April 25, 2024

US Bancorp Takes Fed’s Advice To Lend Aggressively

December 2, 2008 by Leave a Comment

US Bancorp (USB) is still profitably while other banks can’t find enough zeros to put after their losses.  In the latest quarter ending September 30, 2008, USB’s net earnings declined by 48% to $576 million due mainly to an increase in provision for credit losses of $549 million in the quarter.  The increase in the provision for credit losses for the 9 months ending 9/30/2008 increased dramatically also, by $1.3 billion.  Nonetheless, even after these large increases for bad debts USB was still able to show a very respectable 9 month net income of $2.6 billion (down 23%).  A large reduction in their interest expense of $1.1 billion due to lower funding costs helped results considerably.

USB is a highly regarded well run institution still profitable and well capitalized despite horrendous losses by the banking industry in general.   Warren Buffet through Berkshire Hathaway owns over 4% of the company and other institutional investors own approximately 60% of the shares outstanding.  Of 22 analysts covering USB, there are 4 strong buys, 1 sell and the rest mainly hold.

USB pays a generous dividend of $1.70 yielding almost 8% at the current price although this is unlikely to be maintained since the payout is 100% of earnings.   If earnings continue to drop the dividend would probably be cut.   USB is borrowing $6.6 billion under the TARP program via a preferred stock sale.  USB is a non agency lender, retaining many of its mortgages.

USB’s portfolio is not heavily weighted to any particular lending sector, being spread geographically and across a broad spectrum of borrowers.  The short position on the stock is only 2% of the float.  In the last 12 months, of 71 insider trades there were 51 sells and 20 buys.

Level 2 assets as of 9/30/2008 totaled $41 billion and Level 3 assets totaled $3.7 billion, for a combined 214% of total equity, a potential source of earnings trouble depending on what mark to market rules ultimately apply and whether the credit quality of these assets deteriorate.   (Level 2 assets are not actively traded but priced on what similar securities are valued at; Level 3 assets are “model derived” using best guess estimates to determine value.)  As of 9/30/2008, USB had a derivatives position of total notional amount of $52 billion; the company states that it does not use derivatives for speculative purposes.

USB apparently is in a very strong position to lend and gain market share while its competitor banks struggle to stay alive.   With other banks reportedly reluctant to lend, it would seem that USB could cherry pick its customers, lending only to the best credits at a properly risk adjusted rate.  With this in mind, I spoke recently to some mortgage companies that broker loans to USB and reviewed some wholesale rate sheets that USB distributes to its broker network.  The following items are noted:

USB has a wholesale operation that aggressively recruits mortgage companies.  Many other banks have terminated their wholesale side of the business due to volume declines industry wide and also due to the questionable quality of brokered loans.   This gives USB the opportunity to pick up a lot of new business if they can effectively monitor the various brokers that they deal with.  The word on the street as I hear it is that USB is the most aggressive lender out there and if you have a deal you can’t get done, you  try USB.

USB allows debt ratios of up to 50% on a first position fixed rate loan and 45% on a first/second purchase with a FICO score over 680, subject to disposable income limits.   For a score of 650-679 a more reasonable debt ratio cap of 35% is imposed.  A debt ratio over 35% is neither “affordable nor sustainable” as I have detailed in past discussions.  The FDIC has recently proposed that mortgage borrowers in default have their loans modified so that the debt ratios of the mortgage payments do not exceed 31% of income.  There is a big difference between front end and back end debt ratios, but USB’s allowed debt ratios are aggressive lending standards under any circumstances.

No reserves are required for many of the USB loans.  This means you can have a borrower purchase or refinance a home with zero in savings to fall back on should unexpected expenses occur.  With a high debt ratio on top of no savings, this is a recipe for disaster for many homeowners.

USB has a very aggressive jumbo (over agency loan limits) loan program.  Some features as highlighted in their wholesale rate sheets are quoted, as follows:

-interest only to 80% loan to value; competition offers only 65% loan to value limit

-full 80% for cash out -competition allows only 70%

-no hits for cash out refinance – competition does not allow this or charges a rate adder or fee

-revolving debt (credit cards, etc) can be paid with cash out proceeds to qualify-competition does not allow.  (Credit card debt paid off with a refinance can be easily run up again causing payments to become unmanageable.)

-only 36 months out of bankruptcy allowed – competition requires 5 – 7 years.

The Wall Street Journal reports that USB had the greatest increase in loan volume, a whopping 35%, among midsized lenders, beating out BB&T and Flagstar Bank.  The reasons given by the Journal for the very large loan increase are different from mine as noted above.  Typically, the most aggressive lenders fund the most loans.

