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High-risk lenders battered by market turmoil

Good or bad? 125% LTV loans Southern Pacific Funding Corp. FirstPlus Financial Group Inc. IMC Mortgage Co. Criimi Mae Inc. The list of casualties in the nontraditional lending industry is getting longer with each passing day.

Each of these companies dabbled in different areas. Southern Pacific and FirstPlus originated and sold high loan-to-value equity loans. IMC Mortgage Co. offered high-risk, subprime loans. Criimi Mae bought securities comprised of commercial, rather than residential, mortgages.

All have been battered by ongoing market turmoil.

Goes around, comes around
Now, the same industry that has been pushing high loan-to-value (LTV) home equity loans -- which some consumer advocates warn can lead people to bankruptcy -- is finding itself in the same boat as its customers.

Southern Pacific filed for Chapter 11 protection a few weeks ago, as did Criimi Mae. FirstPlus said Oct. 15 that it was firing 3,000 employees (half its work force) and leaving the high-LTV, wholesale home equity loan origination business. The next day, IMC Mortgage said it had secured temporary financing to keep it afloat while it looks for a buyer.

"I've been in the business about 25 years, and I haven't seen anything quite like it," says Jeffrey Zeltzer, executive director of the National Home Equity Mortgage Association. "You're talking about a very, very fluid situation."

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Loans as investments
The problem stems from trouble on Wall Street. Typically, home equity loan companies treat their product the same way traditional lenders do. They package groups of loans to form securities, which are sold through investment bankers to mutual fund companies and others. While securities backed by traditional mortgages are called "mortgage-backed securities," securities backed by home equity loans are referred to as "asset-backed securities."

Ever since Russia defaulted on its debt this summer, investors have become increasingly risk-averse and have drifted away from asset-backed securities and toward more conservative securities, including short-term Treasury bills and notes. That has made enough of a difference in the market that hedge funds have taken it on the chin. The funds are operated by investment companies that cater to the rich and use their money to place bets on the direction of markets. They are heavy buyers of asset-backed and other non-Treasury securities.

Tight cash
In the end, that means home equity and subprime companies can't raise enough money for loans because fewer hedge fund buyers and others are stepping in to grab their bundled mortgages.

"The liquidity in the marketplace is not as great as it was five months ago," says Mark Hikel, the former president of Southern Pacific's Indianapolis-based subsidiary that originated high-LTV loans.

Shortage coming?
What does this foretell for people who might want 125 percent home equity loans in the future?

"(The) 125 is a product that is going to slow down," Zeltzer says. "Even though there's going to be a strong demand for the product from the consumer, I think the sources of funding are going to slow down. That product that is in place is going to become more expensive to the consumer."

Hikel says the industry itself is to blame. "The problem with the product since its inception is that it's gotten too aggressive ... Loan amounts probably went too high, debt ratios went too high."

The loans "are going to be reengineered, reinvented."


--Posted: Oct. 28, 1998

See Also
Main story: 125% mortgages risky for borrowers, lenders
Time to tap your home's equity?
How to deduct home equity interest on your taxes
Home equity loans vs. lines of credit
Home equity glossary
Track prime rate/other leading rate indexes
More home equity stories


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