Wall Street Law Blog

Subprime Analysis by Salomon Brothers, May 1994: Return of the Wall Street Law Blog Time Machine

WSLB Time Machine -From the Horse's Mouth? Fascinating  1994 Report on Subprime MBS From The Firm That Coined the Term Securitization.

MAY 1994

May 1994

B and C lending is aimed at residential borrowers who are denied access to traditional first mortgage financing because of tarnished credit histories or higher debt-to-income ratios. As a result, B and C borrowers pay above-market mortgage rates to compensate for increased credit risk. However, most of these borrowers are homeowners who have sufficient equity in their properties to borrow at below-market loan-to-value (LTV) ratios. For example, the average LTV for a traditional, nonconforming ARM is about 75%, compared with 65% for recently securitized B and C ARMs. Therefore, with substantial equity at risk, these borrowers should have a powerful incentive to repay their mortgages to avoid forfeiting equity in a foreclosure proceeding. Lending that relies strictly on borrower equity is commonly known as equity-based lending. In contrast, current B and C programs rely primarily on borrower equity to minimize default risk, in conjunction with an underwriting process that categorizes and then

prices the riskiness of each borrower.

First-Lien Mortgage Bankers

In this report, we focus mostly on three first-lien B and C mortgage bankers: 

Long Beach Federal Savings Bank, Quality Mortgage USA, Inc. and 

Option One Mortgage Corp.Long Beach Federal Savings Bank is a Federally chartered savings bank whose principal business is mortgage banking. Long Beach has been in the B and C lending business since the late 1980s. Since 1992, MBS totaling $1.7 billion have been issued with Long Beach acting as the primary and master servicer.

Quality Mortgage USA, Inc. is a California corporation acquired by CALMAC Funding (also a California corporation) in 1991 for the purpose of originating and selling B and C mortgages. In addition, DLJ Mortgage Capital has exercised an option to acquire a 49% interest in Quality Mortgage. Quality’s loan originations began in January 1992 and have collateralized $1.4 billion of MBS. Lomas Mortgage USA, Inc. acts as primary and master servicer.

Option One Mortgage Corp. is a subsidiary of Plaza Home Mortgage, a holding company with subsidiaries that also include Plaza Home Mortgage Bank, a California savings and loan/mortgage banker, and Plaza Home Mortgage Servicing, a mortgage servicing company. Option One was founded in 1992 with a primary business line of B and C lending and originated its first loan in February 1993. To date, Salomon Brothers has underwritten two Option One MBS totaling $165 million. Plaza Home Mortgage Servicing acts as servicer for Option One originations.

Other B and C Lenders

Traditional second-lien lenders also are active in the B and C mortgage market. The major players include Advanta, Alliance Funding Corporation (AFC), Old Stone Credit Corporation (OSCC), and The Money Store (TMS). As a group, these issuers sold approximately $2.7 billion of B and C securities in 1993. 

 

Although these finance companies are thought of as home equity lenders and their securities are considered home equity asset backeds, in fact, first-lien mortgages comprise up to 90% of some pools.

READ THE REST OF SALOMON ON SUBPRIME

 

1998: The first subprime bust...

In 1998, the first wave of big subprime profits (Yankee fans should remember Phil Rizzuto commercials for The Money Store) came to a sudden end when subprime lenders lost their financing as investors fled to quality in the wake of Russia's unforeseen default on it's debt and the bailout of Long Term Capital Management.

As it turned out, there were massive default rates by subprime borrowers during the first subprime boom.

Nearly all major subprime lenders went bankrupt before the end of the 1990s. The story of the second subprime boom - during the recent unprecedented housing bubble - had the same ending (with a whole lot of other consequences thrown in)...