I’m reading Richard Bitner’s book, “Confessions of a Subprime Lender: An Insider’s Tale of Greed, Fraud, and Ignorance.”
The author started his own subprime lending company, Kellner Mortgage Investments, in 2000 and at its peak, it did about $250 million worth of mortgages a year.
When he worked previously at Residential Funding Corporation, a division of GMAC, Bitner found his subprime loans were three to five times more profitable than any other loan he serviced.
Bitner says subprimer borrowers are an interesting bunch — strippers, cons, pimps, thugs, in additional to just folks. During his five years at Kellner, Bitner found that ministers had one of the highest fraud rates of any profession.
The vast majority of subprime borrowers make their payments on time.
Most subprime borrowers have been late paying their bills. Many of them have little credit history. Some have had bad luck, bad health, etc.
Until 1998, home prices kept pace with income changes. The next ten years, home prices soared while income grew slowly. This created a gap in affordability. People had to struggle to get a mortgage. They had no down payment and not enough income to qualify for a regular mortgage.
What does it mean when Wall Street securitizes mortgages? Thousands of mortgages are put together as mortgage-backed securities (MBSs). These things are backed by loan payments.
Until 1990 or so, there was no securitization market for subprime loans.
Lenders sit between two groups with differing aims. Investors care about loan performance and repayment. Lenders also deal with brokers, who’s only concern is closing the loan. Brokers have no financial incentive in seeing to it that loans are repaid.
Aside from banks, lenders don’t use their own money to finance mortgages. Instead, they use lines of credit from investment houses. It’s like a giant credit card. The note to the property serves as collateral.
Fannie Mae and Freddie Mac offer automated underwriting programs. If you conform to their standards, it is automatic that an investor will buy the loan. Subprime loans by definition do not meet the standards of Fannie and Freddie.
Prime mortgages are dealt among people who wear suits and ties. Subprime mortgages are dealt among jeans and t-shirt types. Early subprime operators got their start in the consumer finance industry at companies such as The Associates, Conseco and Beneficial. These companies lent money to people with bad credit.
To make it as a subprime lender, you have to have a tolerance for risk and a willingness to get your hands dirty.
The people in it tended to be colorful characters. They tend to be reckless and fearless. Gunslinger types.
That’s how Richard Bitner acted when he got his subprime lender off the ground. He needed to secure Countrywide as a client. The problem? Countrywide required wholesale lenders to have a minimum net worth of $3 million. Bitner’s company had a word of $414,000.
Richard spent 45 minutes on the phone with the Countrywide analysit and convinced her to do the deal. He made some “delusional argument about Kellner and Countrywide working together to house America.”
Many loan originators aka loan brokers worked from home. They tended to be less professional and less educated.
One sales person for Carteret Mortgage recalls: “I had so many loan officers calling me who didn’t know a tax return from a credit report, I eventually stopped returning their messages. It amazed me that some of them could earn a paycheck.”
More than 70% of brokered loan applications received at Kellner were deceptive or fraudulent.
With access to dozens of lenders and hundreds of loan programs, mortgage brokers sound like the best option when shopping for a mortgage.
Conforming or conventional mortgages are considered vanilla loans. They are easy loans to make because borrowers have good credit and solid incomes.
Processing a subprime loan can be arduous. People have dodgy credit and dodgy income. They have to be counseled how to act so their credit score does not drop between applying for a loan and getting approved.
Brokers will advise clients not to go to competing brokers because they too will pull the client’s credit report, which lowers the borrowers score.
So if you are dealing with one broker and he presents you with one offer, how do you know it is a good one? Remember the broker has no financial liability. He’s not regulated much. “When a vulnerable borrower puts a mortgage in the hands of an unscrupulous broker, the mix can be toxic.”
Mortgage brokers originate about a quarter of prime loans but over half of subprime loans.
Lenders usually pay brokers a yield-spread premium (YSP) to sell a loan with a higher interest rate.
