Like a Hallowe’en zombie rising from its grave, lucrative subprime mortgage lending is poised to make a comeback with the help of a forgiving secondary market, an improving housing market and new tools to assess risk.
Subprime lending?mortgages made to borrowers whose risk factors are so high they don’t qualify for prime loans?never entirely disappeared even though the practice was widely blamed for the 2007 crash of the secondary mortgage market that triggered the US housing crisis and a worldwide recession. In the latest survey of senior loan officers by the Federal Reserve in July, for example, six out of sixty lenders, all banks, said they still make high cost subprime loans to high risk home buyers. That’s more than twice subprime lenders as in April, when too few responded to the survey to be counted.
Five years after the subprime crash, a renaissance in subprime mortgage lending may be greeted warmly by Wall Street. In July, as the national housing market started to show signs of life, investor interest in non-agency subprime-mortgage bonds from 2005 through 2007, the years that produced the most defaults leading to the worst financial crisis since the Great Depression, soared to 5.4 percent on the private market. Securities backed by option adjustable-rate mortgages jumped over the past month by 7 percent to the highest level since May 2011.
“There’s been a lot of investors waiting on the sidelines until home prices stabilize and now that they have, they’re moving in,” said Adam Yarnold, managing director of securitized products trading in New York at Barclays’s investment-banking arm in July. In addition, “the absolute low level of rates out there is driving institutional investors like pension funds to put money into anything with” returns that can top 7.5 percent and so- called non-agency securities offer that potential, he said. Investors in mortgage bonds are gaining confidence the housing market has reached a bottom, in part because of a surge in money devoted to buying and renting out foreclosed homes, Barclays’s Yarnold said.
Subprime-mortgage securities lost an average 5.5 percent last year, Barclays’ index data show. Some of the debt fell as much as 30 percent from early 2011 peaks. Record defaults on subprime loans, which went to borrowers with poor credit or high levels of debt, sent bond prices tumbling and helped spark the financial crisis that led to $1.6 trillion in write downs and losses at the world’s biggest banks.
A major subprime lender, Residential Capital, is poised to reap billions in a bankruptcy auction of its subprime mortgage assets as high-profile bidders, including Fortress Investment Group’s Nationstar Mortgage Holdings and Warren Buffett’s Berkshire Hathaway line up for an Oct. 23 auction that could raise the money it needs to repay creditors. The key asset on the block is ResCap’s mortgage loan servicing and loan origination business. The sale is expected to raise at least $4 billion, which will then become part of a pool of money used to pay back Ally and other investors.
Though the GSE’s stopped buying subprime paper after the 2007, which drove virtually all major lenders out of the subprime mortgage market, tougher regulation and new tools using the latest technology to assess risk may make future subprime lending less risky.
A new tool “FICO Mortgage Score” introduced by CoreLogic last week helps lenders evaluate and approve applicants who otherwise might not qualify for a mortgage based solely on their traditional FICO score. The score combines a traditional FICO score with a supplemental score called CoreScore, a credit formula that debuted last fall from CoreLogic. CoreScore looks at financial records such as credit card borrowing, bank transactions and mortgage information, and examines the kinds of transactions likely to occur at the lower end of the income scale. These include car and rental payments and payday loans. The score even examines the record for missed child support payments.
Experian also recently launched a new credit score in June called Extended View, targeted for use by banks, credit unions and auto lenders, as well as phone and utility providers. Experian says the new score could bring as many as 64 million new borrowers into the lending fold.
As access to financing continues to stifle the housing recovery, the demand for subprime loans will surely be great among prospective buyers tho can’t meet today’s strict lending standards.. Only 39 percent of applications for purchase mortgages were approved and closed in August, according to Ellie Mae. The median FICO score for closed loans was 750 compared to 708 for denied applications. Last year the total volume of mortgages that ran through Ellie Mae’s Encompass360 software was approximately two million loan applications, or 20 percent of all U.S. mortgage originations.