Misfit Borrowers Attracting Lenders as Housing RevivesJohn Gittelsohn and Prashant Gopal
Raj Date helped write new rules for U.S. mortgage underwriting as deputy director of the Consumer Financial Protection Bureau. Now he’s building a company that will offer loans to borrowers blocked by the agency’s standards.
Date, 42, left the CFPB in January to found Washington-based Fenway Summer LLC, which plans to provide loans, including interest-only financing, to borrowers he considers low risk even though they might carry debt that exceeds the agency’s threshold. He estimates that nonqualified mortgages make up as much as $1.5 trillion of the $10 trillion home-loan market.
“There are plenty of borrowers who are eminently responsible people but fall outside of the bright-line boundaries,” Date said in a telephone interview. “And there’s a meaningful-sized business that can be quite good for borrowers and for lenders and investors to be able to satisfy that need.”
Fenway joins a growing group of companies offering financing to consumers with irregular incomes, damaged credit or past foreclosures as the housing market recovers and rising interest rates drive down demand for refinancing, the industry’s biggest source of business since the 2008 credit crisis. That’s slowly bringing mortgage availability back to Americans shut out of homebuying after a real estate crash triggered by loose lending to subprime borrowers.
“At least a few lenders are starting to dig into the nooks and crannies of borrowing,” Keith Gumbinger, vice president HSH.com, a Riverdale, New Jersey-based mortgage information website, said in a telephone interview. “These are misfit mortgages because they don’t align well with the new standards in the marketplace.”
Fenway, named after the Boston Red Sox’s ballpark by Date, a Boston-area native, plans to serve people with high credit scores or net worth who still fall outside the qualified mortgage rules, which offer legal protections to companies that issue loans without high fees and other risky features.
Other companies are reviving products to subprime borrowers, usually defined as those with FICO scores below 620 on the scale of 300 to 850. Citadel Servicing Corp., based in Irvine, California, raised $200 million in April from a private-equity firm to offer mortgages to those with blemishes on their records such as credit scores below 620 or a recent foreclosure. Athas Capital Group in Agoura Hills, California, has begun marketing loans to people with FICO scores as low as 550.
The 2010 Dodd-Frank financial-regulation overhaul mandated that the CFPB create the qualified mortgage rule to curb abusive lending. Under the regulations, which take effect in January, underwriters must consider borrowers’ ability to repay based on current income or assets, employment status, debt obligations, credit history and the maximum cost of a loan at the time it is made in the case of adjustable-rate mortgages. The U.S. Senate this week confirmed Richard Cordray as director of the CFPB.
Lenders who step outside the box won’t be offering the types of “toxic” subprime loans common before the 2008 credit crisis, when borrowers got 100 percent financing without proof of income or a job, according to Date, who joined the CFPB in February 2011 after working for Capital One Financial Corp. and Deutsche Bank AG.
“The basic rule of the road applies to everybody, which is you have to make a loan to somebody with the ability to repay it,” Date said. “The difference is just that there’s a safe harbor for certain kinds of loans and there’s not for others. If there’s no safe harbor, then you have to be especially confident in your ability to calibrate and price for credit risk. Frankly, that’s what the differentiator is going to be for the firm we’re trying to build.”
Kathy Laurienti, 50, owner of Paisano Sausage Co. in Denver, is buying a $230,000 townhouse in Westminster, Colorado, and could use help from a lender such as Fenway. While she has a prime credit score, no personal debt, and $145,000 in her bank account, JPMorgan Chase & Co., will only finance as much as $100,000 of the cost, she said. That’s because she earned $43,000 last year from her company, which lost $12,000, making her ineligible for a higher loan because of debt-to-income restrictions.
She will have to pull the rest from her savings, leaving little for home improvements, she said.
“I paid off $300,000 for my previous mortgage and now they’ll only give me $100,000,” said Laurienti, who’s been living with her mother since selling her last house in May for $525,000. “This is my bank. They know me when I walk in the door. It’s like it doesn’t count anymore.”