Brokers usually start a conversation with lenders with the words, “I have a guy…” Then they present some guy’s hard luck story and why he is worth taking a gamble on.
What is mortgage fraud? In Bitner’s book, it is any activity intended to mislead a mortgage lender.
Honest loan brokers are in the minority. They behave as if they obligations to both borrowers and lenders. They believe in full disclosure.
What are typical types of mortgage fraud?
* The borrower signs that he intends to live in the property when he’s just using it as an investment and renting it out.
* Falsifying a borrower’s employment history. Has a friend or relative who owns a business say the person works there.
* Holding back critical info from the lender. Thus the lender does not have all the critical info he needs to make an underwriting decision.
By the year 2000, mortgage lending became matrix driven. That meant that lenders took a borrower’s credit profile and put it on a grid to determine his credit grade. The higher the grade, the higher the down payment, the better the interest rate. What if a borrower did not qualify for a loan? You could deny the loan, do fraud, or get creative.
Richard Bitner writes: “Everything in mortgage lending revolves around the four Cs — collateral, capacity, character and credit.”
Which one is most important? Collateral. That’s the property that secures the loan.
Have you heard of credit enhancement? I had not till I read this book. It’s a recent trick in the credit repair industry. A person with good credit is paid a fee for each account they let someone else use. The person with the bad credit doesn’t get to use the account, just the benefit of the performance history that comes with it.
Richard Bitner writes that Accredited Home Lenders were the only mortgage company he knew that tied loan-level risk to an account executive’s commission. This gave reps a financial interest in the quality of the loans they approved.
Bitner found that the percentage of unreliable appraisals he dealt with went up to 80%. The subprime industry’s general willingness to accept inflated appraisals contributed significantly to the dramatic run-up in property values during the early years of this century.
Kellner ordered all appraisal reviews through Landsafe, a whole owned subsidiary of Countrywide. If Ladsafe appraised, Countrywide bought the loan. But when Countrywide forced Kellner to repurchase loans that had gone bad, usually due to fraud on the part of the broker, then Countrywide would order a third-party independent appraisal which was always substantially lower than Landsafe’s value.
Countrywide apparently encouraged Landsafe appraisals to validate excessive property values.
Bitner writes that Wall Street deserves the greatest share of blame for the housing crisis. The relationship between the Street and the rating agencies was fundamentally flawed. Investors thought they were buying quality mortgage-backed securities, when in fact they were buying something with great risk aka junk. As the secondary market determined the types of loans lenders could make, they were the unofficial regulator of subprime lending.
Today’s housing debacle was largely caused by investment banks packaging high-risk loans into securities and the rating agencies assessing them as investment quality. The investors who bought these MBSs did not know what they were buying.
There are three big credit rating agencies — Moody’s, Standard and Poor’s, and Fitch.
Rating agencies face no liability for making a bad call.
“To claim a subprime CDO carries the same risk as bonds issued by the most financially sound corporations is not only mind-blowing, it’s negligent.”
CDO losses have reached into the billions the past two years.
In many ways, the investment firm-rating agency relationship resembles that of the broker-lender. When a broker can’t get a deal approved, his account executive will suggest to him ways of structuring the loan so that it will be approved. Similarly, rating agencies advise investment firms on how to structure securities to maximize profit and get the best ratings possible.
The rating agencies did more to stop predatory lending legislation than any other group.
Lenders lent money based on what the investment banks would securitize and the agencies would rate.
Chapman University law professor Kurt Eggert testified to the Senate banking panel about tranche warfare: “Restructuring the loan poses a substantial fiduciary dilemma to the trustee, because it would almost inevitably involve removing some part of a stream of income from one tranche and adding income to another tranche. This ‘tranche warfare’ is a significant brake on the flexibility to restructure a loan.”
Bitner says Ameriquest did more to give subprime lending a bad name than any other company. At Ameriquest, “every loan was supposed to charge the maximum fees, interest rates, and prepayment penalties to make the company money.”