Risk management rules are being revised as a result of the credit crisis we are currently experiencing. One of the categories under review is Customer Behavior. The proponents of the “strategic adjustments” have come up with supposedly new questions in this category.

This makes sense if the questions were truly new questions engineered for the times. However, after you read the questions, I bet you too will want to know why weren’t these the questions from day one. I write about this stuff because this is the type of mentality that is making decisions on who gets a loan and who doesn’t get a loan.

To me, it is frightening. If one is to measure the qualifications of an individual before granting credit, these questions should form the base of any risk management program.

The Questions

These 4 questions aren’t all of the questions but they seem to form the nucleus of the supposedly new thinking. For the life of me, human behavior has been known to change along with the times for as long as I’ve been alive so where were these questions before the crisis?

1. How has my customers’ spending and payment behavior changed?
2. When did their behavior change and by how much?
3. Has the behavior of all of my customers changed or just that of certain segments?
4. What are the major contributing factors to the various changes?

I found these four questions by the way in the February 2009 issue of Collections & CREDIT RISK magazine in an article titled, “Managing Risk in The New Credit Environment”. The article was written by Edmund V. Tribue. I’m not saying Mr. Tribue is out of line or incorrect. I’m saying these really aren’t new questions or new risk management parameters.

The risk manager, in my opinion, should already have a handle on this type of information. When a person applies for a real estate loan for example, his or her spending and payment behavior is pretty apparent and easily accessible from their credit report. If you were a credit pulling landlord or lender, wouldn’t the answers to the above 4 questions scream out at you from the credit report as well as the answers to a few questions of the applicant?

I don’t believe it is the job of real estate investors to be the macro manager of the credit world. But I do believe it is our job to stay on top of our customer’s behaviors in our personal micro real estate arena. If we don’t, or won’t, aren’t we dooming ourselves to failure?

Your Local Newspaper

Believe it or not, your local print newspaper is probably a good source on the credit aroma in your area. I know our paper is not shy about printing news about problems in the local financial world. It tells us about foreclosure filings, credit card default rates, business failures, etc. I could be lucky in that respect. However, you may enjoy such info in your neck of the woods.

Of course, other sources exist and you may have to rely on them where you live. The local real estate association is a good start. You may even have a local lender’s association. Many regions have real estate investment clubs which are excellent information cauldrons.

So maybe new isn’t really new after all.

Photo Credit: danflo

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Tags: Credit, lender, lending, loan, mortgage, risk management

As the spending stimulus package passed the House and Senate on Friday, lenders large and small took action to stem the tide of foreclosures (1 every 13 seconds) until more details were revealed about President Obama’s $50 billion plan (that’s the portion of the stimulus devoted to foreclosures, according to the AP).

Fannie Mae, Freddie Mac, JPMorgan Chase & Co., Morgan Stanley, Citigroup Inc. and Bank of America Corp said they were halting foreclosures for at least a month on Friday, followed by many smaller banks around the country.

This amounts to a triage until they can come up with a permanent solution,” said Anne L. Weintraub, a Sarasota attorney who specializes in real estate. “Banks are finally trying to come up with an alternative to foreclosure because it’s expensive and they don’t want to become property managers.

I hope the good folks making these decisions (politicians, big banks, etc) realize the implications on the business of lending that their actions will have. The incentive to lend money is fast disappearing . . . I better collect on the $10 bucks I lent to my buddy before that is also deemed unfair by the government!

Tags: fannie, foreclosure, freddie, lender, lending, loan, REO

Even if you’ve been living in a cave for the last few years, if asked, “Who caused the mortgage meltdown?”…the mortgage debacle that triggered a bank implosion and a real estate market slide that would make a Japanese landlord cringe…

You’d answer…”Those greedy mortgage brokers are the cause of this mess.”

Why would you pull that answer out of your hat?

Because that’s the most common answer everyone comes up with due to the never-ending barrage of bad press mortgage brokers get in the mainstream media. I’ll not rehash all the attacks as it only serves to perpetuate the myth. Suffice it to say, from a real estate investor perspective the demise of mortgage brokers will make life much more difficult.

