Will Wall Street still have an appetite for sub-prime loans?James L. Smithconservative, stricter, valuation credit, diligence standards, pre-certification program
As someone who's involved in mortgage portfolio investment, I've
been spending a lot of time answering the same question: Will Wall
Street continue to have an appetite for sub-prime loans in view of
the industry's recent collapse? My answer is yes, but ...
The "but" is that the market will continue to invest, but we're
also expecting investors to tell the sellers that they'll be taking
a more conservative approach to sub-prime loans. According to
meetings I had with Wall Street investors, they'll be very careful
about what they buy and will institute a more conservative
diligence practice around the loans that are purchased. What that
means to lenders is that these investors will be stricter about
their purchase guidelines and will grant very few, if any,
exceptions to them.
Historically, what people in Wall Street firms would do with
sub-prime loans is to take a small sample of the loans in a package
and perform a diligence review of valuation credit and compliance.
For example, a firm would take a sampling of around 10 percent for
diligence. Not now. Sellers can expect a significantly larger
sample selection that could be up to 100 percent, and the sample
selection will be based on whom the sellers are, along with the
characteristics of the pool.
The old adage for sub-prime loans was that you made the loan on
the property, not on the borrower. By definition, many sub-prime
borrowers had distressed credit, so those providing loans to
sub-prime borrowers had to put an additional focus on the value of
the property versus relying on the borrower's credit. Historically,
there has been some tolerance between the appraised value of a
property and the diligence value. If the property value was
$100,000 based on an appraisal and the diligence value came in at
$90,000, the 10 percent variance between the two, most probably,
would be accepted, but not now. Today, the value of the property
would be $90,000. In other words, the due diligence value would
trump the appraised value.
Advice to lenders
So what does that mean to lenders? Know your investors and know
where your programs stand with them. Here are a few concrete
suggestions for moving forward in the new sub-prime
-Understand your investor's new diligence standards. Expect
those standards to be more conservative. You should also know that
investors are more than happy to share those with you. They don't
want to kick loans out of the pool you bring them. Make sure you
keep the lines of communication between your investors and your
institution open so you can meet their needs and yours.
-Have independent diligence companies who have appraisers and
underwriters participate in the review for the valuation and
underwriting of loans prior to selling them to the investment
community. When we do this for lenders it gives their investors a
comfort level that comes from having an independent, unbiased party
establish the value to support property values and borrowers'
-Find out if your investors have a pre-certification program.
Many Wall Street firms are establishing pre-certification programs
where they are using companies like ours to revalue or audit
property values before accepting them. Ask your investors if they
have such a program in place and how you can participate. This
audit allows the investor to have a comfort level before they
purchase the loan package.
-Vet any new loan programs with investors before you roll them
out. Investors will tell you exactly what you have to do to make
your loans more appealing to purchasers. Many investment firms will
give you feedback on the programs before you roll them out. That
way you can change the program to avoid having loans that you can't
sell after you've originated them.
-Readdress your current loan programs to make sure investors
have no issue with their characteristics. Everything's going to
tighten up. There's a concern in the market-place about all
originations, so make sure you don't need to change any of your
current programs before it's too late.
This brings us back to where we started. Will Wall Street
continue to participate within the sub-prime industry? Yes, but ...
the "but" is that lenders need to know what loans they'll want and
alter their lending programs to account for them.
James L. Smith is executive vice president for Fiserv Lending
Solutions-Portfolio Services. He may be reached at (720)
565-9474, ext. 3306 or e-mail [email protected]