USB recently acquired failed $13 billion asset Downey Savings Bank in an FDIC arranged takeover.  Downey had a significant presence in California and Arizona.  USB agreed to accept the first $1.5 billion in losses on Downey’s portfolio; losses in excess of this amount are subject to a loss sharing agreement.

Downey was one of the biggest pay option arm lenders, which allowed borrowers to pay only a small portion of the interest actually accruing on a mortgage, thus resulting in negative amortization.  With the severe property declines in CA and AZ, many of these loans now greatly exceed the value of the mortgaged property.  In addition, many of the pay option arms allowed “stated income”.  80% of pay option arm holders pay the minimum payment each monthly and took out this type of loan because it was the only way they could afford the loan payments.  USB may find that the lossses on the Downey pay option arm portfolio vastly exceed any estimates they might have made, once they establish the borrowers’ true income and property value.

USB’s aggressive lending and acquisition of Downey may put them in an exceptionally profitable position if the economy turns around quickly,  companies start hiring again and the residential property markets quickly recover.  If you believe in regression to the means, however, and that bubbles that burst wind up either at the level where they first started or lower, consider the chart on US home prices below.  Home values may still have much further to fall which would cause great distress to USB’s mortgage portfolio and ultimately their income statement.

Filed Under: Bailout, Banking Industry, Economy, Mortgages Tagged With:

Loan Modifications – Salvation For Former Mortgage Brokers?

November 22, 2008 by 1 Comment

From my industry contacts and investigation of the loan modification “business” there are several conclusions easily reached:

– The Internet is extremely crowded with unknowledgeable, coarse idiots who are all attempting to haphazardly create businesses doing loan modifications. Very few of them have thought through whether or not they can be profitable, or the long term destination of the new industry.Many of the new loan mod businesses are being started by unemployed members of the mortgage brokerage industry who helped to create the very problem that they are now offering to cure. In fact, the very same people who were “helped” by the mortgage industry by getting them approved for subprime and Alt A mortgages are now on the top of the calling list as potential “loan mod” customers.

– The press is highly critical of anyone who tries to assist homeowners with loan modifications. Beyond news driven stories, the only loan mod stories are about bad providers who charge huge upfront fees and deliver little or no results, or others who are simply defrauding customers outright.

– The press and the government, for lack of a real solution, see the idea of loan modifications as THE solution to the housing crisis. If payments are lowered for 2 million of the country’s biggest financial losers, the economy will snap back immediately, job losses will cease and all will be well.  The consensus seems to be that the government should pay for this, and make rules about which people are “distressed” enough to receive a lower rate and mortgage payment through a loan mod. The cost of all of this, as you may guess, will be borne by those who handled their finances responsibly and did not borrow themselves into oblivion speculating on the certainty of eternal home appreciation.

Here is where I think things are going:

– In response to concerns about fraudulent or unknowledgeable companies assisting with loan modifications, most states will implement licensing requirements, as is already happening. Among other things, to maintain the license, you will be subject to strict guidelines on how much you can charge for loan modifications. The fees will be low enough to make any business which exclusively performs loan modifications unprofitable; the theory being that people behind on their mortgages should not have to pay since they are in financial difficulty.  Several states have recently created licensing requirements. Colorado was the latest: http://www.rockymountainnews.com/news/2008/nov/20/loan-modifications-require-mortgage-broker/ .

– As more of our nationalized banking system is pressured/required to do loan modifications, certain universal standards and calculations will develop. These will eventually evolve into a simple calculation that will require only a few inputs to determine exactly how a loan will be modified. This may even reach a point where banks routinely modify loans without even taking an application. This technology provider for the mortgage industry just released an early version of such software: http://www.marketwatch.com/news/story/Lender-Processing-Services-Announces-New/story.aspx?guid={58FCD216-F636-4EF9-8B93-5C1C1A41AD2F}

– The government will eventually fully endorse the idea of loan modifications for troubled homeowners and subsidize the losses. Of all the problems the country faces, for some reason the politicians will decide that keeping 2 million “homeowners” (who should be renters) out of foreclosure is the most pressing issue, instead of letting the free markets, via time and price solve the problem. With the government involved, the criteria will become even more formalized and systematic. Loan servicers or banks will be encouraged or required to deal with borrowers directly. The entire process will become formulaic and there will be little need for an outside party to assist with the loan modification.