What I will discuss is the systematic dismantling of the wholesale lending industry that is quickly making being a mortgage broker so difficult soon there may not be many left.

Bank Wholesaler Slaps Brokers in the Face

Last month we heard the CEO of Citigroup imply the reason they pulled out of wholesale lending was the poor quality of the broker mortgages they received. A ridiculous accusation that a company spokesperson qualified the following day. But the damage was done. Another news cycle blaming mortgage brokers for “poor quality” loans.

A few months back, we had the New York Attorney General Cuomo get his dander up due to what he called a systemic over-valuing issue. The case involved Washington Mutual and an outsourced appraisal management firm called eAppraiseIT. The short version (here is the long version) is Cuomo found a few emails where he noticed undue pressure was being exerted by Washington Mutual on the appraisal firm to the “hit the number”. This could in fact create overvalued homes, but without due process proving the allegation, he simply threatened Fannie Mae and Freddie Mac with a lawsuit.

Fannie Mae and Freddie Mac caved in to the pressure and settled with Mr. Cuomo. The agreement reached ended up forbidding mortgage brokers from ordering appraisals as part of the mortgage process.

What?

How did mortgage brokers get blamed again? The alleged wrongdoing Mr. Cuomo supposedly found, if true, was committed by a bank…Washington Mutual…not a mortgage broker!

The news cycle once again runs for days how mortgage brokers can’t be trusted to order their clients appraisals.

This can’t all be a coincidence, right?

PMI Companies Deal the Final Blow

And finally today The PMI Group of San Francisco announce it won’t insure mortgages originated by mortgage brokers!

If that’s not punative…I don’t know what is. This could be the last straw for mortgage brokers. How is a mortgage broker supposed to make a living only doing loans that don’t require mortgage insurance?

This would mean he could only originate mortgage at 80% LTV or less…impossible!

The National Mortgage News put it this way…

“In what could be another nail in the coffin of the loan brokerage industry, The PMI Group of San Francisco confirmed it will no longer insure any mortgages brought to them by third-party originators unless these firms have a warehouse line of credit.

It’s believed that PMI is the first of the nation’s seven MI firms to totally exclude loan brokers from their coverage menus. In recent months other MIs - including Genworth and MGIC - have tightened guidelines on broker-sourced loans, particularly condominiums and high LTV notes. A PMI spokesman confirmed the new policy change to National Mortgage News adding that, “This does not apply to correspondents.” He said PMI would honor any commitments on broker loans in its pipeline.

Marc Savitt, president of the National Association of Mortgage Brokers, said he is seeking a meeting with White House officials to discuss issues affecting brokers (including the PMI matter) and believes the sector has been unfairly blamed for the nation’s mortgage crisis. “We don’t underwrite loans,” he said. The NAMB chief believes the nation’s largest commercial banks are part of a “well orchestrated campaign” to put brokers out of business and gain market share. In a letter NAMB sent to the White House today he writes: “Make no mistake about it. This campaign to eliminate our profession has absolutely nothing to do with consumer protection. It’s about market share.”(emphasis added)

PMI Companies Do Bankers Dirty Work

Mr. Savvitt is right. This has been the plan from the beginning. The maga-banks have always coveted the market share mortgage brokers possessed. Don’t think for a second they couldn’t pull off the destruction of their biggest competitor. The banks have the clout to pull this off. Clout with the media, the politicians, and obviously they have enough clout with the PMI companies to get them to do their dirty work.

Real estate investors definitely have a dog in this fight. Where is the real estate investor left when the only place to get a mortgage is from Bank of America or Wells Fargo?

Out in the cold…that’s where.

Tags: lending, loan, mortgage, mortgage bankers, mortgage brokers, pmi

There is a plethora of speculations buzzing around Wall Street with the central theme being Bank of America (NYSE: BAC) our nation’s largest bank…and biggest “cleaner upper” of the financial crises buying both Merrill Lynch and Countrywide Home Loans before they collapse…is going to get “taken over” by the government.

