Bankers’ Hours: Sub-prime loans are making a comeback
The big buzz in mortgage lending is the return of sub-prime. You remember, the guy named Liars Loans in the old-fashioned hockey mask who you were sure got thrown under the bus at the end of the Great Meltdown (brought to you by Wall Street Films in association with All American Productions).
Come on, you should know better than that: These horror story villains never die. They just come back in the next episode. And the next. And the next.
Maybe we should be surprised, or maybe not, but the lenders that are venturing back into the jungle that is creative residential lending are getting very big, and quite sophisticated. And their loans are going into AAA-rated mortgage-backed securities. Hey, the beauty of this genre is that the plot never has to change; it saves money on the script.
This isn’t quite as crazy as it sounds. If a lender is making a loan on an individual’s primary home, then that lender must comply with all of the restrictions of the Dodd-Frank Act, and the regulations promulgated by the Consumer Financial Protection Bureau (CFPB). Under these guidelines, a lender is subject to very costly penalties if it funds a loan without thoroughly determining that the borrower can reasonably be expected to repay the loan. And, aside from potential court actions from borrowers, they’re under the constant threat of CFPB audits, and heavy fines, which the bureau dearly loves to levy. These lenders believe they have all of these risks covered.
There’s a flip side to this business, and the same lenders are rushing to take advantage of it like beaver in a new pond. This involves making nonconsumer loans on homes, i.e. rentals or possibly homes held for resale. None of the current consumer protection laws apply to loans for business purposes, and the CFPB, like a certain witch in the Wizard of Oz, has no power in this area. Although it would like to; the CFPB would like to control everything, including the air pressure in Patriots game balls.
These loans often do qualify as Liars Loans. A borrower can buy a property as a rental and state a personal income figure without verification. These are asset-based loans, dependent on the real estate collateral’s value, and the income the property can produce. Since there’s less documentation and criteria, fundings are faster. It can be a nice, simple way to buy a house without all of that silly paperwork. And the program can attract some pretty heavy hitters, since loan amounts can go up to $3,000,000.
All of this has occasioned a neat reversal of obfuscation among borrowers. Back before the Great Recession, the best loans were the ones on owner-occupied homes, so buyers who intended to, say, buy a property and flip it without moving in would swear that the loan was for their primary home. Today, a borrower who can’t show the income to buy that dream home certifies that the house is a rental: “Of course it is; I wouldn’t consider living in that $2,000,000 dog.” Like pro sports, the players are staying in the game, just wearing different shirts.
Of course, the lenders are striving to protect themselves. One item required before funding is a handwritten statement from the borrower that the loan is for business purposes. Should the borrower later aver that the lender should have known that the mortgage was on the borrower’s primary home, the lender has the letter to present in court.
One exec of one of the emerging sub-prime mortgage players stated that he “was concerned about unscrupulous mortgage brokers inducing borrowers to lie about their occupancy intentions.”
Gee, ya think? Has that ever happened before?
These capital sources do several things to get a higher rating on the mortgage-backed paper being marketed to investors. First, they keep a portion of the security in essentially what amounts to a second position. If anything goes wrong, the lender takes the first loss. Then, they have the pools reviewed by an outside underwriter, and any loans that don’t look right are pulled from the security. And finally they commit to buy back bad loans. All are nice enhancements to a security, although the last one, the buyback, is only as good as the strength of the funding entity. If we learned anything from the Great Meltdown it’s that, when the stuff hits the fan, that buyback promise can be worthless.
Will “Great Meltdown II,” starring Larry Liar and all of your favorite victims, be coming soon to a theater near you? Time will tell. Be assured, though, that GM III is in pre-production, even as we speak.
Pat Dalrymple is a western Colorado native and has spent almost 50 years in mortgage lending and banking in the Roaring Fork Valley. He’ll be happy to answer your questions or hear your comments. His e-mail is firstname.lastname@example.org.
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