– As modified loans default again and further borrowers fall into distress, whatever small scale plan the government implemented will be expanded dramatically. The government will increase pressure and incentives for banks and loan servicers to perform loan modifications en mass. Getting a loan modification will become as easy as it used to be to get a loan. Of course, one may wonder when it last occurred, that a government solution to a problem actually worked. Nonetheless, as home prices continue their inexorably decline for years and given the inability to find a better solution, this program will continue and expand, attempting to artificially arrest the decline in home prices that will occur anyways. Someone should clue in the powers to be that unless we want to totally socialize our economy, the free market, if left to do its work, would quickly solve the housing crisis by bringing prices to the point where they are worth investing in again and at a ratio of family income to cost that is sustainable for qualified borrowers.

Conclusion

Loan modification as a stand alone business is transitory since circumstances will change to make the current business models obsolete. At the same time, the fees that will be legally allowed will be too small to allow most businesses to be profitable. To turn this into a business, one would need to align his strategy to be way ahead of the curve and I have only seen one business model for loan modifications that would work if applied by an industrious and ethical entrepreneur.

In the meantime, potential customers who are solicited to have their loans “modified” would be well advised to do a complete background check on the firm that they may chose to deal with. In addition, under no circumstances should anyone pay a nonrefundable fee upfront (other than a modest processing fee). Guidelines vary with each loan depending on the investor, but if you are dealing with a knowledgeable firm, they should be able to determine from an initial prequalification if someone qualifies for a loan modification and accordingly, should only charge a fee if the loan is successfully modified.

As to the financial cost and moral hazards of the loan modification scheme, one should consider the words of Representative Ron Paul, when speaking out against the original $700 billion bank/homeowner bailout bill:

“It is neither morally right nor fiscally wise to socialize private losses in this way. The solution is for government to stop micromanaging the economy and let the market adjust, as painful as that will be for some. We should not force taxpayers, including renters and more frugal homeowners, to switch places with the speculators and take on those same risks that bankrupted them. It is a terrible idea to spread the financial crisis any wider or deeper than it already is, and to prolong the agony years into the future. Socializing the losses now will only create more unintended consequences that will give new excuses for further government interventions in the future. This is how government grows – by claiming to correct the mistakes it earlier created, all the while constantly shaking down the taxpayer. The market needs a chance to correct itself, and Congress needs to avoid making the situation worse by pretending to ride to the rescue.”


Filed Under: Bailout, loan modification, Mortgages

Loan Modification – Someone Forgot To Ask The Investors

November 18, 2008 by 3 Comments

Purchasers of mortgage debt, formerly known as investors but now known as bag holders were distressed that Bank of America (BAC) did not consult with them prior to deciding to modify customer mortgages, as reported by the Wall Street Journal.   The problem was not with the mortgages actually owned by BAC, but rather the mortgages owned by others and merely serviced by BAC.  Apparently so enamored with the idea of saving the banking industry by reducing the rate and loan balances of the lucky mortgagees, BAC decided to apply their therapy to mortgages that they merely service but do not own.

The problem with attempting to modify mortgage loans en masse is that many mortgages originated over the past 5 years were sold to investors as mortgaged backed securities.  BAC maintains that they can modify these investor owned mortgages based on “delegated authority” per the loan servicing contract they have with the investors.   Obviously some of the investors in the serviced mortgages don’t see it that way and are looking to BAC to make them whole on any write downs given to the borrowers at their expense.   These are the types of issues confronting the industry in their attempts to modify mortgages.

Mortgage modifications are seen as a win/win situation by the FDIC, many banks and some of the mortgaged backed securities investors since it appears to offer the ideal solution – homeowners get to keep their homes, foreclosures decrease and the ultimate loss on the loan modification theoretically is less than   foreclosing on the property.  This may all be work out to every one’s advantage unless property values continue their decline which I consider to be a likely scenario.   Home prices won’t stop dropping regardless of government efforts until the economy stabilizes and until the ratio of family income to cost of ownership reaches an affordable level.

The issue with loan modifications that I and others see is one of moral hazard; this program is institutionalizing the repudiation of debt on a national scale and the cost and negative consequences of this rationale are open ended.  In an excellent article by Peter Schiff, he describes loan modifications as “the mother of all moral hazards” as follows:

“No doubt prodded by the administration, Fannie Mae and Freddie Mac announced a new attempt to stop the fall in home prices and foreclosures through a loan modification program that would cap mortgage payments so that a homeowner’s total housing expenses would not exceed 38% of household income for home owners who are 90 days delinquent.

