by Tanta on 4/24/2008 08:46:00 AM

Reuters has the news:

LIVONIA, Michigan (Reuters) - Realtors in many U.S. states say lenders are demanding excessively high prices before allowing distressed borrowers to offload their homes in "short sales," making the housing crisis worse.

In a short sale, a borrower dumps the home at below-market value and the bank forgives the rest of the debt. The borrower's credit rating is hurt but for less time than in a foreclosure. Such sales have been touted by banks as a way out for homeowners unable to pay their mortgages.

Below market, huh? And I thought the idea was they were trying to sell these homes at market, which unfortunately happens to be less than the loan amount. Whatever. My head is still spinning over the banks having "touted" such sales. Was I having a nap when that happened? How come nobody woke me up?

We get one "example":

Borrowers like Judie Quinn echo that, saying their lenders have been uncooperative and have passed up solid offers.

Quinn, 67, is a steel industry sales representative whose home in the Detroit suburb of Belleville had been on sale since August 2005. After back surgery in 2007 left her with large medical bills and out of work for two months, she decided she could not afford the $2,200 monthly mortgage payment.

"I wanted to save my credit rating, so I tried to arrange a short sale," Quinn said at the Livonia, Michigan, office of Linda McGonagle, a Realtor at Quality GMAC Real Estate.

The loan was from Wells Fargo & Co (WFC.N: Quote, Profile, Research) and serviced through an affiliate, America's Servicing Co.

Between April and October 2007, Quinn received four offers, McGonagle said. The first offer of $289,900 -- the asking price was $299,000 -- was rejected by the lender because Quinn was not yet in loan default. "No one at the bank mentioned she had to be in default until after that offer was rejected," she said.

She said the lender ignored the third and best offer of $299,000 long after the bidder had given up. The home went into foreclosure in October.

"The lender was unresponsive and unhelpful, so Judie wasted time and money trying to do the right thing," McGonagle said. "I tell other agents to avoid short sales because you just can't win. This is a commission-based business and if you can't get deals done, you don't get paid," she added.

How much does Judie owe on this house? We didn't get that part. Could the fact that the home had been "on sale" for two years before Judie decided she needed to sell short imply something problematic about Judie's expectations? When did she acquire this property, anyway? And at what exact time yesterday was her Real Estate Professional born? Nobody at the bank mentioned that short sales are widely held to be "work out options" for delinquent loans? That without any indication that the lender would have to foreclose, the lender is not highly motivated to accept a short sale that is "less loss" than the foreclosure that doesn't appear to be on the table? The bank has to mention this?

But I really liked this part:

Some Realtors said banks have an inflated view of what they can expect when home values in many areas have fallen sharply.

"Some lenders harbor unrealistic expectations of what they can get in a down market," said Van Johnson, president of the Georgia Association of Realtors.

He said widespread use by lenders of "broker price opinions" -- quick, inexpensive online property assessment -- resulted in only a "simple best guess."

Andrea Gellar, a Realtor at Sudler Sotheby's in Chicago, said property appraisals there are fair because "appraisers are being called on the carpet to be accurate" after years of inflated evaluations during the property boom.

Banks have inflated ideas of what these houses could sell for. How come? Because they rely on "price opinions" that are prepared by real estate brokers. Like the real estate brokers quoted in the article. Who are now claiming that it's really only the appraisers who have any clue. Because they've been "called on the carpet" and now are afraid to make stuff up.

The solution seems obvious to me: welcome to the carpet, brokers. We expect your next price opinion to be somewhat more sober.

by Tanta on 4/11/2008 09:05:00 AM

To summarize this MarketWatch article: the parties who are actually in first loss position--whose money is on the table if these things go south--have learned their lesson about no-down financing. The parties who just like to party haven't gotten the memo yet.

Mortgage Guaranty Insurance Corp., for example, changed its guidelines last week to exclude coverage of 100% mortgages. At a minimum, borrowers need a 3% down payment and a credit score of at least 680 to be eligible for coverage. In selected markets where home prices are declining, a 5% down payment is the minimum required. . . .

"It's obvious why they're making these changes," [Broker*] Brown said of the insurance companies. "They have to eliminate the losses they're taking." Mortgage insurance companies have been hit hard by the increasing number of defaults and foreclosures, he pointed out.

At MGIC, the changes to underwriting of low loan-to-value loans -- as well as increases to the pricing on some products -- were made due to the recent performance of loans with those characteristics, said Michael Zimmerman, senior vice president of investor relations. But the changes, he said, also reflect a return to more historically normal underwriting standards.

"The more equity that a borrower has -- or, if you will, skin in the game -- in any investment, the more likely they are to have a higher degree of responsibility toward it," he said.

Goldhaber [of Genworth] said that those in the mortgage industry also have a responsibility to put homeowners into the proper mortgage product. These days, it's irresponsible to give people a loan for 100%, he added.

"In soft markets like we have today, with declining home-price appreciation, to put someone in a zero down is really inappropriate," he said. "It's the kind of product choice that gets consumers in trouble."

Let us pause just for a moment to reflect on a distinction I haven't posted jillions of words on for a least a year, probably, but that is really crucial here: loss frequency versus loss severity. Requiring a 5% down payment from a borrower is not really about substantially lowering a lender's or insurer's loss severity, or how much you will lose if the thing defaults. It is about substantially lowering loss frequency, or how often defaults occur. This is what the concept of "skin in the game" means: it means having a borrower with a first-loss stake in the deal that is significant, in dollars, to the borrower. A borrower who does not wish to lose a 5% investment in the property, the logic goes, is less likely to "ruthlessly default" immediately should home prices drop; that borrower has some motivation to hang in there until they recover. (And if current prices are still so high that they have a long way to fall and little likelihood of ever recovering, whatever are you doing putting a borrower into such a loan with only 5% down? That's asking for "ruthless default.")

