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)...

The WSLB TIME MACHINE: 9/26/07 - When Greenspan confirmed U.S. housing bubble (per FT)

In our new WSLB TIME MACHINE series, Wall Street Law Blog looks back at some interesting moments along the road to the global financial crisis...

What better way could there be to launch the TIME MACHINE than with a piece on the "Maestro" himself, Alan Greenspan? 

September 16, 2007, the Financial Times:

"US house prices are likely to fall significantly from their present levels, Alan Greenspan has told the Financial Times, admitting that there was a bubble in the US housing market." (emphasis Wall Street Law Blog).

Please see the original FT article.

 

Published by The Sherman Law Firm

Goodbye to Kidder Peabody! WSLB Time Machine Series (brand new!)

Wall Street Law Blog Time Machine: 

October 1994 - January 1995...  

Meltdown in Mortgage-backed Securities was the nail in the coffin for Kidder Peabody.

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129 year old investment bank Kidder Peabody - a Wall Street leader in constructing, selling, and trading mortgage-backed securities  - disintegrated fast in the wake of sudden illiquidity in the market for mortgage-backed securities in 1994. 

Pictured:  1943 Stock Certificate from a Kidder Peabody underwriting

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The following excerpt is from an article that originally appeared in the Wall Street Journal in 1995.  We found the story in the archives of the Seattle Times.

NEW YORK - Another one bites the dust.

Kidder, Peabody & Co., one of Wall Street's longest-running names, will disappear when the investment bank is dismantled later this month.

PaineWebber Group Inc. agreed to acquire most of Kidder's assets in October but wanted to mull over whether it wanted to acquire the Kidder name.

Now, after a six-week "global study" of its retail, banking and institutional clients, PaineWebber has decided that it's time to make the Kidder Peabody name a Wall Street footnote.

"Our research, as well as other considerations, is showing us that PaineWebber is the name to go forward with," said Jerry Johnston, manager of corporate communications. "Now that we are a bigger force internationally, we want to behave as one company, with one voice and one name."

The demise of Kidder will mean the end of a name that has been kicking around Wall Street for nearly 130 years.

Kidder was founded in Boston on April 1, 1865, by Henry Kidder, Francis Peabody and Oliver Peabody. When the firm first opened, it advertised "banking, brokerage and exchange business."

Unlike other Wall Street names, which have gone through various incarnations, the Kidder Peabody name has remained intact throughout the firm's history.

Kidder, long known for its investment-banking prowess, was acquired by General Electric Co. in 1986 and stumbled in a 1980s insider-trading scandal. 

In the 1990s, Kidder rebuilt itself into a Wall Street juggernaut in mortgage-backed bonds. 

But [1994's] sharp rise in interest rates, coupled with a bond-trading scandal, crippled the firm.

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Although the Kidder name had cachet in the late 1970s and early '80s, analysts say today it has little, if any, luster.

"Fifteen or 20 years ago, the Kidder name would have made a difference," said Perrin Long, an independent securities-industry analyst. "Kidder was strong in utility underwriting, it had a crackerjack research department, it had high-net-worth retail clients and a very strong investment-banking franchise."

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In 1994, Kidder Peabody "claim[ed] ... the No. 1 spot for mortgage-backed underwriting..."

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Kidder is the second Wall Street name to be shelved in less than a year. Last May, Travelers Group, parent of brokerage giant Smith Barney Inc., scrapped the Shearson name after Smith Barney and Shearson's brokerage operations merged.

FOR THE FULL ARTICLE, PLEASE VISIT THE SEATTLE TIMES ARCHIVES HERE

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Commentary and editing by Brett Sherman, The Sherman Law Firm

March 2006: Wall Street concedes problems in housing market (WSLB Time Machine)

EXACTLY 2 YEARS AFTER BEAR STEARNS COLLAPSED, WE THOUGHT WE'D SHARE SOME WARNING SIGNS FROM ALMOST EXACTLY 2 YEARS BEFORE THE EVENTS OF MARCH 2008...

As reported by Bloomberg...

Bear Stearns, Lehman Mortgage Growth Crimped by Housing Market

"Executives at Lehman Brothers Holdings Inc. and Goldman Sachs Group Inc. said revenue from mortgage bonds in the U.S. is dropping as rising interest rates depress home sales. Lehman, the fourth-biggest U.S. securities firm, is cutting almost 200 jobs at two home-lending units in California.

Bear Stearns Cos. Chief Financial Officer Sam Molinaro said on a March 16 conference call after the company reported first-quarter earnings that he sees ``weakness'' for new mortgages across the industry."

 

Please check out the Bloomberg piece in its entirety.  It raises some interesting questions (as usual) - like, if you know there are problems with your main revenue stream in 2006, how can any competent risk management not take steps to make sure that the problem cannot snowball in the way that it did, driving two legendary firms out of business.

Brett Sherman, The Sherman Law Firm