December 23, 2024

FHA Increases Minimum Credit Score Requirement

February 26, 2009 by 60 Comments



FHA And VA Increase Credit Score Requirement

Effective March 6, 2009, a minimum credit score of 620 will be required to be eligible for FHA and VA loans.

The credit score requirement had recently been changed less than a month ago.  As of February 9, 2009 the credit guidelines had required only a minimum credit score of 580, subject to certain exceptions.

The increased credit score requirement is an attempt to lower the large number of FHA defaults, which have been running at about 12%.  A 580 credit score reflects a sub prime borrower and in conjunction with minimal down payment requirements, the risk of mortgage default is very high, as reflected in the FHA default ratios.

New Home Buyers With Empty Pockets After Closing

Another area that should be examined by the FHA in their underwriting guidelines is the amount of reserves that a borrower has after closing on a home purchase.  Many borrowers are left with empty pockets after paying for closing costs and the down payment to purchase a home.  As every homeowner knows, the expenses of maintaining a home are never ending.  In addition, a major and unexpected repair could be thousands of dollars that can put a severe strain on the family budget, leading to the inability to maintain the mortgage payments.

There are no guidelines per se that require a potential home buyer to have a specific amount of savings available after purchasing a home.   The ability to save should be viewed by the FHA as a prerequisite for home ownership.  Additional mortgage defaults do not benefit the FHA nor the homeowner.  Savings (reserves) of 3 to 6 months of mortgage payments should be considered by the FHA as a part of their underwriting guidelines.  Buyers might have to postpone the purchase of a home to acccumulate some savings and strengthen their financial position, but the end results would benefit all – a stable housing market with fewer defaults.

Update Regarding 620 FICO Score Requirement – April 2009

There are now some lenders that will do FHA loans at sub 620 FICO scores – see Sub 620 FICO Score Lenders

Update on This Topic: 

-See FHA Introduces New Minimum 580 Credit Score Requirement, September 6, 2010

-See FHA Zero Down Payment Financing Returns

Filed Under: FHA, Housing, Mortgages Tagged With: ,

FHA Increases Loan Limits

February 26, 2009 by 2 Comments

FHA Announces Higher Loan Limits

As part of the Economic Recovery Act, the FHA loan limits were increased.  The new higher loan amounts are effective until December 31, 2009.  The higher loan limits will allow many borrowers with jumbo mortgages to refinance at much lower rates than would be available under jumbo mortgage pricing.

Due to the high level of defaults, banks are becoming very reluctant to approve jumbo mortgage loans for either purchases or refinances.  Since Fannie Mae and Freddie Mac  will not buy or insure jumbo loans, the lending bank must assume all the risk, keep the loan on their books and set aside additional reserves for possible losses.  All of these additional risk factors are reflected in the higher jumbo rates and strict loan underwriting guidelines – see Jumbo Mortgage Rates.

FHA Announcement

PRESIDENT’S ECONOMIC RECOVERY PACKAGE TO MAKE MORE FAMILIES ELIGIBLE FOR FHA-INSURED MORTGAGES
FHA implements temporary higher loan limits to help families keep their homes

WASHINGTON – More American families will be eligible this year to purchase or refinance their homes using affordable, FHA-insured mortgages, thanks to the economic stimulus package signed into law by President Obama last week. The American Recovery and Reinvestment Act of 2009 will allow HUD’s Federal Housing Administration to temporarily increase its maximum loan limit, allowing FHA to insure larger mortgages at a more affordable price in high-cost areas of the country.

“This is one of many elements of the President’s recovery plan that will help homeowners and homebuyers in these high cost areas secure lower cost mortgage financing,” said HUD Secretary Shaun Donovan. “These loan limit increases will help FHA continue to provide safe, affordable mortgage products to families in all areas of the nation. Today’s announcement is just one example of how the President’s recovery and homeowner affordability plans work together to make homeownership more affordable for those looking to buy a house or refinance their current loans.”

