Shrinking Lenders in Mortgage Hub Cut Into Recovery: Real Estate

CashCall Inc., a lender run by racehorse aficionado Paul Reddam, is one of the mortgage industry’s biggest office tenants in Orange County, California. It’s about to get smaller.

The company has almost doubled its office presence in the past three years to more than 400,000 square feet (37,000 square meters). Now it is seeking to sublet about 40 percent of its space as rising interest rates start to hurt lenders, said Jay Carnahan, founder of Orion Property Partners Inc., the Irvine, California-based brokerage representing CashCall.

Orange County was once a hub for the subprime-mortgage industry, which helped drag the U.S. into a recession in late 2007 after borrowers with the worst credit histories began defaulting in record numbers. A resurgence that began in 2010 is slowing as rising borrowing costs discourage home refinancing and make purchases more expensive, threatening to slow an office-market rebound that pushed vacancies to a five-year low.

Lenders “have the mindset to be able to downsize quickly,” said Jeffrey Ingham, an Irvine-based senior managing director at brokerage Jones Lang LaSalle Inc. “If you churn out a thousand refis a month and suddenly you go to a hundred, you have the ability to scale down. Some lenders in 2006 and 2007 had the mindset that the good times would never end. Not so today.”

Subprime Ripple

Orange County, the region southeast of Los Angeles with 3 million residents, is home to amusement parks Disneyland and Knott’s Berry Farm as well as companies including chipmaker Broadcom Corp. and surfwear retailer Quicksilver Inc. Before the U.S. housing market’s slump, the area’s office market was dominated by such subprime companies as New Century Financial Corp. and Ameriquest Mortgage Co. Vacancies more than doubled with their collapse in 2007.

Companies including New Century originated subprime loans, then sent them to Wall Street banks, which packaged the mortgages into securities and sold them to commercial banks, hedge funds and pensions. When borrowers defaulted, the ripples went up the chain, causing the collapse of firms such as Lehman Brothers Holdings Inc. and the resulting U.S. economic slump.

The lenders that replaced Ameriquest and New Century as U.S. housing market recovered, many started by veterans of Orange County’s subprime industry, now have more awareness of the mortgage business’s ups and downs, said Anthony Hsieh, chief executive officer of Foothill Ranch, California-based mortgage and consumer-finance company LLC.

‘Cyclical Business’

“Mortgage lending has always been a cyclical business, but more so since the crisis,” Hsieh, 48, said in a telephone interview. With new lending regulations and lack of certainty about how fast interest rates will rise, “mortgage lenders are trying to stay as agile as they possibly can. That means they are looking for flexibility with fixed costs, such as rents.”

Such flexibility will help as rising interest rates lower demand for loans. Across the U.S., banks and other financial firms are firing workers. Wells Fargo & Co., the country’s biggest mortgage lender, has eliminated more than 5,700 jobs in its home-loan unit since midyear, and JPMorgan Chase & Co. plans to reduce its mortgage-banking employees by 11,000 this year. PNC Financial Services Group Inc. cut at least 7 percent of its residential-mortgage workers this month.

In anticipation of a possible lending decline, some Orange County mortgage companies negotiated office leases that allowed them to vacate their space with just 90 days’ notice, Ingham said. Rental agreements today also tend to be shorter, many lasting two to three years rather than the leases of five years or longer that were common during the subprime heyday, he said.

Employment Decline

Ingham said he’s been receiving calls from several of his mortgage-lending customers about the possibility of giving up some of their office space. He wouldn’t identify the tenants.

“We’ve talked to many of our clients, and there is this sense that if interest rates are going up, there’ll be a lot of shedding of employees,” Ingham said.

Lender-related employment may drop by at least half within the next year locally because of a decline in refinancing, he said. Since 2009, jobs in the mortgage industry have climbed 23 percent to about 38,000 in Orange County, according to Jones Lang LaSalle. Mortgage-related businesses employed about 2.9 percent of office workers as of the third quarter, down from 5.5 percent at the peak in 2005.

