much sooner than most subprime servicers. Because of that, Adams explained, Saxon's portfolio might show a higher foreclosure rate in the early stages of a deal; however, by speeding up the default resolution process, the loss rate is generally lower.

In a comparable example, Saxon adjusts its front-end pricing more quickly than some other issuers. As soon as Saxon sees a market move, it prices that in, in some cases slowing down volume.

"So all of a sudden for a few days we're behind the market, but we're accurately priced," he said. "Some other people are getting loans but not at the profitability they perhaps expected."


Though Saxon has developed a new Web site, the site is mainly being used to distribute information to investors. Saxon is hesitant to launch an aggressive Internet program too soon.

"As far as originating on the Internet, we receive leads through relationships with several online mortgage services," Adams said. "We are looking at originating through the Internet, but we're not sure it's gong to be the future of the industry. I think there are certainly some efficiencies, doing some of the information gathering online."

Adams admits Saxon is not as far along as some of its competitors might be, though he doesn't consider this any sort of shortcoming. "Let some other people make some mistakes and then we'll see," he said.

In the meantime, Saxon will continue wallowing in a healthy, expanding sector.

"There's a lot of pent up demand," he said. "The market for subordinate home-equitys has grown quite a bit just in the last few months."

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