HUD will increase FHA loan limits up to $729,750 in high-cost metropolitan areas such as New York, Los Angeles, San Francisco and Washington, D.C. There are 73 counties in the U.S. that will now be eligible for the highest loan limit of $729,750. Previously, FHA’s loan limits in these high-cost areas were capped at $625,500. The change in loan limits is applicable to all FHA-insured mortgage loans originated until December 31, 2009.

Increasing loan limits will help FHA continue to provide needed stability to housing markets across the country. As conventional sources of mortgage credit have contracted, FHA has been filling the void. From September to December 2008, FHA facilitated $97 billion of much-needed mortgage activity in the housing market, $35 billion of which was through FHA’s refinancing products. By focusing on 30-year fixed rate mortgages, FHA helps homeowners avoid and escape the risks associated exotic subprime mortgage products, which have resulted in rising default and foreclosure rates.

Filed Under: FHA, Mortgages, Stimulus Plan Tagged With: ,

Two More Massive Investment Frauds Reported

February 26, 2009 by Leave a Comment

Capital Vaporized By Hedge Fund Fraud

How many more frauds are lurking out there?   Two more large cases of investment fraud by hedge fund managers were reported today by The Wall Street Journal.

In the latest round of financial-fraud allegations to erupt, two money managers have been accused of misappropriating at least $553 million, and using it to fund a lifestyle of lavish homes, horses and even an $80,000 collectible teddy bear.

The two men, Paul Greenwood, 61 years old, of North Salem, N.Y., and Stephen Walsh, 64, of Sands Point, N.Y., were arrested by Federal Bureau of Investigation agents and face criminal charges of conspiracy, securities fraud and wire fraud by the U.S. Attorney for the Southern District of New York.

Court documents list several companies as being controlled by the two men, including WG Trading Co. and WG Trading Investors LP in Greenwich, Conn., and Westridge Capital Management Inc., based in Santa Barbara, Calif. They owned Westridge with another individual, prosecutors say.

Westridge Capital managed $1.8 billion in assets, the firm told the SEC in an adviser-registration filing in January. It oversaw a total of 20 accounts primarily for institutions including pension funds, charitable foundations and hedge funds, according to the filing. It lists Messrs. Walsh and Greenwood as principals since 1999.

Alleged victims include Carnegie Mellon University, which had invested more than $49 million, and the University of Pittsburgh, which put in more than $65 million, court records show. The Iowa Public Employees Retirement System said it had invested about $339 million, or 2% of its portfolio. The Sacramento County Employees’ Retirement System in California said on its Web site that it had invested $89.9 million, or 1.6% of its total fund.

The case marks the latest in a series of scandals, topped by Bernard Madoff, who authorities say admitted in December to masterminding a $50 billion Ponzi scheme. Other cases include R. Allen Stanford, a Texas financier who has been accused by the Securities and Exchange Commission of an $8 billion fraud involving certificates of deposit, and Marc Dreier, a prominent New York lawyer charged in an alleged $400 million hedge-fund scam.

If proved, the latest case “will be the biggest direct hedge-fund fraud we’ve seen,” according to Chris Addy of Montreal-based Castle Hall Alternatives, which provides risk-assessment services for investors in hedge funds.

Separately, another alleged fraud began unfolding Wednesday when the U.S. attorney charged hedge-fund manager James Nicholson with securities and bank fraud in U.S. District Court in Manhattan. Prosecutors don’t have a clear idea of the size of the alleged loss, saying only that as much as $900 million could have been invested with his firm.

Is Anything Safe?

Investors have to be wondering if there is any safe place left to invest their capital.  Stocks are down 50% and there seems to be another major investment fraud reported almost daily with total losses well over $100 billion and counting.

Large investment losses, loss of confidence and a weak economy restrict investment and risk taking which further impede economic recovery.  It looks like it’s time to take Will Rogers advice and be more concerned with return of capital rather than return on capital.