After Federal Reserve Chairman Ben S. Bernanke indicated in May that the Fed may slow its buying of government and mortgage bonds, the average rate on 30-year home loans jumped to a two-year high of 4.58 percent from a near-record low of 3.35 percent, according to Freddie Mac data. Bernanke said last month that more signs of lasting improvement in the economy are needed before the central bank reduces its $85 billion in monthly purchases.

Applications Decline

Loan applications for U.S. home purchases declined 4.8 percent in the week ended Oct. 11 to the lowest level this year, the Mortgage Bankers Association reported last week. Mortgage originations probably will drop to $1.1 trillion next year, down 31 percent from the forecasted 2013 total, with refinancings likely to plunge 61 percent to $388 billion, the Washington-based trade group said last month.

Purchases of existing U.S. homes fell 1.9 percent last month from August, the National Association of Realtors said yesterday.

While rising interest rates are likely to cut into the lending business short term, the mortgage industry’s fragmentation probably will lead to consolidation in coming years, said Hsieh, who wouldn’t comment on his own company’s office leases.

‘Massive Consolidation’

“There will be a massive consolidation in the non-bank lending world because of the lack of business and regulatory pressures,” he said. “Smaller lenders will most likely consider a roll-up strategy.”

The mortgage industry’s comeback amid record-low interest rates and rising home sales helped reduce Orange County office vacancies to 14.4 percent in the third quarter, the lowest since early 2008, according to Jones Lang LaSalle. That’s 2 percentage points lower than the statewide rate, the brokerage said. Orange County vacancies had risen to a post-crash high of almost 22 percent in 2010 from a low of 8.6 percent in 2006.

Brookfield Office Properties Inc. and Dune Real Estate Partners LP, both based in New York, and Ocean West Capital Partners, a Los Angeles-based investor, are among local landlords. Office owners with mortgage lenders as tenants include closely held Irvine Co., which rents space to Greenlight Financial Services, and Beverly Hills, California-based Kennedy-Wilson Holdings Inc., CashCall’s landlord.

Christina Cha, a Kennedy-Wilson spokeswoman, declined to comment on CashCall’s office-space plans, citing lease confidentiality agreements.

Kentucky Derby

Anaheim-based CashCall, which offers mortgages and short-term loans, was founded in 2008 by Reddam, the owner of last year’s winner of the Kentucky Derby, I’ll Have Another. Reddam, a former philosophy professor, made his fortune with subprime lender DiTech Funding Corp., which he founded in 1995 and sold to a unit of General Motors Co. in 1999 for more than $240 million.

Reddam didn’t return telephone calls seeking comment on CashCall’s plans.

Orange County’s mortgage industry is populated with “serial entrepreneur” types such as Reddam and Hsieh, Ingham said., which Hsieh started in early 2010, is his third mortgage-related business. In 2002 he founded Home Loan Center Inc., which was later sold to LendingTree LLC, and in 1994 started, which was bought by E*Trade Financial Corp. in 2001.

Less Pain

Even with some mortgage companies starting to pull back in Orange County, the impact on the local office market probably will be far less painful than it was following the housing crash, said Greg May, a Newport Beach-based executive vice president and managing director at brokerage Newmark Grubb Knight Frank.

“The possible effects from a downsizing in the mortgage industry here are certainly a concern,” May said in a telephone interview. “It’s going to impact us, but it’s not going to be anything close to what we endured in the last cycle. Some of these larger firms have been much more disciplined and are healthier than in the subprime days.”

Rising demand in the area from a “growing pool of diversified international and national companies” also will help counter cutbacks by lenders, said Carnahan of Orion Property Partners.

Automaker Honda Motor Co. added 26,000 square feet and insurance brokerage Hub International Ltd. leased 20,000 square feet in Orange County, according to a third-quarter report by Jones Lang LaSalle.

Space Demand

Orion is in negotiations with a “finance-insurance” company for about 80 percent of the space CashCall wants to sublet, Carnahan said. That speaks to demand for Orange County office space, he said. And despite the expected pullback in mortgage lending, the industry will make it through the slowdown, Carnahan said.

“The predicted death of the mortgage industry in the O.C. was proved wrong,” he said. “There is a significant amount of serial entrepreneurs in this region that have re-emerged, even if not in the same size. The truth of the matter is that the O.C. is still one of the regions of the country with the best talent pool in the mortgage industry.”

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