Former community banker and occasional guest poster Pat Dalrymple is a columnist for a Colorado newspaper who has a former insider's view on the sometimes wild and wacky world of commercial lending. You didn't think it was either wild or wacky? Read Pat's latest column.
No, neither Jason, nor Freddie, nor Arnold has returned after having been absolutely, irrevocably annihilated in the last episode.
Rather, it’s subprime, the evil force that terrorized America, from Wall Street to Main Street to Elm Street, that may be coming soon to a closing near you.
A residential mortgage lender has announced that it’s making loans of up to $2 million that don’t require tax returns or employment verifications. Nor does it set a minimum time from a short sale that the borrower might have had. Bankruptcies and foreclosures require only two years’ seasoning after the event. Income is verified through bank statements, and an income-to-debt ratio can be as high as 50 percent.
The loan to value ratio is capped at 85 percent, but no mortgage insurance is mandated. A 700 credit score will qualify a borrower for a $2 million loan, and only 500 is necessary for a mortgage up to $750,000. And, to top it all off, cash-out refis are OK.
Sounds kind of scary, doesn’t it?
Pat parses the underwriting risks, and comes to the conclusion that money can be made on this type of lending, "subprime" or not, and that from an underwriting standpoint, it's not "scary" at all. To him, the business reward can outweigh the risk. However, the "scary" fly in the ointment is something far more terrifying than a default on an undercollateralized loan. It's something that utters the horrifying names "trial lawyers" and the Cherokee princess known as "The Spawn of She Who Dances With Donors" (h/t Dennis Miller) in the same fetid breath.
The new regulations that have come online in 2014, and this year say that lenders have a so-called “safe harbor” if they make loans underwritten to conforming, i.e., Fannie Mae, guidelines. These loans are called “qualifying mortgages.” If a loan is outside that qualifying mortgage safe harbor it means that a borrower, whose house is in foreclosure, can actually allege that the lender did not adequately assess the borrower’s ability to repay when making the loan, and sue the lender.
If the suit takes place during the first three years of the life of the loan, and the borrower is successful, that borrower can collect from the lender all the interest and fees paid during those three years, plus attorney fees (this last phrase is kind of important). After three years, there’s no cash settlement; the amount is simply offset against the foreclosure.
For a big lender, there has to be a goodly number of these cases before the company is at risk, and the likelihood of that is less in a recovering economy. But those three little words, “plus attorney fees,” really gets the attention of the class action bar.
And then there’s the regulatory risk, which could be considerable. No law or reg says a lender can’t make loans that are not “qualifying mortgages.” But the assumption of the Consumer Financial Protection Bureau, the federal big-dog regulator, is that these loans can be traps to abuse consumers. And no lender wants to spark the attention of the CFPB.
This agency has enormous power. It answers to nobody but Congress, which isn’t exactly the best manager of anything. And the bureau can levy enormous fines, called civil money penalties, on the companies and people who work for these businesses. Just one CFPB audit can pull the plug that can send a lender down the drain.
A lender venturing outside the safe harbor can be like a Methodist missionary taking pictures in North Korea.
You’re definitely being watched.
Coloring outside the lines used to be dangerous because you could lose your shirt if you didn't manage the elevated risks with dexterity and price the product appropriately to compensate for the fact that the "earners" had to more than makeup for the "non-earners." In that respect, the economics were pretty much the same as those governing a Mafia family, so most subprime lenders "got it." Today, it's much more dangerous because you may have to face your two biggest nightmares: a lawyer with an cause of action that might have actual merit, and a government bureaucracy staffed by true believers and accountable only to God/Gaia/Zeus/Baal/Richard Dawkin's Eternal Nothingness/[Insert Name of Favorite Cosmic Muffin or Nihilist Here].
That should scare away all but the psychopathic, the suicidal, or the moronic. Or, perhaps, that rare fellow who looks into the muzzle of the .44 Magnum and says to himself, "Ya' know, come to think of it, I AM feeling lucky today!"