In a classic case of unintended consequences, the plan will encourage a massive new round of delinquencies and household income reduction as homeowners will jump through hoops to qualify for the program and maximize their benefit. Those who could conceivably economize to meet their existing obligations will now have a strong reason to forgo such sacrifices. Those who are not 90 days past due will intentionally become so. In many cases, dual income families may decide to eliminate one job altogether as reduced mortgage payments combined with lower child care and other work related expenses will likely exceed the after-tax value of the lost paycheck.

Unfortunately, the last thing our economy needs is falling household incomes and even more bad debt. But that is precisely what this plan will give us.”

Transferring all the losses of homeowners, automakers, banks, insurance companies, credit card companies, mortgage companies etc etc onto the balance sheet of the US Government does not correct the incredible excess of leverage that has been ongoing in this country since the early 1980’s; it merely transfers the losses to the US taxpayers and shortens the day that the US Government itself will need to be bailed out.

Filed Under: loan modification, Mortgages, Stocks Tagged With: ,

Some Borrowers Will Need Very Large Loan Modifications

October 11, 2008 by 2 Comments

As discussed in a previous post, Bank of America agreed with the state attorneys general to offer  concessions to 390,000 sub prime and pay option arm borrowers by reducing both the principal owed and/or the interest rate to a level that allows these borrowers to have a an “affordable and sustainable” monthly mortgage payment.   An affordable and sustainable payment was determined to be a mortgage payment (including taxes and insurance) that would not exceed 34% of gross monthly income.   With this agreement apparently setting a standard for future concessions to homeowners, consider some recent mortgage transactions/applications that I have seen.

  • Woman wants to refinance her Connecticut home which she bought in early 2006.  The home today would probably sell for no more than $260,000.  Home was purchased for $305,000 with 95% financing; the current interest rate is at 11.625% and she owes $285,000.  The negative equity is only $25,000.  Borrower has a gross monthly income of $3780 per month and her current monthly payment of principal, interest, taxes and insurance is $3682 giving her a debt ratio of 97%.   She is currently in arrears on the mortgage and obviously not capable of making the payment.   In order for her payment to become “affordable and sustainable”  with a 34% debt to income ratio, the lender would have to reduce her loan balance to $158,000 with an interest rate of 1%.

If the home owner gets this deal, not only would her payment become affordable, she could also sell the house and reap a gain of $102,000.  The applicant’s income is about the same today as it was when she purchased the home, so there was no drastic decline in income.  Obviously, this woman should have never been approved for a mortgage in the first place; both the bank and borrower knew this.

  • A self employed carpenter applied for a mortgage to purchase a home for $185,000.  Applicant has no credit score since he pays for everything “in cash”.  The yearly income reported on his tax return for the past two years averaged $5500.  When I told the applicant that he did not qualify he became indignant and arrogantly proclaimed that his bank told him they would approve him; I wished him good luck.  This guy hasn’t been reading the papers lately but the days of borrowing based on what you say your income is are over.   The applicant understood his situation; his income averages $458 gross per month according to his tax return and the monthly mortgage payment with taxes and insurance would have been at least $1650 per month which he insisted he could afford.  I would say that the IRS should conduct more audits of self employed individuals.
  • Borrower with very good credit and working two jobs has a sub prime mortgage and applies for a lower rate under the FHA mortgage program.   Borrower gets approved with with a debt to income ratio of 56%.  At this point, instead of bringing his lunch to work everyday, he might be better off to stop paying on his mortgage and  ask his bank for a loan modification once he is delinquent.  The interest rate would need to be reduced  from 6.25% to 1% which would put him at the recommended 34% DTI.  Although most loan modifications are currently being offered only to sub prime and pay option arm customers, I am certain that in the name of equitable treatment, the offer will expand to include the multitudes of other borrowers with a debt ratio over 34% .  Why discriminate against better credit borrowers?
  • Borrower with fair credit purchases a home with 100% FHA financing with the help of a down payment assistance program.   Borrowers debt ratio at time of approval was 48%, which is extremely high and not affordable or sustainable for very long.  Why is the FHA approving loans at this ridiculous debt ratio when the state attorneys general are forcing Countrywide to modify loans to a debt ratio of 34%?  I suggest that a state attorney general be named Head Underwriter for the FHA.

I could go on and on, but one thing is for certain; there are millions of home owners currently in a stressed income situation with negative home equity who would like to refinance but can’t due to low credit scores/lack of home equity or both.   As word spreads of the great deal that Countrywide borrowers got from the recent Bank Of America settlement, there will be many indignant and angry home owners demanding the same treatment.   Can the banking system, already insolvent, handle huge new write downs?