But the idea here is that the "skin in the game" is significant to the borrower, not representative of the lender's likely loss. If a 95% financed loan defaults tomorrow, even with no change in the home's value, the lender/insurer is still going to lose somewhere in the neighborhood of 20% of the loan amount. Default servicing and foreclosure and resale of REO is expensive, more expensive than that 5% down is going to cover. Down payments in this view of the world are set to "what the borrower can't afford to lose," not "what the lender can't afford to lose." Or again, it is about making defaults less frequent--because borrowers are motivated not to default "optionally"--than about making defaults less severe, although they surely do mitigate severity.

Try telling these mortgage brokers that:

That said, while the conventional no-down-payment products may have disappeared, there are still ways to buy a home without a down payment, said A.W. Pickel, CEO of LeaderOne Financial in Overland Park, Kan., and former president of the National Association of Mortgage Brokers.

"You have to broaden your definition of no-down payment," he said, adding that loan options are available, if not in the form they were in before.

A gift from a family member or a community grant can take the place of a down payment, for example, he said. And down-payment assistance programs are available to help those seeking loans backed by the Federal Housing Administration, he added. . . .

"You will see more unique products coming out," he said, as companies search for ways to help down-payment challenged buyers get into a new home.

But as of now, there are fewer options than there were before for would-be buyers who don't have ample cash reserves. And Brown sees that as an overreaction.

He believes consumers should have the option of financing their entire purchase -- even if it comes with extra fees or higher rates. Someone who doesn't have a lot of cash, but is a good credit risk, for example, should have that option, he said.

To quote Professor Krugman, "gurk." It's as if this "conversation" between mortgage insurers and mortgage brokers is happening on two different planets. I have gone on record as being a bit skeptical that "ruthless default" is as widespread as some breathless media stories want to imply--mostly because I suspect that the borrowers in question really can't afford their mortgage payments--but only a fool (which I try not to be) would claim it has never happened and won't keep happening if you put people into "free put option" contracts where there is no financial downside to just walking away from a loan.

And yet here we are, treated to brokers discussing ways borrowers can use OPM (Other People's Money) to leverage 100% financing, even in a falling market, because we can declare them "good credit risks" at the same time we put them in loans that offer no downside to default. What kind of "good credit risks" are these people? Folks who will continue, doggedly, to make mortgage payments on an upside-down property for years and years, unable to move, unable to refinance, all in the name of the sanctity of debt obligations? How, exactly, would any lender or insurer measure this kind of "willingness to repay"? With a FICO? Now that we're being told that many borrowers are keeping up the MasterCard payments--they don't want the downside of having the card cut off--while missing the mortgage payment, because there's little downside there?

There is, of course, one possibility here: we could measure "willingness to repay" by a kind of proxy measure, like, um, "willingness to put one's own money on the table in the form of a down payment." This, however, would involve all of us being on the same planet. And clearly we aren't all there yet.
____________

*Actual title is "a certified mortgage planning specialist"

by Tanta on 4/10/2008 08:34:00 AM

It does upset them so much.

This is a rather startling NPR piece about NACA, a non-profit housing assistance outfit, recruiting former subprime brokers (on the "it takes a thief" model, apparently). I was struck by the phrasing here (I see this a lot):

Barbosa says she was pretty fair to her clients and got them the best deal she could in the marketplace. But she says there was plenty of incentive not to put the customer first: Lenders would offer her 1 percent or 2 percent of the price of the loan as a kickback if she persuaded her client to take a higher interest rate. That was legal and commonplace.

Then there were the negative-amortization or "pick-a-payment" loans. Those offered low payment options to begin with but often exploded on the homeowner. As interest rates reset, often at much higher levels, homeowners faced larger payments. That's because the minimum payment required at the introductory rate didn't even cover the interest on the loan, let alone the principal.

"The bottom line is that the lender offered an incentive of 3 percent to the broker if they put [a client] into that particular loan," Barbosa says.

I truly wonder how people who have never been a wholesale lender or a mortgage broker think this works. Read it with naive eyes: it rather sounds the lender is doing a real sales job on the broker, doesn't it? As if the lender called up and said something like, "I see you have here a 7.00% loan. You know, I could pay you a couple of points if you can change this to 8.00%. Or, you know, three points if you can go with the "Pick A Payment." What do you think? Want to be rich today?"

However. Unless things changed markedly in this business in the few years since I worked in it, it doesn't really play out that way. Brokers get rate sheets faxed to them by wholesale lenders. Those "premium" rates with the 102-103 pricing are simply printed on the rate sheet along with the "par" rates. Certainly you can conclude that if wholesalers didn't want brokers to use those premium rates, they wouldn't have published them on the rate sheet. On the other hand, I'm a touch doubtful about the implication that these rate sheets did such a high-pressure sales job on these brokers. After all, you can conclude that if the wholesalers didn't want brokers to use the par or discounted rates, they wouldn't have published them on the rate sheet either.

It is a bit tendentious of NPR to use the term "kickback" here for what is, currently, a perfectly legal practice. I suggest that this is a measure of how disgusted the public has become with mortgage brokers: the public, unlike the regulators and the industry, fails to see any meaningful difference between an illegal unearned "referral fee" (the classic definition of the "kickback") and "Yield Spread Premiums" or "normal" broker compensation. I suspect, however, that a lot of brokers will want to shoot the messenger.

(Thanks, Ziggurat!)

by Tanta on 4/09/2008 11:07:00 AM

The Center for Responsible Lending released a fascinating paper yesterday, "Steered Wrong: Brokers, Borrowers, and Subprime Loans." Using a nationwide database of prime and subprime loans, both retail and brokered, originated in the 2004-2006 period, the authors "paired" retail and brokered loan transactions with similar risk characteristics (such as FICO, LTV, DTI, and loan amount, among others), to compare interest costs over a one-year, four-year, and life of loan (30-year) horizon. The results are no doubt stunning as well as surprising to a certain reliably-stunned-and-surprised contingent of the regulatory and securitization enclaves:

We find significant differences between broker and lender pricing on home loans, primarily on mortgages originated for borrowers with weaker credit histories. During the first year of the loan, borrowers with credit profiles in the subprime range pay statistically more for brokered loans than they would have if they had obtained their loan directly from a lender. Over a four-year period, a typical subprime borrower pays over $5,000 more, and over the 30-year life of the loan, the cost gap grows to almost $36,000. . . .

