Subprime Fallout Could be Extensive Effects may reach beyond borrowers with poor credit histories By Sarah Colwell, columnist Bloomberg News May 4, 2008 During the past few years, mortgage brokers and financial service companies have been developing creative and aggressive ways to help prospective home buyers, even those with low credit scores, get their piece of the American Dream. Sub-prime loans usually carry a higher interest rate to compensate for the lender’s increased risk. In 2006, sub-prime loans totaled about $640 billion, or 20 percent of new mortgages, according to Credit Suisse Group, an international financial services company. Many sub-prime or near-prime loans were sold as interest only, adjustable rate mortgages, option ARM or negative amortization loans. Interest only loans require monthly interest payments only for a certain period of time. Because the principal is not reduced, the balance remains unchanged. With negative amortization loans, payments do not include interest, so the balance of the loan increases by the amount of the unpaid interest. ARMs have an interest rate linked to an economic index, so rates and payments can adjust up or down as the index changes. An option ARM is an adjustable rate mortgage with four monthly repayment options. Although these types of loans became known as “garbage loans” by many in the industry, they were popular among consumers. The loans made up 50 percent of the mortgages during the past two years, according to Nouriel Roubini, chairman of Roubini Global Economics LLC. Consumer ignorance about mortgage products and mortgage fraud might be reasons why so many people applied, said Craig Carnick, a financial planner with Carnick & Co. “The fact is that the real estate industry has encouraged this behavior,” Carnick said. “People don’t do their homework and, because of their credit, they think they are not in any shape to argue the deal. So, by the time they get to closing, they’ll sign anything including a deal with the devil.” Colorado posted the highest foreclosure rate in the nation for nine of 12 months during 2006, with an annual average of one foreclosure filing for every 33 homes, according to California-based RealtyTrac. In El Paso County, foreclosures are on track to reach a record in 2008, according to the Public Trustee’s Office. In March, there were 325 foreclosures, which is a 45.1 percent increase compared to March 2006 and the highest monthly foreclosure total on record. The total number of foreclosures in El Paso County during the first quarter of this year was 828, a 42.3 percent increase from the first quarter of 2006 and more than the annual totals from 1993 to 1998. Aggressive mortgage products and unexpected increases in payments are, in part, to blame for the rising number of foreclosures, according to The Colorado Bankers Association’s 2006 foreclosure analysis.

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About 16 percent of foreclosures in Colorado during 2006 were on loans that originated from banks and 77. 5 percent originated from non-bank lenders, according to the analysis. In Colorado, there are no educational requirements for a person to become a mortgage broker and there were no regulations until January. Experts speculate that many borrowers who are defaulting on their loans put too much trust in mortgage brokers and agreed to loans they had no ability to repay. There are several bills being considered by the state Legislature that would stop mortgage fraud and increase regulation of mortgage brokers. Loan defaults are having a rippling effect in the financial industry both nationally and locally. Since December, more than 60 sub-prime lenders have closed or filed for Chapter 11 bankruptcy. Last month, H&R Block sold its sub-prime unit, Option One Mortgage Corp., to OOMB Acquisition Corp. for $300 million less than the value of Option One’s net tangible assets — $1.27 billion as of Jan. 31. Wells Fargo & Co. recently settled a $6.8 million class-action lawsuit alleging improper sub-prime mortgage lending practices in California. Washington Mutual Inc. reported a 20 percent drop in earnings and the second consecutive quarterly loss in its housing division because of sub-prime mortgages. “I think every type of loan that’s out there is interrelated, so if there is a major challenge in one area, it is going to trickle into other areas of lending,” said Tim McDonald, regional sales manager of Wells Fargo Home Mortgage non prime lending. “How much is really the issue. I think the jury is still out on that one. It’s all interrelated.” John Kitchen, marketing president for J.P. Morgan Chase Bank in Colorado Springs said there will be a clear impact on the availability of money and in borrowers’ ability to qualify for loans. “It’s going to affect investors and institutional investors,” said Bill Moyer, a financial analyst with Carnick & Co. “If these loans are bundled and packaged into securities, they will find their way into pension funds.” The problem isn’t likely to go away any time soon. More than $1 trillion in ARMs are scheduled to reset in 2008, the majority this summer, according to several industry experts. A tightening of the market might be a good thing, because it was probably too aggressive, according to Dan Bathje, a mortgage specialist with Strong Tower Mortgage. Some lenders have shifted their focus to credit restoration and financial counseling for clients with poor credit seeking home loans. The rental market also might improve because 30 percent to 40 percent of sub-prime loan availability has evaporated and lending standards have been raised, said McDonald with Wells Fargo. “Just about every company I know did some kind of ARM loan. Now there are just less sub-prime loans out there,” Bathje said. “So, it might not be as easy for some people to get a loan these days, but that’s OK. There are still things available, but it may mean they have to have a down payment or wait six months to a year.”   FDIC addressing problems in sub-prime mortgage lending The Federal Deposit Insurance Corp. and other federal bank regulators have proposed for public comment a statement about issues relating to sub-prime mortgage lending, including concerns about borrowers not completely understanding the risks of certain adjustable-rate mortgage (ARM) products, in part because lenders do not always explain them. The proposed statement reinforces the concept that financial education can help consumers make smarter decisions, particularly if they learn to ask questions about product terms. The deadline for comments is May 7, 2008. Contact, Beverlea (Suzy) Gardner at bgardner@fdic.gov or (202) 898-3640 or Mira Marshall at MMarshall@fdic.gov or (202) 898-3912     By Sarah Colwell, columnist Bloomberg News May 4, 2008 Colwell is a staff writer with the Bloomberg Financial News, and an expert on banking and lending issues.

Bills about mortgage fraud and mortgage broker licensing Sign up for the CSBJ daily e-mail for updates HB-1322: Mortgage Fraud Prevention Act A mortgage broker shall act for the benefit of the borrower by taking actions that include, but are not limited to, making a reasonable inquiry concerning the borrower’s current and prospective income, existing debts and other financial obligations. The mortgage broker must then use his or her best efforts to recommend a loan that takes that financial information into consideration. SB-085: Protect Consumer Real Estate Transaction The legislation prohibits a mortgage broker from improperly influencing a real estate appraisal and makes such improper influencing a deceptive trade practice. It specifies criminal penalties for such misconduct and authorizes the director of the division of registrations in the department of regulatory agencies to revoke a mortgage broker’s registration when the broker has improperly influenced a real estate appraisal or has, in the previous five years, been enjoined by a court in any state from brokering a mortgage. SB-203: Mortgage Broker Licensing The legislation changes the regulatory framework for mortgage brokers from registration to licensing. It requires mortgage brokers to maintain errors and omissions insurance coverage and defines the grounds for denial, revocation or suspension of a license. It also requires all documents relating to a mortgage loan for residential real estate to be provided to the borrower at least two business days before closing. SB-216: Mortgage Loan Fraud Acts Practices The legislation creates a duty of good faith and fair dealing for mortgage brokers in their communications and transactions with borrowers. It requires refinancing transactions to have a tangible, net benefit to borrowers. It specifically defines acts and practices that are deemed unconscionable when committed by a mortgage broker, real estate appraiser and others and directs the banking board and the director of the division of real estate to adopt rules incorporating appropriate provisions of the “Interagency Guidance on Nontraditional Mortgage Product Risks” promulgated by the U.S. Department of the Treasury and other federal agencies But as more of those borrowers are defaulting on their sub-prime loans, some lenders are filing for bankruptcy and others are tightening their lending standards — which could have an effect not only on borrowers who don’t have great credit scores, but also on those who have good credit, according to some experts.

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