Filed Under: Bailout, Economy, Mortgages Tagged With: , ,

World’s worst borrowers given astonishing concessions

October 8, 2008 by 2 Comments

Bank of America agreed with the state attorneys general to offer astonishing concessions to 390,000 subprime and pay option arm borrowers that will cost upwards of $9 billion, as reported on by the Wall Street Journal.

Summary terms of the settlement with borrowers for loans made by Countrywide Financial include the following:

Mandatory loan modifications are required due to “unfair and deceptive” practices.

Supposedly this action will keep borrowers in their homes, support local communities and the general economy.  Some background here: loan modifications, still off the mainstream press, have over the past year grown into a sizable cottage industry, manned mostly by ex loan officers and former lenders, who for a fee, will negotiate with the borrowers bank to try and obtain a reduction in either or both the interest rate and the principal balance.

Many lenders are now and have been proactively contacting borrowers and offering them a loan modification where it was obvious that the borrower was in over his head.  The biggest impetus to loan mods was by Indy Mac after being taken over by the FDIC where 38,000 borrowers were sent letters offering to reduce their payments by either rate and/or principal reductions.

Loan mod results to date have been uneven, and each lender has been individually offering concessions where they see it to be in their best interest.  To date, most of the loan mods have been an interest rate reduction since the mortgage investors are hoping that eventually property values recover and their write downs will be limited.  In cases where only an interest rate reduction was offered, initial stats suggest that only 20% of borrowers are still current six months later  thus necessitating either a foreclosure, recovery, or another loan mod.

I recently spoke to a woman in Massachusetts who had a subprime mortgage with Chase at 12%; after months of phone calls and sending paperwork to Chase, she was given a fixed rate of 1% for 5 years, with the rate to rise in steps to 6.25% at the end of 10 years.   The lender did not, however, adjust the loan principal and she has negative equity of around $80,000.  Whether or not this loan mod works out for both parties is subject to debate.

In an excellent post by Mr Mortgage, a very compelling argument is made that negative equity is one of the prime motivators for payment default by the borrower, regardless of the rate.  Apparently the attorney generals read Mr Mortgage, since the loan mod mandate settlement requires that changes be made to the borrowers loan so the that loan payment is “affordable and sustainable”; thereby necessitating in most cases both a rate and principal reduction.

A Credit Suisse study of subprime loan mods, however,  indicated that over 20% of subprime mortgages in which a principal reduction was granted were 60 days delinquent on their mortgages within eight months of the loan mod, so the success rate is not much different were only a rate reduction was granted.  Keep in mind that all the statistics on loan mods are preliminary and based on small sample numbers over short periods of time since there have not been a great number of loan mods done to date.

Borrowers’ monthly PITI (principal, interest, insurance and property taxes) should not exceed a 34% front end debt ratio.

This means the PITI should not exceed 34% of the borrowers’ monthly gross income.  See my post on Mortgages still being approved for unqualified borrowers) and Unsound lending policy.

For borrowers who took out pay option ARMs, Bofa will reduce the loan amount so that borrowers have as much equity, if not more, than when they took out the loan.

Borrowers will not be charged for the loan mod and any prepayment penalties will be waived.

The mandate that no fee be imposed on the borrower for modifying the loan will make it very questionable from an ethics and business standpoint for the nascent loan mod industry to try and attempt to charge a Countrywide mortgagor a fee to modify their loan, since Bofa will be contacting all the Countrywide customers with no cost offers to modify their loans.

In those cases where the loan is serviced by Countrywide but owned by an investor, Bofa will work with the loan servicer to get the necessary approval for a loan mod.

BofA will send offers of a loan mod to qualified borrowers by December 1 and stay any foreclosure action until a borrower’s eligibility has been determined.

Bofa will provide $150 million to refund some closing cost on the original loan if the borrower is in foreclosure and also provide $70 million of “key money”, cash payouts to help with moving costs.

It is only logical to conclude that since one of the largest banks in the country has agreed to this type of settlement that virtually every other lender and loan servicer will also be required to participate, either by invitation or legislative decree.  Indeed, banking regulators are now calling on every subprime loan servicer “in the strongest possible terms” to adopt a similar loan mod program as possible.

In the rush to “do something”  to address the foreclosure problem, it appears that there is a collective rush to judgment that loan mods are the best manner in which to address the problem.   Superficially, it appears to be a compelling solution to the problem; make the payments low enough so that the homeowners can easily make their mortgage payments.  Every easy solution, however, seems to create unanticipated adverse consequences.