Tom Kelly, a spokesman for New York-based JPMorgan, declined to comment on the loan.
While companies entering the market for nonqualified mortgages such as Laurienti’s don’t represent the kind of easy-money lenders that pulled the U.S. into the worst recession since the 1930s, there is a risk the bets will sour if home prices fall and mortgage standards become too loose, said Paul Willen, a senior economist at the Federal Reserve Bank of Boston.
“If house prices continue rising over the next couple of years, these investments look very attractive and there is going to be a lot of demand for them,” Willen said. “The danger would be that people get it into their heads at some point that it isn’t a risky business. When you go back to 2005 and 2006, people had the attitude that it was low risk, high return.”
Subprime lending accelerated in the 1990s as new companies entered the market to offer first-lien mortgages and capitalize on the securitization of loans, said Guy Cecala, publisher of Inside Mortgage Finance. As the housing market boomed, originations grew from $100 billion in 2000 to a peak of $625 billion in 2005, led by Ameriquest Mortgage Co., New Century Financial Corp. and Countrywide Financial Corp., according to the trade journal.
The industry collapsed in 2007 as home prices fell, foreclosures increased and sources of funding evaporated. Dozens of mortgage companies put themselves up for sale, including Countrywide and Ameriquest, closed down or, in the case of New Century, declared bankruptcy. Weak lending standards also raised questions about the quality of assets held by financial institutions, triggering runs on banks including Bear Stearns Cos. and leading to a global credit freeze.
As the U.S. housing market rebounds -- prices rose 12.2 percent in May from a year earlier, the largest increase since February 2006, according to Irvine-based CoreLogic Inc. -- lenders have started catering to a broader set of borrowers.
Mortgage-lending standards loosened in June to their highest level since September 2011, driven by “a small uptick” in loans that offer cash-out refinancing and credit to investors, high loan-to-value buyers and jumbo-loan borrowers, the Mortgage Bankers Association reported earlier this month.
Credit quality of loans originated in May -- measured by FICO scores, loan-to-value and debt-to-income -- continued a “slow loosening” that started in January, Jonathan Corr, president of Ellie Mae, a Pleasanton, California-based company that tracks about 20 percent of U.S. monthly home loan originations, said in a June 19 report.
Borrowers with FICO scores below 620 who submitted applications to Tree.com Inc.’s Lending Tree received 266 percent more “matches” from lenders willing to offer financing in the second quarter than a year earlier, said Megan Greuling, a spokeswoman for the Charlotte, North Carolina-based company.
“It’s not a big area for us, but it could be at an inflection point,” she said in a telephone interview.
Lenders may extend credit more widely as they seek business to replace refinancing activity, which has plummeted since interest rates began to increase in the last two months, Greuling said. The average rate for a 30-year fixed rate conventional mortgage has risen to 4.37 percent from 3.35 percent in early May, according to Freddie Mac, after touching a two-year high last week of 4.51 percent.
Refinancing is expected to shrink to 36 percent of mortgage origination activity in 2014, down from 76 percent at the start of May, according to a June 20 forecast by the Mortgage Bankers Association.
JPMorgan, the largest U.S. bank by assets, may see a “dramatic reduction” in profits as higher mortgage rates erode demand for refinancing, Chief Executive Officer Jamie Dimon said during an earnings conference call last week. John Stumpf, head of San Francisco-based Wells Fargo & Co., the nation’s biggest home lender, said refinance volume may come down significantly.
Large lenders must be cautious about broadening their mortgage guidelines because they’re still resolving issues from the 2008 credit crisis and applying rules for buffers against losses. Bank of America Corp. “will only originate loans to borrowers who can truly afford them,” said Terry Francisco, a spokesman for the Charlotte, North Carolina-based company, which has spent more than $45 billion to resolve disputes tied to defective mortgages and foreclosures since its 2008 purchase of Countrywide.
