By Lon S. Cohen
The rumors of the death of the subprime mortgage market are not exaggerated or even untimely. In fact, it seems as if a plague of sorts has infected the industry, and it started with the dubious and sometimes downright predatory habits of many mortgage bankers and brokers. Cries of irresponsible business practices in the industry and marketing schemes that drove lending guidelines are cropping up all over the media nowadays, but it seems like a little of the hindsight is 20/20 type rhetoric.
The history of the mortgage industry as it relates to ever-expanding and ever-loosening underwriting has been very public and very obvious. This current implosion has only caused more attention to be directed at the symptoms, while the public and the politicians are crying for a quick cure. Where are the banks in this time of crisis and what benefit, if any, can they procure from the collapse of the subprime market?
Many homeowners are faced with debt they cannot repay, staring at the possibility of foreclosure and perhaps even bankruptcy. Are the stodgy old bankers now poised to become the heroes of the hour as they scoop up borrowers who may be able to refinance into a new, more manageable, mortgage product? And more importantly, do they even want to?
After the smoke clears, banks – traditionally much more conservative and subject to stricter lending practices – may emerge from the rubble as the only players able to hold some semblance of lending ability. Now they are faced with the situation of either delivering or denying credit to the customers once serviced by the subprime companies.
Frank McKenna, co-founder of BasePoint Analytics, a leading provider of predictive analytic fraud and risk management solutions for global banks and the mortgage industry, said that although “there is a potential for banks to gain as much of the market share from subprime lenders that they want” he thinks that won’t happen anytime soon.
“Demand for mortgages is high, primarily among borrowers in trouble or borrowers that have poor credit,” McKenna said. “Unfortunately, while banks have the capability to lend to these borrowers, they will not because there is currently no interest in buying these loans in the capital markets. Essentially, investment banks are not buying subprime loans anymore, so if a traditional bank wants to lend to a subprime borrower they will have to keep the loan on their books and service the loan themselves, at least in the near-term. Most banks are not willing to do that.”
While subprime lending “can actually be quite profitable if the risk is managed correctly” according to McKenna, he believes that “the risk, in large part, was mitigated incorrectly by some of the lenders that have gone bankrupt.”
The traditionalism in the banking industry does tend to make them shy away from almost any loan that must be held in-house (otherwise known as portfolio loans). The riskier the loan – as with subprime mortgages – the less likely they are to hold these loans. In the infancy of the mortgage industry, what had helped provide such a glut of mortgage funds was the fact that the government essentially created a secondary marketplace for banks to sell off loans, providing them with more cash to lend to other clients.
McKenna explained that as a whole, banks are depending more and more on their retail branch network and less on brokers, who are more inclined toward the incendiary lending practices that have plagued the industry as of late.
“Banks are able to capitalize on their own internal networks [branches] to deliver higher-quality loans to the secondary markets or if they choose, for their own servicing groups,” he said.
At Bethpage Federal Credit Union (BFCU), with 146,000 members, $2.7 billion in assets and over 300 employees in Nassau and Suffolk counties, they have recognized that the current crisis may affect some of their customers. They are looking to do something about people stuck in “mortgage limbo.”
“Bethpage has never underwritten subprime loans and doesn’t face the credit liquidity crunch that contributed, by example, to the recent American Home Mortgage bankruptcy or closure of Capital One’s GreenPoint mortgage unit,” notes Bethpage President and CEO Kirk Kordeleski.
Although they are not exactly jumping into the subprime game, BFCU is trying to attract its customers away from bad deals. Because of this shake-up in the industry, people are finding their mortgage commitments restructured into outrageous terms. BFCU is advertising directly to affected members (open to anyone who lives, works, worships, attends school or regularly conducts business in Nassau or Suffolk counties, with some exceptions) by promising to honor pre-existing commitment and closing dates. The credit union is also waiving its application fee and offering mortgages with a variety of rates and terms. They say that currently one of their more popular mortgages is the 5/1 ARM (a five-year adjustable-rate mortgage).
Maria Tullo, mortgage manager for BFCU, said her company is advertising to customers to make sure they know their bank is unaffected by the crisis.
“We are marketing more than ever and making sure the message is clear that Bethpage Federal Credit Union does mortgages,” she said.
As for the failure of one of the largest area subprime companies, “The bankruptcy of the American Home Mortgage resulted not only in the loss of jobs for Long Islanders, but placed people in jeopardy of losing their homes,” Tullo commented. “The correction will take some time.”
