S&P is telling it like it is today...
Subprime lenders in calm before possible storm-S&P
(Press release provided by Standard & Poor's)
NEW YORK, May 17 (Reuters) - What appears to be a reprieve in the disintegration of the sub-prime specialty lending market could be the eye of the storm for many companies, Standard & Poor's said Monday.
''Sub-prime lenders are experiencing a sort of stability right now, but it could be just a matter of time before the other shoe drops,'' said Dan Martin, director in Standard & Poor's Financial Institutions Ratings group.
This other shoe could come in the form of an inability to renew funding facilities, a recession, litigation, or even more bad headlines. The problem is that the financial condition of most lenders in the sector remains fragile.
Delta Financial reported respectable earnings and a positive operating cash flow for two straight quarters, due in part to a scaling back in the volume of loan production and securitization. Delta Financial's situation is an exception, however, as other sub-prime lenders, including Aames Financial and ContiFinancial, are reporting poor earnings and continue to demonstrate vulnerability to the extreme risks associated with their reliance on the securitization and whole loan markets for the disposition of assets.
Conditions in these markets are volatile, making it difficult to predict from quarter to quarter whether these companies can profitably securitize or sell the loans they acquire, Mr. Martin added. Hedging against this risk has also become problematic, as the most liquid hedging markets, such as the U.S. Treasury market and related derivatives markets, may not always correlate with the nonconforming mortgage-backed securities (MBS) market.
The problems faced in the sector are exacerbated by the fact that its working capital needs are funded by bank lines or bank-guaranteed facilities, which must be renegotiated on a recurring basis, Mr. Martin added. Moreover, some companies, including Contifinancial, have encumbered a large portion of their excess servicing assets, which are created at the time of securitization. Contifinancial also faces the task of renegotiating over the next several months two unsecured bank facilities.
''The misassumptions regarding prepayment speeds and, in some cases, loss severity have produced large writedowns of excess servicing assets and residual certificates. Liquidity remains a worry as debt and equity markets have come to treat the sector as pariahs. The bottom line is that many companies have entered 1999 seriously enfeebled. What's to become of the industry if we slip into a recession?,'' Mr. Martin added.
The average rating for the industry is single-'B', and Standard & Poor's currently has a negative outlook on most subprime mortgage lenders it rates. While the current strong economic environment insinuates stability among these companies, Standard & Poor's does not expect any upward pressure on ratings. Even if companies could obtain fresh equity, as Aames has recently done, the best that such companies can expect, short of an outright sale to a more highly rated company, is a change in outlook to stable. The burden is on management to prove the business model can work and that the new money will not be squandered, Standard & Poor's said.
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