Many More To Benefit

Implications: This article is a very good brief about the RiskMetrics IPO, but doesn't attempt to broadly touch the many areas that are set to shine from recent events in the subprime mortgage market.

Analysis: In any major market phenomenon, good or bad, varying firms across the globe stand to benefit or decline from the event.  The current issues involving the subprime mortgage market will be no different.  This commentary is about just a few of the winners and losers in the space.

Advantaged

Appraisal Vendor Management Companies
Due Diligence/Outsourced Underwriting Firms
Default and Foreclosure Service Providers

Handicapped

Offshore/Outsource Providers
Title Insurers
Retail Credit Providers & Retailers Themselves

The types of firms that will see a positive light shine on them are those that either will have enhanced demand as more workable subprime and alt-a lending gains a foothold, as well as those seeing enhanced revenues because of default and foreclosure activities.  Putting the latter, more obvious scenario of enhanced revenue from additional business aside, the thesis is that any firm that will provide product that enhances the overall quality of the loan's in securities going forward will do well.  Far better if those firms are firmly entrenched in the industry already.  Two good examples are appraisal vendor management firms, and due diligence organizations.

An appraisal vendor managment firm is a middleman between the originator of the loan and the appraiser who performs the valuation and provides the data.  Handled properly, the vendor manager can greatly enhance credit quality by:  a) making the selection of the appraiser independent of the requestor; b) providing detailed quality control review of the product (including AVM comparison) prior to submission to the underwriter; and c) maintaining a database of qualified, licensed or certified, and insured appraisers from which to choose.

Due diligence organizations like Clayton (NASDAQ: CLAY), Bohan (a subsidiary of First American, NYSE:  FAF), and Watterson Prime (a subsidiary of Fidelity Information Services, NYSE: FIS) already are firmly entrenched in the quality control component of mortgage lending.  Their biggest customers are the Wall Street firms that make a market in buying and securitizing loans.  With a few changes in the product line, they will be able to stratify mortgages and better classify risk.

On the flip side, those to be most hurt by the subprime marketplace are those that have high levels of "brick and mortar" expense while operating at far diminished levels (such as title insurers), those who provided services to the industry from a far (offshore/outsource), and firms that are affected by borrowers carrying fully charged up credit cards without room to spend.

Title insurers are uniquely challenged in that for the most part they must maintain presence in every local community they wish to serve.  Beyond the need for office space, they also must maintain those that handle the relationship end of the business, the salespeople.  In an environment of diminished volume, this group of companies will be the hardest hit.

A current issue in subprime liquidity and reduced market value from homes is that borrowers cannot easily attain cash out refinance transactions which would allow them to pay off their cards and start spending again.  Retail credit providers (the banks behind the store cards, for example) will begin to feel the pinch as late payments will no longer be cured so easily, and more accounts will go to chargeoff.  Retailers themselves, in addition to dealing with diminshed consumer confidence, will not so easily be able to extend new credit as FICO scores will not support the lending.

Finally, those firms in the Phillipines and India who have so much supported the mortgage lending industry will see diminished transaction volume, and hence less seats needing filling.  While much of this is tied to the reduction in mortgage originations, there are several other factors affecting the sector.  One of these is that troubled loans require more "high touch" interaction, which generally is not outsourced.  Another, and perhaps the most significant is that in times of diminished credit quality, it is not uncommon to take more work in house and not less - keeping layoff at the lowest possible rate, while keeping a sense of higher overall quality to the work.