But with “proper risk management and internal controls” she believes the banking industry can fill the void left by the subprime companies. Already she has seen the organic growth of her division because of the natural drift of those left behind seeking reputable banks, as opposed to the failing mortgage companies, resulting in a doubling of BFCU’s mortgage production.
In the future there may be reform in the way banks and brokers issue mortgages. Unlike many other industries, the mortgage industry has a lack of oversight by a central licensing agency.
“Many are now looking at ways to improve the rather unregulated mortgage industry [with] recent stories about instituting new evaluations for licensing mortgage brokers,” Tullo said.
Deborah VanAmerongen, commissioner of the New York State Division of Housing and Community Renewal, said, “Not all subprime loans are necessarily bad. In some instances, they are a valuable tool for individuals who don’t qualify for a prime loan.” Her agency provides counseling to help consumers make better choices when it comes to home loans and to avoid predatory lenders.
Frank McKenna agrees, saying that he thought the subprime companies didn’t have the proper underwriting guidelines and controls in place.
“These problems are correctable,” McKenna said. “And banks have the opportunity to get subprime lending right. A lot of subprime borrowers out there will be able to pay.”
He said banks must alleviate themselves of a list of risk factors before refinancing a potential customer’s subprime loan, including making sure there is no fraud on the original file, ensuring that there are no predatory lending issues, and watching out for payment shock, equity in the home and reserves in the borrower’s bank account. If they follow those considerations, then there is no reason banks can’t jump into the subprime market to help capture some of the business that is faltering.
In the short term, banks have been pulling back on their lending to avoid being lumped into the subprime category. Many lenders have dusted off those massive old procedures books and shifted focus back to traditional underwriting and fraud solutions. Of course, the entire back end of the business is now more beholden to risk management and tightening of products guidelines instead of the wants and desires of the marketplace.
“Banks will probably capitalize on the opportunity by developing special programs for their customers that have other subprime products with the bank,” McKenna said. “For example, if the borrowers have a credit card or auto loan with a good payment history, then they will probably target them for a home loan.”
By leveraging existing strengths, banks can capitalize on subprime business, if they decide to take the plunge.
“I think that banks could be more successful for several reasons,” McKenna said. “They have more access to capital, so they are not solely reliant on the secondary market to be able to fund loans. They can leverage their extensive retail branch network to originate more and higher-quality loans. And they can leverage their internal sources of data to mitigate risk.”
Some new tools are being offered to help banks better serve the subprime marketplace in a safer, more effective way that will hopefully stem the predatory lending stigma of these mortgages. Christopher Dodd, chairman of the Senate Committee on Banking, Housing and Urban Affairs, implored Treasury Secretary Henry Paulson and Department of Housing and Urban Development Secretary Alphonso Jackson to take steps to make the FHA release affordable loans to homeowners in danger of foreclosure, mostly due to bad lending practices.
Just recently, New York Gov. Eliot Spitzer announced $100 million in funding for the State of New York Mortgage Agency’s (SONYMA) “Keep the Dream” program to help consumers who are at risk of defaulting on their mortgages. Through partnerships with Fannie Mae, mortgage lenders and mortgage insurance companies, SONYMA will offer at-risk homeowners the ability to refinance their current mortgages with 30-year or 40-year fixed-rate mortgages at competitive interest rates. The agency began accepting applications for the new refinancing program from banks in September.
“Our mission at SONYMA is to help working-class families buy their first home and keep their homes,” said President and Chief Executive Officer Priscilla Almodovar. “That is why our ‘Keep the Dream’ program is so important; it will give families in danger of losing their homes the ability to refinance their mortgages and remain as homeowners.”
Obviously, the secondary market has no taste for subprime loans right now. Subprime lending will be in a drought until the market puts some space between this current crisis and their risk assessment. McKenna predicts that over the next two years, “more ARMS will reset, foreclosures will increase to record levels, more independent lenders will go bankrupt, more consolidation will occur.”
When asked whether he thought the secondary mortgage market (not including FNMA, FHA, SONYMA, etc.) was completely dead he said, “No, just in a coma.”
“The secondary market will return,” McKenna predicted. “Independent lenders will return. The cycle will repeat, however, on a much more limited and rational basis.”
Lon S. Cohen is a freelance writer based in Long Island. He has been in the mortgage business at a large Northeast regional bank for six years, where he specializes in construction-to-permanent financing and has originated almost every type of loan product, including subprime loans brokered to other companies. After four years as a loan officer, he became the manager of the Long Island region in the bank’s mortgage department, where he still works.
Copyright 2007 The Warren Group