Significant disparities exist between broker and lender pricing. After matching loans on objective factors that affect interest rates, the analysis reveals that interest payments were significantly higher on broker-originated mortgages in the majority of risk categories we examined. Disparities are greatest for subprime borrowers. For people with weaker credit, brokers consistently charged higher interest rates than retail lenders. A typical subprime borrower was slated to pay $5,222 more during the first four years of a $166,000 mortgage compared to a similar borrower who received a loan directly from a lender. Over thirty years, this borrower would pay $35,874 more in interest payments, equivalent to an interest rate approximately 1.3 percentage points higher than a similar borrower with a retail loan.

Cost disparities grow greater after initial years. For subprime borrowers, significant disparities are apparent even during the first year of the loan. However, because so many subprime mortgages come with short-term introductory rates that rise substantially when they adjust, the cost disparities become more pronounced after the first four years of a loan. Prime borrowers generally do not pay more for brokered loans. In general, people with higher credit scores—those who received prime loans—did not pay higher interest on broker-originated loans. In fact, some borrowers with very high credit scores who received loans from brokers achieved modest savings, although long-term savings were largely limited to fixed-rate loans.

The study zeroes in on two basic "market mechanisms" in play: the fact that borrowers with weaker credit are less informed about competitive rates and less able to analyze the often complex products they are offered than prime borrowers, and that brokers are more inclined to raise "profit margins" on low-volume business (subprime) and maintain thinner margins on high-volume business (prime). What I find most refreshing about the approach is that it mostly dismisses the issue of "better disclosures" as a regulatory side-track. That's a long-time hobbyhorse of mine, too.

Given the prevalence of brokers in today’s market and their impact on the ability of borrowers to build and maintain home equity, we propose specific policy recommendations below.

First, yield spread premiums and prepayment penalties should be banned on subprime mortgages.

Second, lenders should be more accountable for the actions of mortgage brokers originating loans in their names and investors should share responsibility. Third, mortgage brokers should have a
fiduciary responsibility to the borrowers they serve. . . . Notably, our proposals do not focus on increased disclosures. While improved disclosures and increased financial literacy are laudable goals, the magnitude of the problems identified in this paper indicate the need for a direct and immediate response. Moreover, experience and findings from behavioral economics as well as findings related to limited financial literacy among consumers suggest that improved disclosures are likely to have limited effect, at best.

I strongly recommend the entire paper to those of you with an interest in the matter. I want to suggest something that the authors of this paper do not suggest, but which I think cries out for further study.

The CRL paper does comment on the possible causes for retail lenders' pricing practices in regard to subprime loans:

People with weaker credit scores naturally pay more for mortgages than people with strong scores. However, it is very difficult for borrowers with weaker credit or less experience in financial matters to know precisely how much more is appropriate, especially since, unlike prime rates, subprime rates are not generally publicly available. In addition, subprime loans tend to be much more complex than the fixed-rate mortgages that have long dominated the prime market, making their costs more difficult for borrowers to compare. Accordingly, we hypothesize that brokers have been able to take advantage of this situation by
emphasizing maximum revenues per loan for subprime borrowers. While retail lenders are probably not immune from these dynamics, we believe the effects on the costs of retail loans are less pronounced due to more regulation, better internal controls, and concerns about reputational risk.

Depository retail loan pricing has been subject to "fair lending" as well as safety and soundness examination--not just regulation--for quite some time. What I doubt most consumers and observers realize is that since at least the early 90s, retail lenders used loan origination systems that "integrated" the lender's rate sheet and the loan application; the "rate sheet" is simply a printed version of rates and prices calculated by the system based on imported market price data, established tables of profit margins by branch, and "rules" or calculations that adjust rates for lock periods, "buy up" or "buy down" rates by calculating premium or discount prices for higher or lower rates, and apply various loan-level adjustments to rates or prices for individual loan characteristics. Importantly for our present purposes, these systems "know" when a loan is priced above or below the required rate sheet price--this is known as an "overage" or "underage," meaning that the price or points of the loan are more less than the required price. Not only do they "know" this, they also store this information, which can then be pulled into reports and analyzed for frequency, patterns, and possible discriminatory practices. There just aren't many "rogue loan officers" in a retail environment in which all loans must be "priced" with the computer, and in which a pattern of "overages" will result in a report on someone's desk sooner rather than later.

A practice that developed, formally or informally, in the 90s was often called the "point bank" or "price bank." Individual originators or branches were basically allowed to charge overage or underage on individual loans, as long as the monthly or quarterly pipeline "balanced" to zero or thereabouts. An overage or two (or three . . .) could be "banked" and used in essence to subsidize a concession or two on other loans.

Point banks, in my view, were complete disasters. A whole lot of lenders found--sometimes with the assistance of their examiners--that the concessions were being offered to, precisely, those "best customers" who could shop around or negotiate or quite possibly were just part of the loan officer's social or business network. (They were frequently RE agents, builders, or other mortgage market participants the loan officers wanted to "reward"). Meanwhile, the overages that paid for those concessions were being charged to the least informed borrowers with the weakest "bargaining position": weak credit borrowers, first time homebuyers, and small-balance loans (the latter of which don't pay handsome commissions in dollars, but are just as much work for a loan officer as a larger loan).

In other words, weaker and less informed (and possibly more financially prudent) borrowers were "subsidizing" the rates offered to the strongest, best informed, and quite possibly most debt-heavy borrowers. Insofar as the largest loans were most likely to get a concession, and the smallest loans most likely to be charged overage, it generally required several small loans with overage to each single large loan with a concession to make the "point bank" balance. It does not take long for this pattern to appear on the reports. There was a time, at least, when it didn't take long for regulators to issue some threats regarding this behavior. Retail originators basically lost interest in the "point bank" idea as corporate policy.

