Tuesday, April 15, 2008

Stripped Bare - Beneath the Feel Good Veneer of Subprime Lending

Chapter 14 - Full Disclosure

As I mentioned when I first started posting this series on subprime lending, I first got into the mortgage business in 1987.  The corporation I began with was a small, four (4) man mortgage broker shop, writing strictly “A” paper, prime, mortgage loans.  In 1989, I became a partner in this closely held corporation, and we grew the company into a full FNMA/FHLMC seller/servicer.  Meaning, instead of selling our loans off to larger lenders, brokering, we now held our loans and our customers made their monthly house payments to our corporation.  Additionally, we created a wholesale lending division wherein we marketed our corporation to mortgage brokers who now sold their loans to our company, we also serviced these mortgage loans.

I sold my interest in this corporation in January 1995.  At that time we had over one-hundred and twenty (120) employees and sales of just under one billion.  It was a profitable venture.

After selling my interest in this company, I originated loans for a short period of time for a smaller mortgage lender which folded not long afterward.

Upon the closing of the previously mentioned shop, in 1997 I marketed my mortgage talents to an individual with no mortgage experience who desired to startup a new mortgage broker business, on a contract basis.  I remained with this small broker for two and one-half years.  The first full year with this company was dismal, but in the last year we had sales of forty-one (41) million.  It was when I was with this company that I first originated and closed a subprime loan.

After this venture, I spent the years of 2001 through 2003 in the banking software industry.

In 2004, I joined Countrywide’s Full Spectrum Lending Division, Countrywide’s subprime lending behemoth.  I initially filled the position of assistant branch manager for this organization, and six months later I was made branch manager.  It was while with this national company that I saw just how deep the rabbit hole went in subprime lending.  Though I was initially impressed with Countrywide’s ethical statements regarding lending to subprime borrowers, I soon formed the opinion that this was mere window dressing.  I did not mesh well with this organization.  I attempted to have my staff facilitate prudent subprime lending, i.e. making my people correct bad debt issues which the company’s underwriting guidelines stated did not need correction, not pushing borrowers’ debt income ratios, etcetera.  Because this conflicted with the company’s volume goals, I was asked to resign in mid 2006.  Which I did.

I still think subprime lending could be a viable and profitable business concern, if done ethically, and with sound underwriting.

Posted by John Venlet on 04/15 at 08:20 AM
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Stripped Bare - Beneath the Feel Good Veneer of Subprime Lending

Chapter 13 - Self Inflicted

The collapse of the subprime lending industry was self inflicted.  It did not have to be that way.  For many subprime borrowers, the preceding statement is also valid, except the end result was personal financial collapse.

The stage was set for the collapse of the subprime lending industry with the origination of the individual subprime loan underwritten to foolish; one could say incompetent; underwriting guidelines.  As more and more of these structurally deficient loans piled up in lenders’ servicing portfolios, to be mined again and again for any remaining equity subprime borrowers may have retained in their homes, the swiftness of the final collapse lacks any astonishment.  The subprime lending business model was fundamentally flawed and myopic.

Subprime lenders had an opportunity, when lending to subprime borrowers, to build long term lending relationships, and sound, profitable performing loan portfolios, but instead subprime lenders chose to follow a path of what could be considered as mutually assured destruction.  Subprime lenders, investment houses which purchased subprime loan mortgage backed securities, and subprime borrowers, opted for quick cash rather than sound, long term financial stability.

It does not require a degree in economics, or personal financial, to understand that when you write mortgage loans, to marginal borrowers, and do nothing to but give lip service to the necessity of paying your creditors on time, or satisfying past due debts, that you are simply applying a rotten bandage to an already festering wound, thus facilitating further infection.

These risks could have easily been mitigated by the subprime lending industry by requiring subprime borrowers to adhere to stricter lending standards, i.e. by requiring subprime borrowers credit issues to be corrected, rather than ignored, and by utilizing sound debt to income ratios.  Instead, subprime lenders took the short view, throwing good money at bad borrowers in order to book loans.  And as subprime lenders continually stripped subprime borrowers’ home equity, while allowing subprime borrowers to remain high credit risks, with debt to income ratios which were beyond their financial means, the industry collapsed.  If the subprime lending industry would have practiced sound lending and underwriting, actually correcting subprime borrowers credit issues, while at the same time lowering subprime borrowers monthly debt expenses, which was possible, subprime lenders could have built strong loyalties with their borrowers, and sound mortgage loan portfolios.

Would subprime borrowers have complained about the need to pay off bad debts, rather than receiving some cash in their pockets?  No doubt they would have.  Would the over the top profit margins subprime lenders grossed on each subprime loan been reduced by sound underwriting guidelines which would have required bad debts be satisfied as a condition to lend new money.  Without a doubt.  But requirements such as these would have been short time losses in exchange for long term investment profitability.  Both parties would have gained.

Instead, today, the foolishness of the subprime lending industry has spilled over into all aspects of the credit lending industry as a whole, and into individuals’ homes.  The goose which many thought was laying the golden egg was actually defecating, and the mess which this has created is not easily cleaned up.

Posted by John Venlet on 04/15 at 08:16 AM
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