Filed Under: Corruption, Fraud Tagged With: , ,

Banks Tighten Lending By Restricting FHA Cashout Refi

February 26, 2009 by Leave a Comment

FHA Loans Become Tougher To Qualify For

Effective January 1, 2009 HUD announced that any FHA cash out refinance would require two appraisals when the loan to value exceeds 85% – see FHA Takes A Closer Look At Home Values. Since the customer usually has to pay for the appraisal, this adds around $350 to the cost of refinancing with the FHA.  In addition, many underwriters are taking a very close look at appraised values, due to the continuing drop in home prices.   In turn, the close scrutiny of appraised values by the underwriters are making many appraisers more conservative in the values that they assign to a home.  The FHA also raised the down payment requirement on purchases to 3.5% and increased mortgage insurance premiums.

The net result is that an FHA loan not only has higher costs but also a higher probability of being turned down due to insufficient equity and more stringent underwriting guidelines.

Some Banks Reduce Cash Out Limits On FHA Loans

Two smaller banks today have reduced the cash out limits on FHA loans to 85% loan to value, despite the FHA guideline allowing 95% cash out.  Rumor has it that larger banks will also follow through on lowering the loan to value limits on FHA cash out refinances.   Tougher guidelines quickly spread industry wide, so expect many more lenders to make it more difficult to cash out on an FHA refinance.

Since FHA loans have a very high default rate (roughly 12%), it is only logical that banks are imposing tougher guidelines for borrowers.   The banks simply cannot afford to take on additional default risk given their weak financial position.

Many potential borrowers will continue to find it difficult to obtain mortgage approval until the economy recovers and the housing markets stabilize.  Based on the way things are going, it could be a long wait.

Filed Under: Banking Industry, FHA, Housing, Mortgages Tagged With: ,

Can The Economic News From Japan Possibly Get Worse?

February 25, 2009 by 2 Comments

Japan’s Exports Plunge By 45% In January

Six months ago, no one in his right mind would have predicted a 45% decline in Japan’s exports.  The drop in exports has no comparable statistics, as Bloomberg reports.

Feb. 25 (Bloomberg) — Japan’s exports plunged 45.7 percent in January from a year earlier, resulting in a record trade deficit, as recessions in the U.S. and Europe smothered demand for the country’s cars and electronics.

The shortfall widened to 952.6 billion yen ($9.9 billion), the biggest since 1980, the earliest year for which there is comparable data, the Finance Ministry said today in Tokyo. The drop in shipments abroad eclipsed a record 35 percent decline set the previous month.

Exports to the U.S. tumbled an unprecedented 52.9 percent from a year earlier, and shipments to Asia and Europe also posted the largest-ever declines as the global recession deepened. The collapse is likely to force Japanese companies to keep firing workers and closing factories, worsening an economy that shrank the most in 34 years last quarter.

“The pressure on companies to cut jobs and investment is rising and that will make the recession deep and protracted,” said Yasuhide Yajima, a senior economist at NLI Research Institute in Tokyo.

Shipments to Europe slid 47.4 percent in January from a year earlier, the Finance Ministry said. Exports to China fell 45.1 percent and those to Asia dropped 46.7 percent.

Central bank Governor Masaaki Shirakawa said last week that the economy will remain in a “severe” state next quarter and companies will struggle to obtain financing as investors shun risk. The bank, which lowered the key overnight lending rate to 0.1 percent in December, last week said it will buy corporate bonds for the first time to stem the credit squeeze.

The Nikkei Puzzle

With astonishingly horrible economic news coming out of Japan almost daily, one would expect that the Nikkei would be crashing below its 2003 low – see Nikkei – Black Hole or Buying Opportunity. Is it possible that we are looking at a classic “buy on the bad news” opportunity?   At this point, one could take the position that the Nikkei’s refusal to sell lower means that the present bad news has been fully discounted.

Contrary Opinion Time?

The fact that the Nikkei refuses to hit new lows may indicate that the world economy will improve going forward.   How could it get much worse?  If we extrapolate the present rate of decline for Japanese exports, they would drop to virtually zero within six months!   Is the world’s second largest economy really going to ground to a dead stop?

This may turn out to be a classic (long term) “buy on the bad news” opportunity for the Nikkei, as long as the 7000 level can hold.

