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Wednesday December 31, 1:14 pm Eastern Time
YEAREND-US home equity lenders eye prepay penalty
By Aleksandrs Rozens
NEW YORK, Dec 31 (Reuters) - Just two years ago, home equity lenders recruited retired baseball stars to drum up business. Now, in the wake of a costly rise in prepayments, the focus has shifted to retaining, rather than attracting, clients via prepayment penalties.
While a handful of lenders have used such penalties for years, market players said they will probably become even more widely accepted in 1998.
Some states have outlawed prepayment penalties and market participants believe consumer groups would actively oppose any nationwide campaign by lenders to restrict prepayments.
But lenders, fearing massive prepayments will erode earnings, are expected to impose penalties in states which allow them.
AGGRESSIVE LENDERS FUEL REFINANCINGS
Observers and participants said competition among lenders, rather than low U.S. interest rates, is propelling home equity loan (HEL) refinancings.
The link between low interest rates and prepayments in the HEL market is not as strong as in the conventional A-quality loan market, according to Christine Clifford, vice president and analyst at David Olson Research.
HEL originators, Clifford said, are chasing a finite number of customers ''who are more aware of their alternatives.''
The home equity market has grown at a breakneck pace in recent years with a flood of new participants. According to Securities Data Publishing, 19 finance companies went public in 1996 and 1997 to raise $2.643 billion.
This fast pace of growth in the industry may explain why lenders have been reticent in employing prepayment penalties.
''If your objective is to do a lot of (lending) volume quickly, you may be oriented to giving up (prepay) protection,'' said Thomas Hallman, president and chief executive officer of The CIT Group Inc, a Livingston, N.J.-based lender.
The move to impose a prepayment penalty comes as lenders are enduring erosion of their earnings by waves of borrower prepayments, said Clifford.
Participants agreed that much refinancing activity in the HEL market has occurred in floating-rate mortgage products.
''The consensus is that the adjustable rate products have more volatile prepayments than fixed-rate products,'' said Greg Witherspoon, executive vice president at Aames Financial Corp [NYSE:AAM - news], a California-based lender.
Many lenders securitize their home equity loans to finance other loans and this securitization process is disrupted by homeowner refinancings.
PREPAYMENTS PINCH INCOME FROM SERVICING
Jeffrey Salmon, asset-backed analyst at UBS Securities LLC,
noted that if prepayments deviate substantially from expectations, originators can lose expected cashflow, such as income earned from servicing the pool of securitized loans.
''The gain on sale was assuming future cash flow would be x,y and z,'' said Salmon.
Salmon warned the prepay penalty may be difficult to implement because of the intense competition among lenders for market share.
Meanwhile, David Bigelow, executive vice president of corporate finance at Countrywide Mortgage, said his firm views home equity lending as a sideline rather than the backbone of its business.
Countrywide, he said, does home equity lines of credit (HELOCs), and these account for a small percentage of the firm's total loan portfolio. The Countrywide executive said HELs serve more as a supplement to the firm's A-quality paper business.
In fact, having the HEL product available has helped mitigate prepayments in A-quality home mortgages and has helped retain customers, he said.
''Countrywide mines its existing portfolio of borrowers. Since these are A-quality borrowers, a high percentage of our HELs and HELOCs are A-quality borrowers,'' Bigelow said, noting that much of the prepayment activity has been linked to B-quality and C-quality borrowers who are always looking to refinance into cheaper loans.
''HEL and subprime lending are not our primary businesses,'' said the Countrywide executive.
PENALTIES MAY SPOOK SOME BORROWERS, CONCEDES LENDER
Meanwhile, some lenders such as CIT have already used prepayment penalties to keep their loan pools intact.
Some of CIT's loan pools can be subject to prepayment -- -- many states where CIT operates forbid prepay penalties -- and Hallman conceded the lender ''left some business on the table.''
But, he said, ''we are making our objectives, which include volume and quality.'' Having the prepayment penalty in place, said Hallman, has allowed CIT to better judge and meet its earnings goals.
Aames Financial's Witherspoon also said prepay penalties have been effective in curtailing refinancings and he noted the lending process itself may determine whether certain loans have a greater tendency to prepay.
''In 1995 and 1996 we bought bulks of loans (from other lenders). Our employees did not originate loans face-to-face with the borrower,'' he said.
Witherspoon noted that the life expectancy of these loans purchased from other lenders tends to be shorter than the retail-originated loans because of the ongoing relationships between lenders and borrowers.
David Van Dam, head of the asset-backed securitization group at Key Capital Markets, a unit of KeyCorp, said the securities backed by HEL pools with prepay penalties will be more palatable to investors.
''Those deals will be more attractive and lenders will get better execution for deals with collateral prepayment protection,'' he said. |