Oh my God!

The sky is falling…the sky is falling.

Everyone seems to think this could trigger the failure of the “whole banking system” (heard that tune before) and signal to the world our currency and debt are not worth holding.

In a Bloomberg report, Paul Miller, analyst at Friedman, Billings, Ramsey Group Inc said,

“You have got to nationalize the banks,” … “We’re past the tipping point, and the government is taking small steps.”

Tons of Bailout Money…For What Exactly?

Bank of American was one of the first recipeints of at least $25 Billion of TARP bailout money last year. This year they were recently given more assistance in the form of another cash infusion of $20 billion and a $118 billion plan to off-load losses in mortgages, corporate loans and derivatives to Uncle Same.

All this massive amount of government help ..check that…TAXPAYER help…and BAC stock continues to freefall below $5 this week!

We had to “nationalize” the GSEs, Fannie Mae and Freddie Mac, because for decades we gave an “implied’ but still meaningful guarantee on those MBSs to every central bank around the globe to get them to buy our debt. Defaulting on that would truly be a signal to the world to stop being our bankers.

Letting BofA fail would not even come close to having the same effect regardless of what you hear.

Don’t Nationalize Them…Let Them Fail

Don’t “take them over”, just let them fail…file bankruptcy…whatever. Everybody knows they have a zero balance sheet anyway…which is why there stock is headed to the basement.

How many more billions of taxpayer dollars to want to throw down a rat hole just to save a “brand”…a private brand at that?

The earth didn’t stop revolving when IndyMac died…or any of the dozens of failed regional banks, so what’s good for the goose is good for the gander.

In this case, I think it might good to signal to the world that when you make bone-headed mistakes like taking over an investment firm that loses $15 billion a quarter and whose CEO spends $1.2 million on an office redecoration in the middle of a banking crisis, you need to die too…

Treasury Secretary NOT To The Rescue

So, Mr. Giethner, your first real move as Treasury Secretary, should be to let Bank of America fail. I see this week you resisted the idea of an aggregator bank which I thought was a horrible idea…so at least I know you can read.

Read this…and don’t bailout BofA. They are not “too big to fail” …they are too stupid to survive.

Sure your predecessor tossed a bundle of dough at them, hundreds of billions in fact. But he worked for Bush. We’d expect that from “those guys”. Don’t make his mistake. Let the world know it’s not “business as usual” at the Treasury.

Let them die!

Tags: BAC, bailout, bank of america, banking, banks, countrywide, fed, federal reserve, lending, loans, Merril Lynch

According to the AP, Treasury Secretary Timothy Geithner is set to give a major speech on Monday to outline the $700 billion rescue plan.

As a part of any bailout package we’ll see, the government will certainly make some major moves in the real estate and banking space.

Meanwhile, real estate lobbyists were pressing the government to spend billions to temporarily subsidize lower mortgage rates. They were looking to Geithner’s announcement Monday in hopes that some of the financial rescue money would be used to reduce mortgage rates and prevent foreclosures.

The Federal Reserve has been buying up mortgage-backed securities guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae for a month. Before rising a bit in recent weeks, mortgage rates had plunged since the Fed announced the creation of the $500 billion program late last year . . . Geithner said the overhaul of the rescue program was aimed at improving the effort to get credit flowing again and to support the Obama stimulus plan being debated in Congress.

Some Questions:

• What will happen to the lending environment if private lenders are forced to set rates according to government regulations?
• How will they “convince” banks to loosen credit and lend in the current environment?

Tags: $700 billion, bailout, Credit, Geithner, lending

I came across a research paper published by the Boston Federal Reserve Bank where the researchers looked into among other things a mathematical formula that demonstrates subprime lender have little financial motivation to modify mortgages facing default.

This research I thought was interesting because I am caught between wanting the government or the lenders to “help” foreclosure victims, especially if they were tricked or lied to (a typical practice among subprime mortgage sellers). Of course, everyone on the planet knows best how to accomplish this “helping”. I on the other hand don’t. Nor do I have the arrogance or stupidity to believe just throwing money at defaulted homeowners will work any better than burying the banks in mountains of cash thawed a “frozen” credit market.

