'Sub-prime' lenders face credit crunch Companies that make loans to consumers with blotched records feel pinch

October 13, 1998|By LOS ANGELES TIMES

The days of easy money for many consumers with bad credit may be about to end.

In a sign that an emerging global credit crunch may soon affect more U.S. consumers, companies that specialize in so-called "sub-prime" lending to people with blotched credit records -- often via high-interest home equity loans -- are quickly running out of money as banks and investors cut off their funds.

The result is that many of the consumers who rely on such loans, frequently as a way to consolidate other debts, may be forced to pay even higher interest rates -- if they can get the money at all.

While that could be a hardship for individual consumers, many financial counselors would cheer a trend away from the aggressive marketing of loans they say ultimately will get too many borrowers in trouble.

"Most people are looking for the easy way out," said Steve Rhode, president of the Debt Counselors of America, a nonprofit group that counsels debt-ridden consumers. "You think you're better off [with a home equity loan], but you're just fooling yourself."

The troubles of sub-prime lenders are a rude awakening for companies that have enjoyed explosive growth -- and profits -- in recent years. The lenders thrived by pitching their products through mailers that resembled checks and through television ads that feature sports stars such as Miami Dolphins quarterback Dan Marino.

The companies' fierce competition for borrowers fueled a surge in home equity loan originations, which are expected to total $55 billion this year, compared with $7 billion in 1990.

Now, however, the Wall Street financing that provided much of the capital for these loans is drying up, as severe losses in foreign financial markets and in the U.S. stock market in recent months have caused major banks and brokerages to shirk from risk-taking.

That has already forced some major sub-prime lenders into bankruptcy, and has decimated the stocks of most industry players.

"It's reaching fairly cataclysmic proportions," said Michael Sanchez, a portfolio manager at Hotchkis & Wiley, an investment management company in Los Angeles. "In the 11 years I've been in this business, I've never seen anything like it."

The bottom line for consumers likely will be less competition, less loan availability and higher loan rates in the sub-prime market, analysts said.

"There's going to be a shakeout, and a lot of these lenders are going to disappear," said Reilly Tierney, a finance company analyst at Fox-Pitt, Kelton in New York.

Sub-prime lenders make their money by charging higher rates and fees. While a traditional home equity loan to someone with good credit might carry a 9 percent rate, sub-prime lenders typically charge 11 percent to 14 percent, plus up to 10 percent of the loan amount in additional fees.

Sub-prime lenders survive by packaging most of their loans and selling them as securities to institutional investors: pension funds, insurance companies and banks who want the fat returns that typically accompany these higher-risk investments.

The companies rely on banks and brokerages to lend them money to tide them over in between the times the loans are made and sold. Until recently, banks and brokerages such as Merrill Lynch & Co. made tidy profits underwriting new issues of these so-called asset-backed securities.

But now sub-prime lenders are being hit from two directions. Many institutional investors that once bought the loans are backing away amid global financial turmoil, preferring super-safe U.S. Treasury securities instead. At the same time, banks and brokerages are cutting off many of the lenders' lines of credit, fearful of being on the hook to a borrower that might suddenly develop financial problems.

"The market's focus has gone from return on capital to return of capital," said Charlotte Chamberlain, an analyst at Jefferies & Co.

A similar flight to quality has affected regular mortgage rates, which increased last week as institutional investors demanded higher returns.

The sub-prime lenders' problems could ease if institutional investors and major banks and brokerages come back to the market soon. But some lenders have already suffered irreparable harm.

Oregon-based Southern Pacific Funding Corp. fell into bankruptcy Oct. 1. It was followed by Criimi Mae Inc., another major sub-prime lender, on Oct. 5, and by Cityscape Financial Corp.'s bankruptcy Oct. 7.

Investors in other sub-prime lenders' stocks have responded by dumping the shares in panic. Some of the stocks plunged up to 70 percent in the last week alone.

Pub Date: 10/13/98

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