Subprime Crisis #1 – March 15, 2007

Welcome to this MortgageMediaMag special report on an issue that has been plaguing the subprime mortgage market in particular, as well as the mortgage industry as a whole.  I'm Rob Hain, and to reach us here, call 800-209-0007.  The e-mail address is rob@mortgagemediamag.com. 

The mortgage industry news, in fact the national financial news, has been littered with stories and rumors of troubled subprime lenders, foreclosures, buybacks, and the wake of devastation left behind for consumers, lenders, and mortgage professionals. On March 13, the Mortgage Bankers Association released their latest National Delinquency Survey, which highlighted some of the key trends underneath the headlines. According to the report, the delinquency rate for loans on one-to-four-unit residential properties was 4.95% in the fourth quarter up 28 basis points over the third quarter and up 25 basis points over the report a year earlier. Subprime and VHA loans were the primary contributors to the increase, says the MBA. Doug Duncan, the MBA’s Chief Economist and Vice President of Research and Business Development, said this about the fourth quarter results:

… delinquency rates again increased across the board. Increases in delinquency and foreclosure rates were noticeably larger for subprime loans. …

With many mortgages every day, the mortgage broker originates a loan, and then sells it to a lender - often a so-called warehouse lender. The loans are often bundled by similar characteristics, and mortgage backed securities (or bonds) are issued based on those bundles of loans. This simplified version of the process has many variations, depending on the type of mortgage originated and the credit-worthiness of the borrower.

Recently, many in the industry have been raising warning flags about the quality of loans that entering the mortgage banking system.  The housing boom, while creating wealth for many homeowners and generating originations for the industry, has created an environment ripe for letting hindered loans in.  News reports have come out daily, telling the stories of mortgage lenders and servicers whose very existence is now in question, due to loans that have turned sour. According to a March 13 Bloomberg story, over 24 subprime lenders that have either left the business, been forced to close, or announced large losses.  According to the February 12 edition of National Mortgage News, the Mortgage Lenders Network, which was once ranked in the top fifteen subprime lenders, filed for Chapter 11 bankruptcy protection from unsecured creditors, owing over $90 million.  Also in the February article, London-based HSBC shocked the industry by increasing its bad debt reserves a whopping 25%, and a review of their files under improved models indicated that their troubles may not be over just yet.  Even the Federal Reserve is keeping an eye on the situation and its impact on the economy as a whole, according to a February 28 Reuters news story. Fast-forward to March 13, where Bloomberg reported that Accredited Home Lenders lost over half of their market capitalization and New Century Financial, whose woes have been widely reported, was delisted from the New York Stock Exchange, unable to meet their creditors’ demands for repayment.

Rob Pommier, SVP with Lender E-Source, whose company provides a technology-driven pricing and guideline engine, says that underwriting requirements from many investors are becoming more strict, and some programs are disappearing altogether.  He says that their company is receiving changes every day to lender programs.  <Are GL Tightening> <No of Updates>  <37 Profiles>  <More Strict Doc>    In February, mortgage GSE Freddie Mac announced that it would be tightening its lending guidelines and slowing or stopping purchases of new subprime loans. According to Bloomberg on March 13, Countrywide has stopped funding subprime loans with no downpayment and no income documentation.

So what is subprime lending anyway?  Subprime - or non-prime as some call it - has different definitions, depending on the person using the term.  Generally, it is said to be the type of mortgage lending that relies on risk models to determine lending guidelines, rates, and fees for loans to borrowers who are not able to borrow at the best rates.  The conditions placing a loan in the subprime category may include a lower credit score, a high loan-to-value ratio, lower income than a particular loan might require, or the hindered ability to verify certain parts of a mortgage application, including borrower income and assets. The Bloomberg article reports that subprime rates are often 2-3% higher than prime mortgage rates.

