Here We Go Again: Demand For Subprime Debt Is "Out Of Control"

As Kyle Bass once eloquently noted, the brevity of financial memory is about two years; and nowhere is that more clear than in the explosive resurgence of demand for new subprime-mortgage-backed products. As Scotsman Guide reports, some subprime lenders are reporting strong investor appetite for the once-reviled mortgage products (for borrowers with credit scores as low as 500 and with debt-to-income (DTI) ratios as high as 50 percent). "It's out of control; it seems like there’s 10 times the amount of demand to buy this paper as there are borrowers that want the loans," said one lender. As Bass may have also said "proceed with caution."

 

As Scotsman Guide reports,

Although a number of people still cringe at the term subprime, some subprime lenders are reporting strong investor appetite for the once-reviled mortgage products.

 

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Investors are interested in recent subprime loans for their better returns than traditional mortgages.

 

Depending on the risk of the borrower, these mortgages carry interest rates between 5 percent and 9 percent. Hutchens said that all types of investors are after the Angel Oak subprime products, from hedge funds to large mortgage lenders — “anyone who’s looking to participate in the mortgage business at higher coupons besides agency modes.”

The reach for yield - and ignorance of risk - but this time it's different...

Angel Oak Mortgage Solutions offers a “non-prime" product on a wholesale basis for borrowers with credit scores as low as 500 and with debt-to-income (DTI) ratios as high as 50 percent, while the company's “recent housing event” product offers similar terms for borrowers one day out from a short sale or foreclosure. Borrowers, however, are required to put down at least 20 percent.

 

“This is the new subprime,” Angel Oak Senior Vice President of Sales and Marketing Tom Hutchens told Scotsman Guide News. “Everyone has preconceived notions about what subprime means. This really resembles how subprime first began — [the borrowers] have equity in the transactions, and fully documented incomes.”

 

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Athas Capital Group Inc., one of the first companies to reenter the subprime space several years ago, is keeping almost all its mortgages on the books, stopping to sell about 10 percent to 20 percent of production to investors per year. Athas CEO Brian O’Shaughnessy calls the products “sane subprime.”

 

There were investors asking about Athas subprime products from the beginning, O’Shaughnessy said, but lately investors have been seeking subprime with fervor.

 

“It’s out of control; it seems like there’s 10 times the amount of demand to buy this paper as there are borrowers that want the loans,” O’Shaughnessy told Scotsman Guide News. “There is a line outside the door to buy our paper.”

 

One reason, O’Shaughnessy said, is because Athas has has had no defaults and has no current 30-, 60- or 90-day late payments on its subprime loans (there was one 60-day late payment last year, but that borrower caught up, O’Shaughnessy said). Typical borrowers, he said, come to Athas because they can close on a mortgage quickly. The average credit score is 702 on its subprime products, even though Athas goes as low as 550.

 

“Probably the biggest reason [borrowers] come to us is alternative proof of ability to repay, or if they have a past foreclosure or bankruptcy that’s too recent for a bank to consider,” he said.

 

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"The people investing in this understand that these are well thought out mortgages for people who can actually pay," Perl told Scotsman Guide News. "We're having no problem selling it."

 

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“We’ve known since 2008 that it’s not the subprime borrower that went away, it’s the product availability,” Hutchens said. “I think we’re going to continue to grow. It’s hard for us to say which year it’s going to hit and at what level, but we know it’s going to be significant.”

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Now, what happened the last time that investor demand for a product massively outweighed the supply that lenders could provide? That could never happen again, right?