So are we stuck with the alternative…do nothing?

Maybe that is the best answer. Do nothing and let the real estate market absorb all the foreclose homes at depressed prices. This will eventually mean a bottom in home price gets hit or what economists call an “equilibrium”. The theory goes this will happen anyway and the only thing the Feds or lenders can do with too much “help” is slow down the inevitable. If that’s true, well-meaning “help” turns out to be “hindrance”. Not good…

I don’t know…this “free market equilibrium” rationale sounds very self-serving for the banking and mortgage servicing industries. Am I biased against it just because it aligns with the wants of an obviously crooked couple of industries?

Probably…

When I get caught in a “bias debate” with myself it can go on forever, so I seek out facts and figures to make the differences. Enter this new report…

Subprime Mortgages, Foreclosures, and Urban Neighborhoods - Authors: Kristopher S. Gerardi and Paul S. Willen

In the report, I found a few nuggets of gold to help me break the logjam.

First, the reason for the subprime lenders do NOT want to help is the fact that according to fairly simple “risk vs. reward” calculation, lenders know that most underwater borrowers will in fact pay!

Did you get that?

The worst hurt by this subprime meltdown, the lowly subprime borrower…those horrible folks who “took advantage”…even after losing a ton of equity…those folks will find a way to pay. Under this scenario the banks lose nothing…so why modify a loan with a costly principal or rate reduction.

We all forget to ask for the numbers in a fervor to “act” or “help”. In the case of subprime borrowers, the numbers show most will pay even when you or I might walk away.

Here’s a chart …

The chart shows even with a negative equity of 20% a prime and subprime borrowers’ chances of foreclosure are 4 and 33 percent respectively. Yes, subprime borrowers will default at a much higher rate than prime borrowers, but we should still remember if 33% default, that leaves 67% who don’t. That reflects a majority who don’t default under the same conditions.

A quote from the report,

“Specifically, many commentators have recently argued that lenders should eliminate negative equity for borrowers in such a position by writing down a portion of the principal balance on their loans. The argument runs that such a plan benefits the lender as well as the borrower because the new principal balance exceeds the yield from foreclosure, once one takes into account the costs of foreclosure. Many commentators have argued that this solution is so obvious that one wonders why lenders do not implement it on a large scale. In the following discussion we show why lenders have not engaged in such a policy as a matter of course, but we also argue that for multi-family properties in the inner city, such a scheme
might work.

There is a serious flaw in the logic of principal reduction. To see why, it is useful to think of two mistakes a lender could make. One mistake is to not offer assistance to a borrower in distress. The lender loses here if the increased probability of foreclosure and the high costs incurred by foreclosure make inaction more costly than assistance. We call this scenario “Type I Error.” But there is another mistake, often overlooked, which is to assist a borrower who does not need the help. The lender loses here because it receives less
in repayment from a borrower who would otherwise have paid off the mortgage in full. We refer to this case as “Type II Error.”

Type II error is precisely the reason that lenders rarely engage in principal reduction. One lender summed it up this way, “We are wary of the consequences of being known as a bank that forgives principal…we have not to date forgiven any principal.” Some have suggested that principal reduction would benefit investors, but that complex agreements between servicers and investors make such a policy infeasible. However, the evidence for this explanation is severely lacking. For example, Freddie Mac, which retains credit risk when it securitizers a mortgage, and thus has complete discretion over the disposition of troubled loans, rarely grants any loan modifications. Furthermore, for the instances in which it does offer assistance, few involve any “concessions” like principal or interest rate reductions.”

Why don’t we have more meaningful foreclosure asistance…prinicpal and/or rate reductions? Because lender’s …”are wary of the consequences of being known as a bank that forgives principal…”.

But is this because the banks are simply horrible, evil people with no compassion…or is it due to some macro-economic theory of hitting bottom unimpeded?

Nope…on both accounts!

