A Beacon of Sanity in Subprime
"Send money." That was Brendan McDonagh's plea to top brass after he was tapped last year to clean up HSBC's mortgage mess in the U.S. (HBC) McDonagh, 49, had just inherited a massive pile of troubled loans, and as he saw it, the cash was critical to staving off a wave of foreclosures at the world's second-largest bank by assets. "It's an economic fact," says the Irish native, who favors pin-striped suits with bright ties. "The more people we can keep in their homes, the better it is for them, the bank, and the country."
McDonagh, since named chief of the bank's U.S. operations, got his wish. "The mother ship," as he calls headquarters back in London, O.K.'d a $2.6 billion cash injection in the first quarter of this year. (It's a pittance compared with the massive sums many big banks have been forced to raise from outside investors since the mortgage meltdown began, something HSBC hasn't had to do.) The funds have boosted reserves and fueled McDonagh's fix-it strategy: namely, a command center launched eight months ago in Tampa where roughly 640 employees work with troubled borrowers 24 hours a day, seven days a week to modify their mortgages so they don't lose their homes. These so-called loan workouts are his No. 1 priority for the bank, which handles the processing for what is one of the largest portfolios of subprime loans. One in 20 of its borrowers is two months or more behind on payments—and delinquencies are climbing.
Across much of the industry, workouts simply aren't happening. Instead, mortgage lenders, servicers, investors, and regulators are battling over who has to take the financial lumps when the loan terms change. The average servicer—the outfit charged with collecting payments from homeowners and distributing the money to the investors or banks that own the loans—has modified less than 1% of its troubled loan portfolio, according to estimates by the Office of Thrift Supervision. As a result, more homes are falling into foreclosure, exacerbating the plunge in housing prices.
HSBC, which has already suffered $21.5 billion in loan-related losses and writedowns, has an advantage. Unlike its U.S. rivals, the bank keeps the bulk of its loans on its books instead of repackaging them into pools and selling them off to Wall Street. That's a big reason HSBC reported a hit from mortgages earlier than most major banks—its February 2007 announcement about increased losses sent one of the first subprime shivers through the market. But it's also why the bank has been able to move more quickly to fix the problems: It doesn't need anybody's permission to tinker with loan terms. "We have complete flexibility," says McDonagh, who has also tightened lending standards, stopped buying loans from third-party brokers, and made cost-cutting moves since taking the helm. "We're dealing with this entirely internally, within our bank."
The initiative seems to be working. HSBC has restructured or modified $18.2 billion worth of loans, or about 20% of its entire portfolio as of Mar. 31. "They have been way ahead of the curve in terms of realizing that they need to lower rates significantly and forgive principal," says Mike Shea, executive director of nonprofit advocacy group ACORN Housing, a longtime critic of the subprime industry that won a class action against HSBC in 2003 for predatory lending. "We know from their record they won't leave people stranded."
The war room for HSBC's effort is a 66,000-square-foot space in a former strip mall 14 miles from downtown Tampa. It's a traditional call center: Staffers from college students to retirees talk on headsets in identical putty-colored cubicles. But the former customer service center has been repurposed as the bank's intensive-care unit for sick loans. Three large open-air rooms are divided by aisles with names like "Motivation Way" and "Integrity Row." Employees are trained for six weeks to become "loan mitigation specialists"
—part touchy-feely counselors and part nitty-gritty lenders who work directly with homeowners. "The first thing you want to do when you are working out a bad loan is say: 'I'm listening, I hear what you're saying,'" says Toni Nadolski, HSBC's head of collections in Tampa.
Besides dealing with homeowners who are already behind on their payments, HSBC is being proactive, scouring its files for the most at-risk customers whose adjustable-rate mortgages are due to jump to higher rates. The bank initially sends letters to borrowers 120 days before the increase, then phones them 60 days before.
Many borrowers don't realize such mortgage relief is even an option. As a result, they often don't respond to HSBC or other lenders' communications for fear that callers will demand payments. To help get the message out, HSBC is working with nine community groups, including Detroit HOPE Center and the Center for NYC Neighborhoods.
Before HSBC could begin to attack the problem, a small team spent six months developing processes and technologies to automate loan workouts. Each homeowner is sorted by three characteristics: geography, credit profile, and type of loan. The system allows HSBC to rank borrowers into seven different risk categories and decide the best course of action. That could be anything from a short-term loan modification, which lowers the interest rate on a temporary basis, to selling the property.
A homeowner in Pennsylvania with a $277,800 mortgage whose rate is scheduled to jump from 7.5% to 9%, for example, was offered a fixed rate of 8% for the life of the loan. In North Carolina, where housing prices have held up relatively well, a borrower got only a six-month break on interest. "Without a framework, we couldn't understand what we're dealing with or how to deploy solutions," says Grant Miles, HSBC's head of default services, a 25-year risk-management veteran for the bank.
Of course, there can be kinks in the system. Rick Arvielo, president of New American Funding in Irvine, Calif., a brokerage firm that works with homeowners to help restructure their loans, hit a dead end when he contacted HSBC using the normal channels. Arvielo says he made more than 50 phone calls to several different departments. Only after he heard about the bank's centralized effort through the industry grapevine did he make any headway. "Most of the time with lenders, it's like trying to call the Pentagon to find someone who will answer questions about a legitimate offer," he says.
A RETIREE'S RELIEF
Despite the hiccups, even Arvielo concedes the bank is among the most responsive lenders in the industry. Back in 2005, his client, Calvin Croom, a retired public school teacher, refinanced the $220,000 mortgage on his three-bedroom ranch house in Stone Mountain, Ga. After fees, his new adjustable-rate mortgage ballooned to $251,000. Earlier this year, with rates that had already jumped once and were set to explode again, Croom was on the verge of losing his home of 16 years.
Arvielo intervened with HSBC on Croom's behalf in mid- February. Eight days later, Croom had a new, less onerous mortgage. His fixed monthly payment is $1,200—less than half the amount he was struggling to pay before. The bank has also cut the balance on his mortgage to $186,000. Says Croom of the workout: "I just wanted to break into tears."
"A Beacon of Sanity in Subprime" (In Depth, July 7) should have cited Moody's Investors Service as the source for a finding that lenders have restructured 1% of troubled mortgages.