Filed Under: Japan, Nikkei Tagged With: , ,

Do Bernanke And Obama Talk To Each Other?

February 24, 2009 by 1 Comment

Bernanke Gives Upbeat Assessment On Economy

Chairman Bernanke predicted today that the recession would end in 2009.  Some of his upbeat, optimistic comments included:

“If actions taken by the administration, the Congress and the Federal Reserve are successful in restoring some measure of financial stability — and only if that is the case, in my view — there is a reasonable prospect that the current recession will end in 2009 and that 2010 will be a year of recovery”.

“I would anticipate some stabilization in the housing market going forward.”

“I do believe that once the economy begins to recover, we will see improvement in the financial market.”

The Big Question

The really big question is, was the President listening to him?

The Bloomberg report that follows is really tough to reconcile with Bernanke’s comments earlier in the day.  Do these guys talk to each other?  There does not appear to be a consistent message or plan for dealing with the greatest economic chaos since the 1930’s.

Feb. 24 (Bloomberg) — President Barack Obama will tell the public tonight the “day of reckoning has arrived,” and that pulling the U.S. out of a recession will mean sacrificing “some worthy priorities” the nation can no longer afford.

“We have lived through an era where too often, short-term gains were prized over long-term prosperity; where we failed to look beyond the next payment, the next quarter, or the next election,” Obama will say in his first address to a joint session of Congress, according to excerpts released by the White House.

“The only way this century will be another American century is if we confront at last the price of our dependence on oil and the high cost of health care; the schools that aren’t preparing our children and the mountain of debt they stand to inherit,” he will say

Obama is seeking to convince lawmakers and voters that his plans to revive growth will succeed while cautioning that the recovery will take time. The president has spent his first month in office focused on three initiatives — a $787 billion stimulus bill, a bank-rescue plan and an effort to limit home foreclosures — while warning of economic “catastrophe” if the government doesn’t take aggressive action.

With all the warnings about the severity of the economic crisis, Obama now must look for ways to boost public optimism, analysts and economists say.

“It’s a real balancing act,” said Stuart Rothenberg, a Washington-based political analyst. “The president’s got to walk this fine line between reminding people of the difficult situation we’re in and emphasizing the inevitable victory.”

“It’s all about confidence,” said Bruce Foerster, a former Lehman Brothers Holdings Inc. managing director and now president of South Beach Capital Markets in Miami. “That’s the heart of what is going on. We have problems but they are being exacerbated because there’s no confidence in the capital markets.”

I applaud the President’s honesty on the challenges we face and I wish him the best of luck. The stock market, however, has lately been registering a resounding vote of no confidence in the actions taken by Washington.  The nation is searching for a thoughtful, workable plan to solve the economic problems we face.  A coherent and unified message from Washington would be good for starters.

Predicting an end to the recession in 2009 while concurrently describing the economic situation as “catastrophic” and a “day of reckoning” does not project a coherent message.   But it could have been worse – at least they didn’t let Tim Geithner say anything.

Filed Under: Bernanke, Confidence, Economy, Federal Reserve Tagged With: ,

Bernanke Predicts 2010 Recovery In Stocks, Housing & Economy

February 24, 2009 by Leave a Comment

Bernanke Predicts Recession To End In 2009

The stock market jumped over 200 points today, partly due to Federal Reserve Chairman Ben Bernanke’s optimistic comments to the Senate Banking Committee.  Some selected comments by the Chairman follow:

“If actions taken by the administration, the Congress and the Federal Reserve are successful in restoring some measure of financial stability — and only if that is the case, in my view — there is a reasonable prospect that the current recession will end in 2009 and that 2010 will be a year of recovery”.

Mr. Bernanke also sounded optimistic on housing as well, although without a specific time projection for recovery.

“I would anticipate some stabilization in the housing market going forward.”

Mr. Bernanke seemed to dismiss the need for bank nationalization stating that:

“I don’t see any reason to destroy the franchise value or to create the huge legal uncertainties of trying to formally nationalize a bank when that just isn’t necessary”.