The real interesting part of the study comes when the algorithm gives both types of credit borrowers back a 10% percent equity stake in the home and recalculates the foreclosure probability and the “Net Gain” between Type I and Type II Errors.

Looking at this we see the probability of foreclosure on the prime borrowers barely move but on the subprime borrower it drops considerably…from 33% down to 9%. One the surface, you’d think that would support the idea lenders and policy makers could benefit from a “principal reduction” strategy.

But wait…

We still have a negative net gain number even after simulating a principal reduction for all home-owner borrowers. The authors define the chart this way…

Type I error measures the cost of not assisting borrowers who need help. Type II error measures the cost of assisting borrowers who do not need help. The net gain to the lender, as shown in Section 6, equals the difference between Type I and Type II error.

So the researchers factored in the cost of the “accidental helping” of those who didn’t need it…which does occur when you do en mass loan modification ala Sheila Blair’s method. With this factored in, the subprime borrower now shows a negative “Net Gain” of -12.7%. The bank loses money even after reducing the principal amount…a no-win situation.

Combine this fact with the fact that 67% of subprime home-owner borrowers were going to pay in full without any help whatsoever, we get a reluctant banking industry when it comes to principal reduction loan mods.

It appears to me it’s a double standard for us to ask the banks to “help” subprime foreclosure victims in a way that loses them money. At the same time, preaching “Be smarter next time”. They are just trying to ‘be smart’ right now.

Of course, it really won’t matter because Congress and other politicians are already geared up to spend about $100 billion at last check to “help foreclosure victims”. I feel I can now say with certainty, no scheme of “helping” homeowners with principal “cram downs” or government investing in the “underwater” portion of their home will solve a thing.

I say this with equal parts relief that the debate is over…and overwhelming sadness the only logical conclusion means, in this case, “help” turns into hindrance.

I really wanted it to go the other way….

Tags: foreclosure, lender, lending, mortgage, subprime, subprime meltdown

This was a question posed by an editorial in a prominent financial news media publication recently. I have asked myself the same question.

For those of us whose primary objective is raising capital and attracting authentic, unique, and compelling opportunities for that capital, the Madoff scandal could not have come at a worst time.

Or could it?

The conventional wisdom holds that everyone is hoarding their capital right now - so skeptical about anything that they’d rather wait until after the election before they open folger’s can of cash sitting under their bed. Or was after the new year? Or was it after the inauguration? Or was it after winter? Or was it once ‘the economy comes back around’? (whatever that means and whenever that will be).

The fallout from the Madoff scandal is, of course, tremendous. I’m not trying to belittle it. After all, his ponzi scheme was so large that almost every major world financial institution was affected, including some of the wealthiest (and smartest?) investors in the world. Not to mention the unconscionable detriment of charities.

However, in the initial days after Madoff’s arrest, the same prominent financial news publication indicated that the Dow gained 3%, the S&P up 3.5% and the Nasdaq almost up 5% suggesting investors don’t care about the Madoff scandal so much. Of course, all three are down big-time as of this writing but that doesn’t have as much to do with the Madoff scandal as much it does with, in my opinion, years of unrealistic price to earnings ratios (and the volatility to the day traders getting in and out repeatedly).

So, do investors really care about the Madoff scandal?

Well, yes, of course they care. It’s another painful reminder that perception in the confidence of markets counts more than anything and homework is required on any investment and the promoter of that investment. Almost every investor I’ve presented our projects to since the Madoff scandal story was broken has brought it up (some know, or even have family members, who have lost money in one of Madoff’s investment schemes actually). And these are people we know, and that like us, have invested with us in the past, and are inclined to invest with us now. Imagine if they and we were complete strangers.

So, yes, it’s a major problem.

However, it’s also an opportunity to remember that capital raising needs to be seen as a relationship development exercise FIRST and that you must have an AUTHENTIC opportunity and that YOU remain authentic about yourself and the investment to your potential investors.

Do that and you’ll deserve the wealth that comes to you and your investors’ loyalty/good graces.

Tags: billions, borrowing, crime, finance, lending, madoff, money, ponzi, SEC