Specifically, the following issues may cause adverse consequences that outweigh the presumed advantages:

1. Moral hazard may be a significant factor.  I talk to many people who would like to refinance but cannot due to insufficient or negative equity in their homes.  Most of these people have good credit and sufficient income to pay their mortgage but many of them (especially with negative equity) bring up the question of whether or not they should stop paying their mortgage and mail the keys back to the bank and to what extent this would impact their credit.

As publicity about the loan mods programs grow, the flood gates could open here especially since there are around 12 million households that now owe more than their house is worth according to Moody’s Economy.com.  Modifying a loan may sound like an easy solution, but the reduction of a loan amount equates to a loss for someone else – a bank, pension fund, insurance company etc.   A reduction of only $25,000 on 12 million homes means another bailout of $300 billion – someone gets burned by this loss and our government does not have an unlimited ability to borrow money.

2. The social backlash and resentment from the 40 million households who have a mortgage but still have equity, as well as from the 24 million households that have no mortgage is going to be tremendous; the consequences will not be positive.

3. Every borrower who has a subprime or pay option arm loan was not a victim; I am sure some did not understand the terms of their loans and there were abuses, not to mention that many of these borrowers should never have been granted a mortgage approval in the first place.  However, most people of reasonable intelligence normally ask about the terms and details of their mortgage and are given numerous disclosures during the loan process and at the closing table.

Why should someone else pay for another’s carelessness with their financial affairs and failure to properly evaluate their actions?   There is plenty of blame to go around here, both on the borrowers part and certainly on the part of the lenders who knowingly made loans that they knew could not be repaid.

4. For a nation that has a tremendous debt burden on every level, loan mods could encourage debt repudiation on a massive level which will cause a further destruction of asset values on a scale too large to contain, which is what is already happening.   Every loan represents an asset to someone else; debt destruction and asset price destruction reinforce each other; the evaporation of wealth (assets) on a massive scale will not help anyone.

5. Many of the buyers of properties in the past 4 years purchased with 100% financing.  To the extent that they now have negative equity, what have they really lost?  They received a free call option on future price appreciation of the property that they bought. Now that the property didn’t go up in value, they are entitled to walk away from their loan obligation or simply default and then be given huge concessions?   I have seen many people that purchased a home with 100% financing come back a year or two later and then take out as much cash as possible with a new first or  second mortgage. My math puts these people way ahead of the game.

6. I have also seen many people do 100% cash out refinances in the past four years, often times using the money for trips,  new cars, consumer goods etc.  Many of these refinances occurred at the peak of the market meaning that they effectively sold their properties at peak prices.  For those now walking away or getting their loan balance reduced, it is their gain and the banks’ loss.

7. To modify the loan so that the borrower has a 34% front end debt ratio is extremely generous.  Most of the new first time homebuyers and mortgage refinances that I see approved have debt ratios above 34%, but the borrowers work hard, struggle and pay.  How is this equitable to them??

8. To reduce the principal on a pay option arm borrower back to his original principal or lower is equally inequitable to those borrowers who borrowed in a more conservative manner with a 30 year fixed rate loan.  Many of the pay option arms had initial payment rates based on a rate of  1% or 2% for a period of years; the real rate fully indexed was typically 6 or 7%,  but the borrower was allowed to pay a very low payment based on 1% and the balance of the interest that was due was added to his loan balance.  The pay option arm borrowers reap a windfall here since they effectively were given a 1% rate compared to the conservative borrower who took out a 30 year fixed rate and paid the full payment on a 6% mortgage.  Obviously, the pay option arm customer had a lot more cash left in his pocket at the end of each month; by my math they came out way ahead.

9. Many of the loan mods proposed will probably not work out since a significant number of the subprime and pay option arm loans were done with inflated stated income (liar loans).  Many of these types of loans would have to have a massive reduction in the loan balance for the borrower to have a comfortable payment since his income was never even close to what was needed to service the loan from day one.  The result would be a ridiculous situation whereby we are rewarding those who falsified their income to qualify for a loan.  How inequitable would this be for the financially responsible borrower who bought a home for $250,000 with a $50,000 down payment next door to the guy who also buys a $250,000 home, “states” his income to receive a 100% loan and now receives a loan reduction down to $150,000??

10. The impact of loan mods on future mortgage lending in this country will be incredible negative.  The government can subsidize rates and we can all pay for this, but investors who previously bought the loans or mortgage backed securities (which support the mortgage market) will either have no interest in this type of investment going forward or require a properly risk adjusted rate which is obviously going to be very high.  No one is going to lend out money when they face a substantial risk of large losses by having their original loan amount and interest rate reduced by a loan mod every time there is a price pullback in housing.  Mortgages have become and will remain an asset class of “extremely dubious value” (see 7. above).