I bring all this up because brokers often argue--at least in the comment section of this blog, they do--that they offer highly competitive rates on prime business, indeed, often better rates than a retail lender would offer the same customer. The CRL study backs this up to a limited extent:

[B]orrowers with higher credit scores pay virtually no additional interest and occasionally pay modestly less interest when they receive their loan from a broker versus a retail lender, and borrowers with lower credit scores pay more interest. What’s more, the figures illustrate that the additional interest paid in brokered loans increases dramatically as credit scores decline. The figures also help clarify that the results vary considerably between loans that would be considered prime and those that are subprime.

In essence, retail lenders charge slightly more for prime loans than brokers, and much less for subprime loans. (Note that this analysis is precisely attempting to control for individual risk factors by pairing comparable loans; the difference cannot therefore be due solely to brokers originating the lowest-quality end of the subprime spectrum more frequently than retail lenders.)

My suggestion is that we ask whether brokered mortgage lending is, in practice, running on the old "point bank" model that retail lenders largely abandoned, in which "strong" borrowers are basically subsidized by "weak borrowers." The defenders of "risk based pricing" have always argued that loan-level pricing adjustments are fundamentally fair, because "average" pricing would mean that the highest-quality borrowers were paying more to "subsidize" lowest-quality borrowers. Yet here we have a study that weeds out the "risk-based pricing effect," and that shows that in fact in brokered business the weakest borrowers seem to be paying more than their fair share of risk, with the savings passed through to those borrowers who can demand competitive rates, whether that is because of their credit profile or simply their social profile.

The CRL study touches on the question of the "brokered loan premium," which also needs further analysis and study, in my view:

Finally, we note that part of the explanation for higher rates could arguably arise as a consequence of expectations for worse loan performance among brokered loans. In other words, under this explanation, lenders who expect worse loan performance on brokered loans charge higher baseline rates to “price in” the added risk associated with a loan originated by a broker. Alexander et al offer an analysis of subprime loans consistent with this theory, but end up with a net effect of just half a percentage point.37 Moreover, they do not distinguish whether this increase is associated primarily with increased default risk (which they do detect) or yield spread premiums. Even if the entire amount were attributable to increased default risk, the reported half percentage point difference would be less than half of the 1.3 effective percentage point difference we report here. Moreover, since we control for the vast majority of risk factors, we believe our analysis already directly controls for much of this concern. In addition, to the extent that broker-origination itself is the risk factor that may cause higher delinquencies we question whether the risk factor could be related to the very additional expenses we identify here. In addition, Jackson and Burlingame do explicitly isolate yield spread premiums to identify differences.38 Consequently, the differences they report between brokered and retail pricing have their origin with the broker and cannot be the result of higher prices built in by a lender to account for anticipated worse loan performance.

This is a profoundly important question begging for sophisticated empirical work and analysis, since it gets to the very heart of the matter from a consumer standpoint. If there is such a thing as "brokered transaction risk" that is logically and analytically separate from "borrower default risk," that is to say that there is something about the brokered loan transaction or broker business model that results in higher defaults or (more likely) increased prepayments from churning that eat into lender profitability on loans, all other things being equal in terms of the underlying loan characteristics. The idea of a "brokered loan premium," then, would signal that wholesalers are pricing this in by charging higher rates/prices to brokered loans than to retail loans across all credit categories/loan types.

This immediately raises some troubling questions: If there is a "brokered loan premium," are consumers aware that they are paying higher credit costs by using a broker? If there isn't a "brokered loan premium," then the pricing differentials identified must be due solely to brokers' practices, not the wholesaler's policies. Do consumers understand, then, that by using brokers they are quite possibly subject to pricing practices that differ substantially, at least on the aggregate, from retail pricing practices?

We need to bear in mind that even twenty years ago, there were relatively few nationwide lenders, there was no internet, and there were substantial pockets of the country in which there simply wasn't an easily-accessed depository retail lender who offered a wide array of mortgage product, and specifically subprime credit. Brokers filled the market need in those areas by being able to access out-of-state or niche lenders on the borrowers' behalf. In such an environment, paying a "brokered loan premium" hardly seemed unfair to consumers.

Yet we are long since past such an environment, in my view. Insofar as a "brokered loan premium" exists in areas already saturated by Megabank branches on every corner offering mortgage credit all the way down the spectrum from prime to subprime, and insofar as the internet offers consumers access to direct lenders anywhere at any time, it is distressing to think that borrowers are still paying a premium for the services of an intermediary. This is particularly troubling given that consolidation in the wholesaler business means, in many markets, that brokers are all relying on the same dozen or so mega-lender rate sheets; I see little evidence that brokers are still able to find "inefficiencies" in the delivery of mortgage credit to underserved areas, or seek out small niche lenders to make them available to borrowers who could not otherwise find them--not when the big wholesalers are all offering "niche" products.

No doubt a lot of people will be troubled by the implication I am making that more than a few "good" borrowers got better rates than they probably should have, courtesy of those "bad" borrowers who paid not only their own "risk premium" but part of someone else's, as well. But I am more and more convinced that this has occurred at least in those markets that saw the explosive growth of subprime originations in the period in question. We are clearly seeing higher rates and prices paid by prime borrowers now, in the throes of the credit crunch, than we have in the past. A certain segment of the market (and nearly all the media) wishes to see this as an "overreaction" to "subprime problems," meaning that those most excellent borrowers are "paying too much" and that prices should return to "normal" once everyone realizes that the world hasn't ended. I have my doubts about that.

If, in fact, "normal" prime or "super prime" pricing for the last several years was subsidized by an unprecedented growth in subprime originations--for which there is certainly evidence of some "steering" of decent-quality loans into those high-rate subprime products--then "normal" pricing won't be back if we lose some 20% of the applicants who can be made to keep pricing "competitive" for those who know how to and can "compete." It seems to me, at least, that further research and analysis of this question is time much better spent than, say, tinkering with new disclosure forms.

by Tanta on 1/15/2008 11:34:00 AM

This showed up in my email yesterday:

Is your current mortgage turning out to be too good to be true? Financing your current mortgage into an FHA loan can help save your home. New legislation will allow homeowners in danger of foreclosure to refinance into a low, fixed rate FHA mortgage. To learn more about this new program, give me a call today.