Better financial market performance was also seen by the Chairman:

“I do believe that once the economy begins to recover, we will see improvement in the financial market.”

Mr. Bernanke also stressed his commitment to provide ample amounts of credit for all purposes:

“Our objective is to improve the function of private credit markets so that people can borrow for all kinds of purposes.”

Mr. Bernanke did temper his optimistic statements by noting that his forecast

“is subject to considerable uncertainty, and I believe that, overall, the downside risks probably outweigh those on the upside.”

Conclusion?

If the downside risks outweigh those on the upside, how can Bernanke be so optimistic for a recovery in stocks, housing and the economy??  Based on the confusion and conflicting signals, let’s examine some previous comments by the Chairman for perspective on his batting average as an economic prophet.

Previous Forecasts By The Chairman

“At present, my baseline outlook involves a period of sluggish growth, followed by a somewhat stronger pace of growth starting later this year as the effects of monetary and fiscal stimulus begin to be felt.”
—February 14, 2008

The U.S. federal budget deficit has declined recently and is officially projected to improve further over the next few years. Unfortunately… the United States has already reached the leading edge of major demographic changes that will result in an older population and a more slowly growing workforce. A major effort to increase public and private saving is needed to prepare for the economic consequences of this demographic transition and to address external imbalances. As the global perspective makes clear, the reduction of the U.S. current account deficit also requires efforts on the part of the surplus countries to reduce the excess of their desired saving over desired investment.
—September 11, 2007

“Overall, the U.S. economy appears likely to expand at a moderate pace over the second half of 2007, with growth then strengthening a bit in 2008 to a rate close to the economy’s underlying trend.”
—July 18, 2007

“We will follow developments in the subprime market closely.  However, fundamental factors—including solid growth in incomes and relatively low mortgage rates—should ultimately support the demand for housing, and at this point, the troubles in the subprime sector seem unlikely to seriously spill over to the broader economy or the financial system.”
—June 5, 2007

“We at the Federal Reserve will do all that we can to prevent fraud and abusive lending and to ensure that lenders employ sound underwriting practices and make effective disclosures to consumers. At the same time, we must be careful not to inadvertently suppress responsible lending or eliminate refinancing opportunities for subprime borrowers.”
—May 17, 2007

“The information, expertise, and powers that the Fed derives from its supervisory authority enhance its ability to contribute to efforts to prevent financial crises; and, when financial stresses emerge and public action is warranted, the Fed is able to respond more quickly, more effectively, and in a more informed way than would otherwise be possible. “
—January 5, 2007

No need to assign a grade letter to the Chairman, but maybe we should hold off on celebrating the economic recovery.

Filed Under: Bernanke, Economy, Federal Reserve, Housing Tagged With: , ,

Jumbo Mortgage Rates Reflect Default Risk

February 24, 2009 by 4 Comments

Economic Crisis Impacts All Borrowers

Jumbo mortgages, typically loan amounts above $417,000, are defaulting at a rapid pace as the economic crisis affects borrowers at all income levels.  Bloomberg is reporting that jumbo mortgages, typically associated with higher income home owners, are becoming the next black hole for the banking and housing industry.

(Bloomberg) — Luxury homeowners are falling behind on mortgage payments at the fastest pace in more than 15 years, a sign the U.S. financial crisis that began with the poorest Americans has reached the wealthiest.

About 2.57 percent of prime borrowers who took out jumbo loans last year were at least 60 days delinquent, according to LPS Applied Analytics, a mortgage data service in Jacksonville, Florida. They got to that level within 10 months, almost twice as quickly as 2007 borrowers and the fastest rate since at least 1992, when LPS Applied Analytics began tracking the market.

The jump in late payments on jumbo loans, while still lower than the 20 percent delinquencies in subprime mortgages, signals that the borrowers with the most money and the best credit are hurting as the U.S. recession deepens in its second year. It also means these loans will be even more difficult to obtain and more expensive to pay off.