11. Not Everyone Should Own a Home, Wall Street Journal, Janet Albrechtsen. In an excellent article that explains why Australian banks are not bankrupt entities as in America, the author points out the weaknesses in our banking system and the lack of responsible behavior by borrowers and lenders which helped propel us into the banking, housing and credit crisis.

Instead of prolonging our property market declines with constant costly bailouts, it may be wiser to follow the RTC example in the 90’s when the market was cleared by selling foreclosed properties for whatever bid was offered.  Anything will sell quickly at the right price.

Filed Under: Bailout, Mortgages Tagged With: , ,

Mortgages Still Being Approved For Unqualified Borrowers

October 2, 2008 by Leave a Comment

With foreclosures at record highs and the banking system in collapse, why would the banks still in business be making loans with reckless disregard to the borrower’s ability to repay? As explained in my post “Unsound Lending Policy“, any mortgage borrower with a high debt ratio (large percentage of income devoted to debt repayment) is usually a candidate for default. The borrower may be unsophisticated or simply over optimistic but it should be the responsibility of the lender to ascertain, using sound underwriting policies, that the borrower has a reasonably probability of being able to repay his mortgage debt.

I am still seeing loans being approved by automated underwriting systems for borrowers with total debt ratios in the high 50’s and just this week another loan approved with a 62% debt ratio. The odds of these loans defaulting are astronomically high since the borrower simply does not have enough income to pay his loans and living expenses. These loans are being approved by “desktop underwriting”, a system where the loan is approved by a computer based on input values. Obviously the software underlying the desktop underwriting that determines whether a loan will be approved has not been updated from several years ago when little regard was given to income, credit or loan to value, since it was assumed that the borrower would simply refinance again or sell the home in an eternally rising property market.

The loans being approved today with super high debt ratios are technically not “subprime” loans since that industry no longer exists; these are loans that will be sold to Fannie Mae in most cases, thus assuring that Fannie Mae will continue to have future foreclosures and a need for eternal government support and bailouts.

The really dark question here is, have the automated underwriting systems simply not caught up with the times or is this an effort to keep home sales up, support otherwise starving realtors and mortgage companies and hope that future rising home prices will keep the high debt ratio mortgages from defaulting? If one chooses not to accept the dark theory, the only other answer seems to be that reckless mortgage lending is still alive and well.

Filed Under: Mortgages Tagged With: ,

IOU’S Pile Up – Taxpayers Refuse to Pay

September 29, 2008 by 1 Comment

Forbes Magazine had a great article by William Baldwin explaining the addiction to debt by everyone from the Federal Government on down to Joe Sixpack. Politicians get elected by handing out entitlements that the “future generation” has to pay for, therefore, no new taxes need be imposed and the voters are kept happy; Joe Sixpack can buy his house with no money down and instead of saving for a downpayment can buy the new plasma TV and jet off to Cancun for the weekend; the ultra rich hedge fund operators and bankers can leverage up 40 to 1 and exponentially increase their net worth. Up until now this has worked like magic and no one, except for a few fiscal conservatives, worried about the mountains of debt building up at every level of society. As is the case with most trends that go to unimaginable extremes, all of a sudden it does matter in a very big way. Properly enough, the ones who incurred the most debt are now suddenly suffering the most from hedge fund managers facing liquidations requests and job loss to Joe Sixpack receiving his default notice to towns, cities and states suddenly facing massive deficits as the great credit machine implodes.

Debt to GDP

Here’s where it gets really interesting as the bills come due and the debts can’t be rolled over. Governments cannot cut back due to the nature of democracy; no will vote for someone who tells us what we need to hear – that the bills are due and we now have two options – drastically cut government services or dramatically raise taxes to pay for our past purchases. The option previously used on every occasion was to simply borrow more to pay the bills but, as we saw today, when you can’t borrow more it gets very ugly, very quickly.

Ironically, a few pages after the article by William Baldwin on out of control debt levels, we have the “Taxed to the Max” comment about a ballot initiative that will be voted on in Massachusetts which would eliminate the state income, wage and capital gain taxes which currently brings in the State of Mass over $12 billion a year. After a decade of stagnant wages, increased cost of living and maxed out credit cards it is going to be political suicide to convince the taxpayer that he needs to start paying on the mountains of debt that have piled up. How this problem is ultimately resolved will profoundly affect all of us for many years and there is no easy way out. How many people will accept a much lower standard of living and higher taxes to bring our debts in line with our ability to repay? I fear that as usual, the politicians will take the easy way out and try to continue to borrow until they can’t. The real big question is, short of simply printing the money, do we still have the ability to borrow and roll over our debts?