Respectfully,
Toby Spangler
TJS Financial LLC
407-733-8962
www.homestarfla.com

So what? So this was the subject line of the email:

Skip your mortgage payment for 3 months

I hereby invite any reader of Calculated Risk, including of course any of you who happen to work for HUD and have enforcement authority, to correspond with Mr. Spangler and explain to him the meaning of the following:

The FHASecure initiative for refinancing borrowers harmed by non-FHA ARMs that have recently reset is not to be used to solicit homeowners to cease making timely mortgage payments; FHA reserves the right to reject for insurance those mortgage applications where it appears that a loan officer or other mortgagee employee suggested that the homeowners could stop making their payments, refinance into a FHA insured mortgage, and keep, as cash, the amount of payments not made on time.

I would of course be happy to forward the original message to anyone with a .gov email address; just drop me a line.

If you, a Calculated Risk reader, do not feel particularly motivated to correspond with Mr. Spangler, perhaps you could give some thought to corresponding with your members of Congress on the subject of "modernizing" FHA to allow more "streamlined" participation by mortgage brokers.

If you happen to be an idiot mortgage broker cruising sites like this one to find email addresses to add your sleazy spam lists, why go right ahead. Add me to your list. I'm here to help you get the recognition you deserve.

by Tanta on 10/25/2007 06:15:00 PM

Mr. Lewis is not a happy camper:

CHARLOTTE, N.C. - In addition to scaling back its investment banking operations, Bank of America Corp. is exiting the wholesale mortgage business and eliminating about 700 jobs, bank officials said Thursday.

The nation's second-largest bank will stop offering home mortgages through brokers at the end of the year to focus on direct-to-consumer lending through its banking centers and loan officers. The move also eliminates the jobs in the bank's consumer real estate unit. . . .

The cuts are part of a 3,000-job reduction engineered by Chief Executive Ken Lewis after the nation's second-largest bank reported a huge decline in third-quarter earnings.

"When Ken talks about a top-to-bottom review in five days time, you can't make that happen. These cuts were in the works, and expect more," said Tony Plath, an associate professor of finance at the University of North Carolina at Charlotte. "Don't underestimate the depth of Lewis' disappointment in earnings. This guy is pissed." . . .

"Ken says he likes the retail business, he likes getting to know customers, underwriting, and managing his risk," said Plath, the university professor. "He just doesn't like the securitization and servicing sides of the business."

Hey, I can relate, Ken. These days nobody likes being a servicer . . .

by Tanta on 10/23/2007 10:01:00 AM

I guess we can only hope that the credit crunch cramps the style of identity thieves. From the Wall Street Journal:

Last month, Waldell Thomas, a maintenance worker at Montego Apartments in Atlanta, made a discovery inside the complex's Dumpster: a cache of 40 boxes of loan files containing Social Security numbers, credit reports and other data on customers of Ameriquest Mortgage Co.

Next time you talk to a mortgage broker, you might want to ask about their file retention/destruction policies. As a general rule, "I keep them in cardboard boxes in my basement until I take them to the dumpster of some condo project" is not the right answer.

The worst part of this is that there do not seem to be criminal penalties for file dumping in Georgia. I guess it's not a crime until the dumpster-divers find your credit report.

by Tanta on 9/16/2007 10:41:00 AM

A new paper by Federal Reserve Board analysts I highlighted the other day contains some discussion of the issues of loan pricing and fairness to consumers. I encourage anyone who is interested in this issue to read the entire paper. However, I promised to write something UberNerdy about loan pricing, and this bit from the Fed paper provides me with a place to start:

As price flexibility has emerged in the mortgage market, so have concerns about the fairness of pricing outcomes. Such concerns generally fall into four broad categories. First are concerns about possible discrimination based on the race or ethnicity of the borrower. Such concerns are heightened because loan prices are not always determined strictly on the basis of credit risk or cost factors but can involve elements of discretion, in which loan officers or loan brokers may seek prices that differ from those on rate sheets or other techniques used by lenders to establish baseline prices.

Second are concerns about whether borrowers in the higher-priced segment of the loan market are sufficiently informed and whether they are willing or able to shop effectively for the loan terms most appropriate to their circumstances. For example, it may be difficult for borrowers to determine where they fit along the credit-risk spectrum.

For the moment I am going to largely ignore the first issue, of discrimination based on race or ethnicity. This is not because I don’t think it’s important; I do. But I don’t think we can really get there, in terms of understanding how pricing of a loan can be manipulated at the primary market level (in discriminatory or just equal-opportunity predatory ways) without getting a grip on how it works. What I will propose is that, indeed, it is very “difficult for borrowers to determine where they fit along the credit-risk spectrum.” Not only do borrowers, on the whole, lack the ability to size up their own risk, they don’t know how lenders price that risk. As long as information about “the market price” for certain risk factors is non-public, the public will not know whether the price it gets is the best on offer or not.

It is supposed to be the role of a mortgage broker to locate the best price for a consumer, since the idea is that the broker receives rate sheets from many wholesale lenders, and can choose the best-priced one on any given day or for any given kind of loan. This presumes that the broker is mostly motivated to offer a “competitive” rate/price to the borrower, not to maximize its own compensation by offering a worse-than-market rate/price to the consumer in exchange for higher fees from the wholesaler. The standard riposte of the brokers is that this kind of gouging can’t really happen, because the customers will “shop around” and know whether or not they’re getting the best deal. Or, at least, they should shop around, and if they don’t, it’s their own fault.

As I have argued before, this creates an odd conception of the broker’s role: the broker with access to all those wholesalers is supposed to be “shopping around” for you. If you go to another broker to get a “comparison” quote, you’re going to someone else who is “shopping” the same universe of wholesalers your original broker was, as a rule. So, in practical terms, what you would be “shopping” for here is differences in broker “markup” practices, not “best market rate.” Why you would pay a broker to “shop” for you and then do your own “shopping” is one of those things that beats me.