Most of the mortgage defaults do not appear to be caused by poor loan underwriting but rather by growing job losses among high income earners.  Due to the higher level of defaults, banks are becoming very reluctant to make jumbo mortgages for either purchases or refinances.  Since Fannie Mae and Freddie Mac  will not buy or insure jumbo loans, the lending bank must assume all the risk, keep the loan on their books and set aside additional reserves for possible losses.  All of these additional risk factors are reflected in the higher jumbo rates and strict loan underwriting guidelines.

The difference in interest rates between jumbo loans and prime conforming mortgages, or mortgages eligible for sale to Fannie Mae and Freddie Mac and available to borrowers with top credit scores, had been about 20 basis points “for several decades,” according to BanxQuote CEO Norbert Mehl.

The difference between the jumbo interest rate and the prime conforming rate was 181 basis points on Feb. 18, according to Bloomberg data.

“The only jumbo mortgages being written right now have strict qualification criteria both in the credit rating of the borrower and the down payment requirements and they are nearly impossible to qualify for,” Mehl said. “Some lenders quote a jumbo rate but they don’t make the loans.”

Conforming Loans At 7%?

An interesting point to note is that the size of a mortgage loan is not the determining factor for the interest rate.  Mortgage rates are based on many factors but the primary reason for higher rates on jumbo mortgages is the lack of a government agency guarantee.  This implies that without price support from the government, conforming mortgages would also be in the 7% range to reflect the actual risk of mortgage lending in today’s environment.

No Relief In Sight For Jumbo Mortgage Homeowners

Given the higher risk on jumbo mortgages due to the factors cited above, homeowners who have high rate jumbo mortgages are unable to refinance to lower rates.  In addition, the proposed mortgage plans meant to help distressed homeowners provides no assistance for jumbo mortgage homeowners.

Jumbo Mortgage, Jumbo Headache – Wall Street Journal

Washington is trying to ease the mortgage crisis by helping people refinance into home loans with better terms. But one group is being left on the sidelines: borrowers with loans too big to qualify for government backing.

President Barack Obama’s housing stability plan, announced last week, excludes such borrowers from nearly all of its mortgage-bailout provisions. Instead, it focuses on middle-income consumers who have lower, so-called conforming loans. Such loans top out at $417,000 in most parts of the country

Anything bigger is called a “jumbo” loan — and not only is the government ignoring this segment of the market, so are lenders, few of whom are originating or refinancing jumbo mortgages. The reason: Jumbo loans are too large to be guaranteed by a government-backed mortgage agency, such as Fannie Mae or Freddie Mac, meaning banks assume the risk if the loan goes bad. In the current lending environment, few banks want to take on any risk.

“Every single day I’m talking to people who have a jumbo loan, and I can’t do anything for them,” says Jeff Lazerson, a mortgage broker in Laguna Nigel, Calif.

While total mortgage originations fell by 17% in the fourth quarter from the previous quarter, jumbo originations fell by 42% to $11 billion, according to Inside Mortgage Finance. That’s the lowest volume ever tracked by the trade publication, which has figures dating to 1990.

ING Direct, a unit of ING Groep NV, is one of the few lenders that is boosting jumbo originations, though it requires a minimum 30% down payment in the most expensive housing markets, up from 20% earlier last year. For condos, ING requires a minimum 45% down payment.

“If you have been able to … save for a down payment, that to us speaks volumes about your character,” says Bill Higgins, ING’s chief lending officer.

Some banks, though, are quoting much-higher jumbo rates. Mortgage brokers say that indicates that lenders are reluctant to make jumbo loans and are setting their prices high to deter new deals. For example, Taylor, Bean & Whitaker Mortgage Corp. in Ocala, Fla., recently listed a 7% rate on a 30-year fixed-rate jumbo loan, but charges up-front origination fees equal to 5% of the loan.

Real-estate professionals say that the lack of financing for high-income consumers is putting extra pressure on affluent communities and causing prices to fall even further. “The million-dollar-and-above market is sinking like a lead weight,” Mr. Lazerson says.