“We constantly evaluate several economic factors when considering any change to our credit parameters,” Francisco said in an e-mail.
That leaves alternative lending to smaller companies, such as Citadel Servicing, which offers loans as high as $750,000 in 11 states to borrowers with credit scores as low as 500, according to a term sheet on its website. Interest rates on the 30-year loans, which are usually adjustable after seven years, can be as high as 11.25 percent -- plus 2 points -- for borrowers with a 40 percent down payment and the lowest credit scores.
“There’s a tremendous amount of underwriting and compliance that you cannot automate for this,” Citadel Servicing CEO Daniel Perl, a banker for 35 years, said in a telephone interview. “A lot of lenders don’t want to get involved with it because it’s difficult.”
Athas Capital in May began offering 11 percent rates on adjustable-rate mortgages that are fixed for the first five years for borrowers with FICO scores of at least 550 and 40 percent down payments. Institutional investors are buying the loans from Athas, which continues to service them, CEO Brian O’Shaughnessy said. The firm is committed to providing $100 million of the loans annually for the next five years, he said.
“This is the sane and safe subprime,” O’Shaughnessy said. “These borrowers have skin in the game.”
Rates for borrowers with solid credit scores are as low as 7 percent with down payments of 20 percent, O’Shaughnessy said. Such a mortgage could be used by a self-employed borrower who wants to close quickly and doesn’t show enough income on their tax returns to qualify for traditional financing, he said. Athas allows for “alternative documentation” so the borrower could instead supply bank statements to show sufficient cash flow, he said.
While specialty lenders may jump in to help wealthier borrowers who don’t meet traditional underwriting standards, it will take longer for financing to open up to the millions of renters locked out of the market, said Ellen Seidman, who served as director of the Office of Thrift Supervision during the Clinton administration.
Many of these borrowers may be worthy of loans even though they have limited savings for down payments, she said.
“There are a lot of solid potential first-time homebuyers who are going to miss out on a very affordable market,” said Seidman, a board member of the Center for Financial Services Innovation, a Chicago-based nonprofit organization that promotes financial products for underserved populations. “The housing market is a ladder and if nobody is stepping on the first rung it’s very hard for people to sell houses and move up.”
Regulatory hurdles will likely be temporary, said Roberto Quercia, director of the Center for Community Capital at the University of North Carolina at Chapel Hill.
“We will see more of this lending because we’re a nation of pragmatists,” Quercia said. The industry “will find a way to lend to these families in a sustainable manner. All the regulations they are going to put in place are a good beginning, but at some point they will be revised to reflect the realities of the market.”
Borrowers with subprime scores accounted for 6.5 percent of mortgage originations in 2012, down from 26 percent in 2006, according to an analysis by credit checking firm Experian Plc.
Rising interest rates may help revive the market for the type of private mortgage-backed securities that are necessary to fund non-qualified home loans, because higher-yielding bonds will be attractive to investors, said Cameron Findlay, chief economist with Discover Home Loans Inc., a unit of Discover Financial Services.
That would be more likely after yields on U.S. 10-year Treasury notes exceed 3.5 percent, about 1 percentage point above the current level, Findlay said in a telephone interview from his office in Irvine, California.
Sales of non-agency mortgage securities, which have no government guarantee, have exceeded $7 billion this year, up from $3.5 billion in all of 2012, according to data compiled by Bloomberg. In 2005 and 2006, $1.2 trillion of non-agency mortgages were packaged as securities.
Mortgages securitized by government-controlled Fannie Mae and Freddie Mac or insured by the Federal Housing Administration -- more than 90 percent of the home-loan market market -- are all considered qualified mortgages for now.
Date’s Fenway will start offering credit to borrowers with enough net worth to cover the costs of their home, such as the self-employed or retirees who lack enough current income to qualify for a conventional mortgage, Date said. That underserved population is large enough to keep his company busy, he said.
“The reality is it’s way too hard for good people to get loans today,” he said. “It doesn’t need to be that way and it’s not going to be that way.”