That’s my whole argument about “fiduciary” responsibilities in a nutshell: if the broker isn’t obligated to give you the best rate out there, what’s the point of using a broker? If you’re going to do your own shopping, why not shop a couple of different retail loan officers? Your loan is going to end up with the wholesaler anyway; you might as well skip dealing with someone who may not be around if problems ensue, or may not have regulators breathing down its neck about origination practices as a depository lender will (relatively speaking).

But in reality the whole “shop around” business is nearly meaningless when we look at this “risk based pricing” thing. You might know, from reading blogs or something, that, say, the Freddie Mac conforming fixed rate national average loan last week involved a rate of around 6.375% and 1.00% in points. Do you have any idea if you qualify for that? Are you “average”? Is the kind of loan you want “average”? If you were quoted a higher rate than this, would that mean that you are riskier than “average”? Says who?

It’s not easy to find lots of wholesale rate sheets on the web to do comparisons, because most wholesalers put them behind registration walls to keep people like us out. There are, however, a few exceptions, and I found this one. Please understand that I am not “picking on” this lender because I have any particular beef with Chevy Chase, although I will say this “Cashflow Monthly ARM” you encounter on the first page of the rate sheet is perfectly nauseating. Other lenders have equally or probably even worse products, of course, but CCB is dumb enough to make its rate sheet publically available.

Whilst we are on this subject, notice the verbiage at the bottom of the page: “These rates are solely for the use of mortgage brokers, correspondent lenders, and other arrangers of credit and are not to be distributed to potential loan applicants.” All rate sheets have words to that effect on them. You are not given a copy of a rate sheet like this, if you are a loan applicant, and invited to price your own loan. The better reason for that is that you need a “professional” to assist you in this complex process (i.e., we acknowledge you do not understand “where you fit along the credit risk spectrum”). The less better reason is that if you can’t see the rate sheet, you won’t know if you got a higher rate than the best one you qualified for in order to increase the broker’s compensation. In any case, if CCB doesn’t want to see some blogger go to town with its wholesale rate sheet, CCB can invest in a better (more protected) web portal.

I am not, in fact, going to get anywhere near that “Cashflow Monthly ARM” today. We’re just going to look at the pricing for a plain old vanilla conforming fixed rate. If that makes your eyes cross, then do think about how lost in the weeds people are over these toxic ARMs. If you get the hang of the fixed rate pricing, you can play around with how to determine the price to the customer on the goofy ARM. So we’re going to look at page 5 of the rate sheet (page 6 of the "All Other Property States" pdf), which you might want to print if you’re following along at home, although you will need a magnifying glass to read it. Please note that if you’re following the link, the discussion below refers to the “all other states” rate sheet dated 9/14/2007 at 10:00 a.m. If you are now seeing different numbers, you’re looking at an updated rate sheet.

The first thing you see is a rate/price matrix. Eventually you will see that CCB doesn’t use the word “price.” It calls this “premium.” If you know anything about bond pricing, this will drive you crazy right off the bat. If you don’t know anything about bond pricing, it’ll just keep you very confused. “Everybody” knows (uh huh) about this thing called “discount points,” which are a fee, paid at closing, expressed as a percentage of the loan amount. You pay discount points in order to get a lower interest rate (from the lender’s perspective, the points bring the yield on the loan back to up to market).

“Premium points” would be, logically, money the lender pays you to take a higher rate. Now, lenders don’t hand out premium points in cash to anyone. If you the consumer get “paid” a premium, what you are getting is a credit on the final settlement statement against your closing costs (such as your credit report and appraisal fees, title fees, etc.). The “no cost” loan works on premium pricing; “no cost” just means “no cash outlay,” because the costs are there but paid for with premium. However, you do not always get that premium: it can be paid to the broker, not to you. We call this “back-end points” or “yield spread premium” (YSP).

So, anyway, CCB calls everything “premium” instead of “price," which in itself tells you something about the mindset here. I’m going to keep talking “price,” because I have a point to make. Another thing you bond-people will notice immediately is that the prices on this rate sheet are expressed in a “retail” format, not a dollar price (or “buy price”) format. This varies in the industry. Most correspondent rate sheets (remember, that’s a lender buying a closed loan from another lender) use dollar prices, and some wholesale (broker) rate sheets do. (Dollar prices are things like “par” or 100.00, 101.00, or 99.00, which numbers mean “percent of face value” of the bond or mortgage. The equivalent “retail” or consumer price would be 0.00, (1.00), or 1.00, respectively. Subtract the retail price from 100 to get the dollar price, and remember to change the sign on the adjustments. If that last sentence confused you, ignore it.)

That means that CCB’s rate sheet expresses a premium price as a negative number and a discount price as a positive number. You may also notice that CCB quotes 15-day locks in rounded ticks (1/32 increments) and 45-60 day locks in even eighths. This means that at any given rate, the borrower pays around 0.187 to go from 15 to 45 days, and .125 to go from 45 to 60 days.

Most of the “risk based pricing adjustments” on this rate sheet are also quoted in even eighths, although you’ll notice that the LMPI and Expanded Approval (EA) adjustments are not necessarily expressed in eighths. I will observe that: eighth increments are “traditional” in primary market pricing, and when you see pricing in other increments, you are likely to be seeing pricing that was derived from a much more exact model. The LPMI adjustments are based on the actual cost to the lender of mortgage insurance policies; the EA adjustments are based on the guarantee fee or loan-level pricing adjustments Fannie Mae comes up with in its Desktop Underwriter AUS. The rest of this stuff, my consumer friends, is ballpark. I know; I’ve been in the meetings. For years. We’ve been charging a quarter of a percent for escrow waivers since before Windows was copyrighted. If you tell me that number comes from some fancy cutting-edge servicing valuation model that looks at exact current float costs and some razor-sharp analysis of marginal credit risk differences, I will laugh in your adorable nerdly little face. I’m sure we had some data when we first made that one up, but we used a sextant, not LORAN and certainly not GPS.