Taxed to the Max
Massachusetts is often referred to as “Taxachusetts” because the state’s taxes are so high. Now the Committee for Small Government wants to change that image by pushing legislation called the Small Government Act, which Bay Staters will vote on in November. The legislation repeals the state income, wage and capital gains taxes. That’s a $12.5 billion state revenue cut–with no other revenue to replace it. That reduction would force state legislators to seriously rethink their financial priorities. But it would also leave that money in the hands of families, where it will surely be better spent. Bostonians were once brave enough to tell England–and the world–that taxes were too high. Now let’s see if they have the courage to tell their own legislators.
–Merrill Matthews, Institute for Policy Innovation

Filed Under: Bailout, Economy, Mortgages Tagged With: ,

Unsound Lending Policy

September 29, 2008 by Leave a Comment

Where have these guys been?

This email came across my desk last week from a mortgage lender looking for business.

“More bad news yesterday from the agencies with reduced LTV’s and increased fico’s for cash-out. How can you avoid this latest problem? With a Dream House “combo loan”!

85% cltv with a 650 fico (won’t get there now without a 700!)

No MI required!
DTI to 55%

AVOID LOAN LIMITS and get easier approval with lower LTV 1st mortgage

Call me today for more details!”

Please note that this lender is allowing a debt to income (DTI) ratio of up to 55%. This means that they are offering to lend mortgage money to someone who ultimately will never be able to make the payments on his mortgage, for the following reasons. Calculation of debt to income ratios are a routine part of the underwriting process in determining loan approval, along with credit and collateral review. The front end DTI is the ratio of an applicant’s monthly payment of principal and interest on the mortgage, plus the monthly amount due for property taxes and home owners insurance divided by his gross monthly income. Thus, if the PITI (principal, interest, taxes, and insurance) is $2,000 per month and the applicants gross income (before taxes) is $5,000 per month, the front end DTI will be 40%. The back end debt to income ratio includes the PITI and all other recurring payments for installment and revolving debt, such as credit cards, car loans, personal loans, etc. If the PITI is $2,000 per month and other debt payments total $750 per month, and gross income is $5,000 per month, the total back end debt ratio would be 55%.

If a loan applicant accurately reports his income and has a debt ratio of 55%, he faces almost a certain future of defaulting on the mortgage.

Debt ratios are computed using “gross” income before any deductions for payroll taxes, etc. In this example, the borrower with a gross income of $5,000 will be lucky to take home $4,000 of spendable income after deductions for social security, Medicare and federal income tax deductions. This would leave him with only $1,250 per month for everything else in life such as food, dining, gas, car repairs, home repairs, tuition, medical expenses, life insurance premiums, gifts, clothing, entertainment, etc. etc., you get the idea. If the borrower has no savings, as is frequently the case, one large home or car repair could easily result in a missed mortgage payment. Typically, one missed mortgage payment will easily lead to another until the borrower is in default.

Question???? Why would anyone make a mortgage loan to a borrower with such a high debt ratio? The time tested banking limits on the back end DTI of 32-35% were used for a reason – it prevented the borrower from overextending himself and falling into default. Theoretically, lenders should be able to lend to whomever they wish to using whatever underwriting standards they chose to use. In addition, some borrowers have additional income that they cannot provide documentation for and thus are not able to use this type of income when applying for a mortgage. Therefore, they may have debt ratios that are in reality better than what appears in the formal debt calculation.

The only problem with this rationale is that allowing very high debt ratios is what has led us as a nation into a financial crisis based on easy lending to borrowers who really never had a realistic chance (absent eternal home price appreciation) of paying back the money that they were approved to borrow. Also, it was not a great leap, once you allowed high debt ratios, to also allow approvals of mortgages by applicants with low credit scores and minimal down payments, which totally guaranteed foreclosures for this type of borrower profile.

Given the the large number of mortgage defaults that we already have, I believe that lenders should be constrained in their enthusiasm to make aggressive loans to borrowers who may not fully realize their financial limitations.  In fact, in many ways, lending to a borrower with a verified high debt ratio is worse behavior than the approvals previously given to subprime and altA stated income borrowers since in those cases, at least the lender could look with two blind eyes at the income the borrower stated that they made and say, “ok approved”.  However, approving a loan where you have verified the income and know that the borrower’s income is insufficient is simply irresponsible .

Filed Under: Mortgages Tagged With: ,