New York - As lenders strive to maintain the torrid pace of new loan originations experienced over recent years, the home equity sector of the ABS market has seen growth in alternative loans. Some of these trends, such as the rise in interest-only mortgages and geographic concentrations, raised eyebrows at the recent investor conference UBS held at the Waldorf Astoria hotel in Manhattan.
Admitting that primary issuance volume "is much stronger than expected," home equity analyst Tom Zimmerman expressed concern over the impact of recent loan underwriting trends, should interest rates rise more rapidly than expected.
Additionally, this trend is not limited to one or two issuers either, Zimmerman noted. The number of issuers with greater than $2 billion in quarterly originations is roughly 20, according to Zimmerman, with the two leading originators - AmeriQuest Mortgage and New Century Financial - topping $12 billion in the second quarter 2004.
This is in stark contrast to just a few years ago, when the leading originator in 1Q00 was Household Finance, with just over $3 billion in originations. In 1Q01, only two lenders topped $5 billion in originations, Household and CitiFinancial (formerly Associates).
The growth of IO mortgages, particularly in inflated housing markets such as California, is evidence that "many Americans are using creative financing to squeeze into homes," that they could otherwise not afford.
IO loans currently consist of roughly 10% of subprime originations, according to UBS estimates. Since this loan type has only expanded into the subprime sector in the past year or so, historical performance data does not yet exist for IO loans, raising concerns over performance once rates reset.
While up to 10% of the overall originations in the current market IO loans, Zimmerman estimated that upwards of 40% of some lenders' originations may be of the IO variety. As a result, rating agencies have begun capping the percentage of IO loans an issuer can include in its securitizations, Zimmerman reported.
One participant even suggested that IO loans be split off into a separate tranche within a transaction, something met with only scant skepticism.
Zimmerman's other primary concern, geographic concentration is a development that has always existed, but only lately worried analysts, as California has grown disproportionately faster than other states.
Historical data for California is murky as well, as housing inflation has negated any information the market could have used to stress home equity ABS.
"The mortgage market in general has major exposure to California," Zimmerman said. Adding that as a high cost-of-living state, these alternative mortgage products are offered more frequently in California, this is doubly concerning.
Ironically, loan performance in California is the best in the country, thanks primarily to the 20% annual home price appreciation "severities in California are so low that even with 100% defaults, you don't lose any money," upon repossession and sale of a property.
And thus, "loss severity data currently available [for California] is useless," Zimmerman added.
But, noting his cautious optimism, Zimmerman believes that the lending community learned the what shoddy loan underwriting practices can lead to, following the late 1990s readjustment period. "Currently, lenders are more prepared than they were four years ago," Zimmerman said. "The unemployment picture is going to help us out too," he added.
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