In order to see how this works, let us imagine that Tanta wants a loan: a $140,000 cash-out refi. Tanta’s LTV is 90%, the property is her principal residence, a 1-unit home, and she is providing full documentation of income. However, since she has no idea where her tax returns are hiding, she needs a 45-day lock. Her FICO is 655. Because her brother-in-law’s boss’s Avon Lady’s financial advisor said it had “tax advantages,” she asks for an interest-only loan with “no MI” (that is, LPMI). On the other hand, Tanta read on some website that you should never pay points, so she wants the “no point” rate. You may reflect on how far Tanta and her loan request are or are not “average.”

You can see right now that you have to supply a lot of information to a broker or loan officer these days to get a simple rate quote. Actually, you can’t even get a real rate quote without someone running a credit report on you, because you do not know your own FICO (and even if you think you do, your lender will get that information directly from the credit bureaus anyway). You are already handing over your Social Security Number and incurring cost to someone who will want to recoup it by making a loan, even if all you thought you were doing was “comparison shopping.” And we’re just guessing on LTV at this point; that value isn’t conclusive until some sort of appraisal or AVM determines the value part. But you’ll be in this process fairly deep by the time that happens. Remember that this is a refi request: do you know, really, what your house is worth today? Does Tanta?

So how do we go about quoting a rate/price here? Well, what your broker is likely to do is first add up all the price adjustments you would be subject to. Tanta’s loan gets the following (COR = cash out refi):

Loan amount: 0.125
FICO: 0.750
COR: 0.750

Total: 1.625

Since Tanta doesn’t want to pay points, we must find a 45-day rate that shows premium of at least (1.625). Let’s take that 7.375 rate: it pays exactly (1.625) in premium. So Tanta’s base rate is 7.375: we add 1.625 to (1.625) to get zero points. However, Tanta has some rate adjustments in store:

Interest Only: 0.25
LPMI LTV: 0.30
LPMI FICO: 0.10
LPMI COR: 0.10

Total: 0.75

Therefore, Tanta gets a rate of 8.125% (base 7.375 plus 0.75 adjustments) at zero points. Now, the trouble here is that the broker still has to make some money for going to all the trouble of taking Tanta’s loan application, so Tanta is highly likely to pay one or more “origination points.” Of the many things that makes Tanta a crazy person, indiscriminate use of the term “points” is one of them. Traditionally, the “origination fee” on a loan is the lender’s overhead, which includes commission to the loan officer or profit to the broker. Because it was traditionally expressed as a percentage of the loan amount, it is referred to as a “point,” but it is very important not to confuse it with a discount point: it does not “buy down” the interest rate.

Brokers (or lenders) don’t have to charge origination points; you can and people do just throw in a bunch of flat fees for this and that which end up being profit to someone. I bring this up in part to highlight a real problem in “predatory pricing” land, which is the concept of the “bona fide discount point.” Things have gotten so bad that we actually have to use that term, because you see loans where a borrower got charged one origination point and one “discount” point (they show up separately on the disclosures and settlement statement), but the rate didn’t get discounted appropriately. A whole lot of brokers seem to think that you can charge “discount points” without reducing a premium rate. A whole lot of consumers can never know whether this is happening or not, since, of course, the consumer doesn’t see this rate sheet.

You will notice that, in our example, we picked 7.375 as the “base rate” because we are an honest broker who will get compensation for this loan on the “front end,” by charging some kind of origination fee to Tanta. However, we could have chosen 7.50 as our base rate, which paid (1.750) in premium. If we had done that, after our price adjustments, there would be 0.125% of the loan amount to end up in someone’s pocket. If the broker applies it as a closing credit, Tanta’s closing costs will be reduced by that amount (she would, say, pay a 0.875 origination fee instead of a 1.00 fee). If the broker doesn’t give it to Tanta, it becomes YSP or compensation to the broker. If Tanta doesn’t know that 0.125 is on the table someplace, Tanta doesn’t know whether she should be paying 0.875 or 1.00 in origination fee (or the equivalent in flat fees). She also probably doesn’t know that it doesn’t have to be on the table, because she could have gotten that 7.375 base rate.

Does Tanta have any idea whether that 0.75 add-on for LPMI compares favorably to paying MI herself? Not unless somebody runs some “scenarios” and gives her the figures, carefully explaining the advantages and drawbacks of LPMI. Does she know whether CCB’s add-ons for LPMI are going to be the same at any other lender or not?

Does she understand that the biggest impacts on the price she was offered were her FICO and the fact that she’s taking cash out at a high LTV for cash-outs? If the amount of cash she’s taking is rather modest, does she know that it might not be worth it, considering that she might be able to save up that modest amount of cash in a fairly short time by doing a rate/term refi at a lower rate and therefore lower payment? On the other hand, does she realize that if she reduced her loan amount significantly, her loan amount adjustment would increase?

Does she know she’d get a better rate/price with 5 more FICO points? Is there a way for her to manipulate her FICO in the short term to squeeze 5 more points in? Is there a “credit counseling” company who would be willing to extract some fee from her for assistance in this matter? Will that fee be worth the rate/price break on a 660+ FICO loan?

If this whole rate quote blows up when the appraisal comes back, showing that unfortunately our LTV is over 90%, what will happen? Will the broker go back to Tanta and tell her she has to borrow less, which reduces any of the broker’s compensation that takes the form of a percentage of loan amount, or will the broker lean on the appraiser until a “better” number comes back (or fool around with the inputs on an AVM until it complies)? In the latter case, will Tanta even know that that is going on?

An important thing to bear in mind is that we just looked at one rate sheet by one wholesaler. For some if not most of you, this will be the only exposure to this sort of thing you’ve ever had. If you are now thinking something along the lines of, “OK, so 75 bps is a normal market price adjustment for a FICO in the 620-659 range,” you are making a logical error. It would be a profound logical error if you then assumed that a different wholesaler’s rate sheet with a higher or lower FICO adjustment were “overcharging” or “undercharging.”