Jumbo Mortgage Rates Reflect Lending Risks

Jumbo borrowers are discovering the meaning of “pricing for risk”.  Mortgage lending has become a very high risk business due to the continuing decline of real estate values, the high risk of default due to economic conditions, principal impairment and/or rate reductions from loan modifications, the risk of bankruptcy court cram downs and government supported foreclosure moratoriums.   Some may incorrectly believe they are entitled to a low rate mortgage regardless of risk factors.  This peculiar belief by both banks and borrowers helped to create the destructive credit crisis we are now experiencing.  The banks are doing what they need to do with jumbo mortgages- setting rates to properly reflect risk.

Filed Under: Banking Industry, Economy, Interest Rates, Jumbo mortgages, Mortgages Tagged With: , ,

Defaults Everywhere – More Lending Is Not The Solution

February 24, 2009 by 2 Comments

Mortgage Defaults Only Part Of The Problem

Mention loan defaults and most people probably think of mortgages.  Home foreclosures due to mortgage defaults are getting the bulk of press coverage and the most attention in Washington.  The credit crisis, however, is not confined to home mortgages.  Lack of consumer demand, reduced incomes, lack of credit and an economy that seems to be getting weaker by the hour, is causing growing defaults in almost every category of lending.  Commercial real estate, credit cards, car loans, student loans, second mortgage loans, business loans and personal loans are all defaulting at shockingly high rates that the banking industry never expected.  The losses from these loan defaults are depleting bank capital, making banks less eager to lend to anyone.

The Wall Street Journal reports today that loan Defaults by Franchisees Soar As The Recession Deepens.

From ice-cream parlors to tanning salons, franchisees’ defaults on loans guaranteed by the U.S. Small Business Administration are piling up in amounts unseen in years. A list of loans at 500 franchises shows the number of defaults by franchisees increased 52% in the fiscal year ended Sept. 30, 2008, from fiscal 2007. Loan losses totaled $93.3 million, a 167% jump from $35 million just 12 months earlier.

The figures, a stark barometer of the downturn’s severity and scope, could give pause to banks that have loan money about where to lend next. Banks that make SBA-guaranteed loans say they use the annual list as guidance in assessing future commitments.

SBA-guaranteed loans are aimed at providing capital to small businesses that often can’t qualify for conventional credit. Those loans, made through commercial banks and other lenders, can total as much as $2 million for as long as 10 years. The SBA essentially insures a significant portion of the loan to encourage lending and small-business entrepreneurship. The recently passed stimulus package raises that guarantee amount to 90% from 75%.

The franchise brands where at least 11 franchisees defaulted on loans during the 2008 fiscal year were: Aamco Transmissions, Carvel Ice Cream, CiCi’s Pizza, Cold Stone Creamery, Curves for Women, Domino’s Pizza, Dream Dinners, Planet Beach tanning salons, Quiznos, Subway and Taco Del Mar.

Over time, some businesses have significantly better loan-performance rates than others. Among the worst-performing franchise brands, as measured by the percentage of SBA-guaranteed loans issued to franchisees over the past eight fiscal years that defaulted: Mr. Goodcents Subs & Pastas, 55%; Philly Connection sandwiches, 51%; Cottman Transmission, 49%; All Tune & Lube auto centers, 47%; Cornwell Quality Tools, 42%; and Carvel and Blimpie, both with 41% failure rates. Each had obtained at least 50 SBA-guaranteed loans during that period.

An interesting aspect of the default ratio is that certain franchise operations have a huge number of defaults.  With more than enough bad debts on the banking industry’s books, one would hope that lending would be severely curtailed or eliminated to franchise operators that are showing over a 40% default rate.  A default ratio of almost half of all borrowers  would seem to indicate a basic flaw in the franchise system’s business model.

The bottom line for franchise operations and probably every other business right now is that more loans may keep the doors open, but at the cost of burying the business owners in debt and making future profitability all that much more difficult.   What businesses really needs right now to survive and prosper is increased sales, something that seems very difficult to achieve under current economic conditions.

Filed Under: Banking Industry, Economy, Franchise operators, Interest Rates Tagged With: ,