What has created the current crisis for many companies in the mortgage space?  According to Blaise Dietz, 12-year mortgage veteran and co-CEO of Creative Mortgage Lending in Southfield, Michigan, the problem has more than one cause, but it stems from looser lending practices recently, combined with a significant slowdown in the housing market. <Others>  <Liquidity>  <Going outside> The problem has been disguised recently, because many adjustable rate mortgages have very low “teaser” rates that reset higher a few years into the mortgage. According to a March 12 AP story in BusinessWeek, there are $265 billion worth of subprime mortgages that are due to reset in 2007, with some of the new rates being as high as 12%. Borrowers’ options are significantly more limited than they once were, however. Why? With home prices in a significant slump and lenders tightening their guidelines, borrowers are no longer able to simply refinance their troubled mortgage into a new loan. The option simply no longer exists.

So why did companies put themselves at risk with looser standards?  Again, Mr. Dietz ... <Double> In addition, the Bloomberg article suggests that lenders may have lowered lending standards to increase origination volumes as the housing market cooled.

In the March 2007 edition of Mortgage Servicing News, Paul Muolo compares the causes and effects of the 1998 subprime crisis to the current one.  According to the article, Wall Street investors played a very large role in tightening the availability of funds, both in 1998 and in 2006/2007.  Depository institutions have cash deposits to call on when things tighten up.  On the street, however, when investors smell higher risk than they are willing to bear, they walk - and fast.  They did just that in 1998 and are doing so now.  Many subprime lenders rely on bank loans for funding. A March 12 AP story in Forbes reported how bank lenders cut off funding for New Century, because of their failure to make payments. <Calling>  Mr. Dietz does not see the problem getting any better anytime soon - only worse. <Bloodbath> A March 12 Bloomberg story quotes Fed Governor Susan Bies:

What's happening is the front end of this wave of teaser- rate loans that are coming into full pricing. This is not the end, this is the beginning.

According to the AP/Forbes story, John Robbins, chairman of the Mortgage Bankers Association, in his testimony before the House Financial Services committee, agreed that many lenders “got aggressive” with their subprime products, but he argued that government intervention is not warranted, because the market is swiftly punishing those lenders. The MBA’s Mr. Duncan reiterated that sentiment on March 13:

… market discipline in this industry is swift, can be severe, and is more effective at changing lending practices than any potential changes in regulation.

In the February edition of Mortgage Servicing News, Michael Bates quotes Larry B Litton, Jr. of Litton Loan Servicing.  The article describes the loss mitigation toolbox as now being wide open to help borrowers and investors protect their investments.  Once again, Mr. Dietz...  <Era of Loss Mitigation>

The carnage may not be limited to the subprime sector, however. A March 11 story at MarketWatch.com says that losses may be moving up into the so-called Alt-A lenders as well. The piece describes Alt-A loans as being originally designed for borrowers with good credit, but having issues with documentation of income. The article suggests, though, that subprime loans have begun to creep into the Alt-A space, with applicants being able to overstate their income and/or assets. According to the story, a full 58% of all originations in the fourth quarter of 2006 were low-doc or no-doc loans. In California, the problem is worse, with 86% being low- or no-documentation loans.

What have the surviving lenders, who cannot depend on deposits, done to assure their survival through the storm?  For Mr. Dietz and his company, the solution started long before the bad loans were ever made, back in 2005 when the company began offering warehouse lending.  <Lending to guidelines> <Only Buy>  In fact, Mr. Dietz see opportunity for many people as a result of the current crisis in the subprime market.  <Will Benefit Quality>  The current situation may also benefit those lenders who have balanced their operations.  Mr. Pommier outlined the differences between the companies likely to emerge successfully and those who may not.  <Compare Survivors>  About how many mortgage companies are going beyond investor guidelines, this is what Mr. Pommier had to say.  <How Many Clients>  <Lenders Should Talk>  <Mort Co Must Educate>  <How Does L eS help?>

No matter what side of the subprime market a professional is in, they are very likely to be watching the subprime storm with keen interest in the coming days, weeks, and even months.  We will be watching it as well, and bringing it to you here.

To reach us, call 800-209-0076 or send e-mail to rob@mortgagemediamag.com.  To reach Rob Pommier or Lender e-Source, go to www.LenderESource.com. His e-mail address is rob@lenderesource.com. For Mr. Dietz and Creative Mortgage Lending, visit www.cmldirect.com. His e-mail is blaisedietz@cmldirect.com.  Thank you for joining us.