The fact is, it depends on how you calculate that base price up in the rate/lock days matrix. A competitor of CCB’s could easily calculate a base price that is better, relative to CCB’s, by 25 bps. That competitor’s FICO adjustments could, then, be worsened by 25 bps, so the FICO adjustment for 620-659 might be 100 bps, not 75 bps, although the end price to the consumer is the same. Even those things that are fairly consistent throughout the industry—like the classic 25 bps adjustment for escrow waivers—can confuse the unwary: some lenders calculate the base price assuming that all loans have escrows, and then worsen the price by 25 bps if escrows are waived. Some lenders calculate the base price assuming all escrows are waived, and improve it by 25 bps if escrows are established. You might see the same value but different signs on different rate sheets.

A casual comparison of price adjustments across even a large number of wholesaler rate sheets will not tell you what the “going market price” of a given risk factor is; you have to analyze the base prices together with the adjustments to get that. “You” in this case are a broker or a loan officer; “you” are unlikely to be a consumer.

You must also remember that risk adjustments are tailored to the guidelines of the loan program being priced. Why is there no adjustment for cash-outs over 90%? This loan program does not allow an LTV that high, so it does not price one. If you wandered over to an Alt-A or subprime rate sheet, you would see additional risk adjustments because crazier things are allowed; you might also find very different values in those adjustments, because the “base price” is set very differently.

I’m guessing by now that you all have spotted the trouble with the idea that risk based pricing is “individualized”: it is, but what an individual loan gets are adjustments based on average performance of loans of that type. How reliable those calculations are will be a matter, among other things, of how a pricing model considers variables singly or in conjunction. In other words, these adjustments you see may be “net of” a lot of factors that aren’t obvious to consumers.

Let me observe that I purposely picked an example loan with a lot of risk-based adjustments on it, so you could see how the process works. But if you hypothesize a loan with fewer adjustments, you can see that a broker could end up with a lot more than 0.125 in YSP off of this CCB rate sheet (and there are, or at least were until recently, wholesale rate sheets out there paying a lot more premium—quoting much higher rates—than CCB’s. We are looking at a “post-turmoil” rate sheet.). It may seem counterintuitive to you, but quite often it is the borrowers with the best credit history and the most conservative loan terms who are most at risk for getting a high interest rate—as long as they stay ignorant about what “YSP” is and why it is showing up as a charge on their settlement statement.

It is perfectly true that a similar mechanism works in retail loan origination; in that context this additional premium is generally referred to as “overage” rather than “yield spread,” and it can, depending on the lender’s practices, be additional profit to the lender or additional commission to the loan officer or (frequently) a split. However, it is even less visible in a retail environment, since "overage" isn't disclosed on the settlement statement the way YSP is. On the other hand, depository retail lenders (so far) face a great deal more regulatory pressure to keep "overages" under control than brokers do.

But to get back to the question raised by the Fed analysts, does every borrower with good credit and conservative loan terms think of him or herself that way? Does the rest of the world, or a vocal subset of it, think that way? How widespread is the belief that minority and low-income people are almost always “subprime” borrowers? If you can make a 110-pound adult believe she’s “fat,” or a college student who gets a C believe he’s “stupid,” can you convince someone who makes $30,000 a year fixing cars and happens to have a Hispanic surname that a 655 FICO makes you “subprime”?

I think you can. If I tried to link to every media article that defines “subprime” as “loans to low-income people,” I would blow the server. A loan to a low-income person that the person cannot, patently, afford is certainly subprime. That is not the same thing as saying that all low-income people are “subprime credits,” but how often do you hear that distinction being made?

How often are prime-credit borrowers given subprime loans? Good question, and I am not making or endorsing a particular claim about an empirical matter for which I don’t have satisfactory data (see the Fed's analysis for the difficulties in sorting that out). I am pointing out that we have the necessary if not always the sufficient conditions for predation when we have “risk based pricing” that is opaque to consumers, and consumers who are not educated about what constitutes “risk.” We are not exactly making it hard for discrimination or predation to occur here.

We also have an industry which hasn’t done a particularly fine job lately proving that it really knows how to price risk anyway. Do price adjustments (of any amount) for FICOs “make sense”? Are they enough? Too much? Beside the point? Are you sufficiently convinced of the predictive power of a FICO score to want to justify pricing a loan on that basis? Particularly when an entire sub-industry of various forms of more or less “respectable” FICO manipulation has grown up around this practice? In the midst of all of that, are you confident that putting the onus on consumers to “shop around” still makes the most sense as a “solution” to the problem of pricing distortions? I’m not.

by Tanta on 9/09/2007 07:33:00 AM

Having complained rather bitterly lately about the quality of a lot this stuff that passes for "financial advice columns" recently, I'm happy to have the opportunity to draw your attention to Michelle Singletary's column, "The Color of Money," in my hometown rag the Washington Post. Singletary's stuff is almost always useful, informed, and no-nonsense in attitude.

The opportunity involves a follow-up to my great sprawling post the other day on mortgage "orgination channels." Singletary writes about the dreadful "net branching" practice:

In a relatively new arrangement, some skirt the law by paying to become part of a "net branch" operation. Net-branching is similar to franchising. It allows individuals to operate their own mortgage loan origination branch using the mortgage-lending or broker license of the branching company. Individuals get assistance in running their businesses and gain access to a network of lenders. . . .

The authorities have stepped up their enforcement actions against operations that do business with unlicensed mortgage brokers, loan officers or loan originators. Most recently, 10 states took action against Apex Financial Group, also called Apex Mortgage. Apex was doing business with multiple unlicensed entities, leaving consumers unprotected, the states allege.

One person who worked with Apex was Frederick C. Lee Jr., founder of Financial Independence Group and other mortgage companies, whom I wrote about in an earlier column. Former insiders, with knowledge of the inner workings of Lee's multi-state mortgage operation, said he has assembled a network of people who arrange mortgages, sometimes through net-branching, even though the officers are not properly trained or in some cases licensed as required by the states.

In an interview, Lee denied that he or his company was involved in facilitating mortgage loans. "I'm not a mortgage guy," he said.

Yet loan documents I obtained suggest that Lee is acting as a mortgage broker. In one case, a $504,000 residential loan in Maryland lists North American Real Estate Services as the broker. Lee's cellphone number is listed as the originator's contact number. Lee is not licensed as a mortgage broker in Maryland.