No Mortgage Meltdown For These Banks

The news from Wall Street in recent weeks has not been good, especially in the world of mortgages. Famous lenders with once-fabulous finances are turning up in the headlines among the broke and busted. One result is that the mortgage meltdown is described in global terms, as if all lenders offered toxic loans during the past few years and the entire financial community is universally in trouble.

The facts are different. A number of lenders have maintained traditional underwriting standards and mortgage offerings. Such lenders today are both profitable and growing while competitors flounder and fail.

“When you look at the banks which are successful today you don’t see some magical formula that produced such results,” says James J. Saccacio, chief executive officer at the country’s largest provider of foreclosure data and listings, “Instead, what you see are lenders who merely stuck with tested, traditional lending concepts. They thought long-term instead of quarterly; made sure their underwriting standards made sense and now show profits.”

Which lenders? Let me introduce you to Hudson City Bancorp and ING Direct.

Hudson City Bancorp
Situated in Paramus, N.J., not far from Manhattan, Hudson City Bancorp has a lending philosophy that dates back decades: You can get a dull, boring, mortgage from Hudson at a very low rate — but only if you put equity into the property.

In the era of go-go banking, “non-traditional” loans and “affordability” products, Hudson sounds like the type of lender that should be displayed at the Smithsonian. Unlike virtually every other mortgage lender, Hudson doesn’t make option ARMs, doesn’t sell loans in the secondary market and doesn’t offer credit cards.

As company Chairman, President, and CEO Ronald E. Hermance, Jr. told me, Hudson is really a “spread lender” that’s interested in two things: efficiency and credit quality.
The term “spread lender” means that Hudson makes its money on the difference between the interest income it earns from loans and the costs it pays out to operate its business. While other lenders derive a large part of their income from penalties and fees, Hudson stays away from such extractions and instead tries to reduce operating expenses.

Hudson has deposits of $49 billion, a network of 125 branches in New Jersey, New York and Connecticut and just 1,350 employees — a fraction of the workforce one would find with banks of similar size.

Hermance explains that company incentives are related to credit quality and not stock prices. The result is that the company has small expenses and few bad loans so it costs Hudson about 20 cents to create an additional dollar of revenue versus the industry standard of roughly 61 cents. Hudson also had a net income of $110.7 million in the second quarter — that’s up 52 percent from a year earlier.

Speaking at the start of September, Hermance said his bank had some 80,000 mortgages outstanding. Of this number 328 (.41 percent) were classified as “non-performing,” an expression which means that borrowers were at least 90 days late. This compares with a first quarter delinquency rate of 6.35 percent of all loans outstanding according to the Mortgage Bankers Association.

But the real story with foreclosures is different: The fact that a loan is delinquent does not mean foreclosure is sure to follow. Loans can be brought current and homes can be sold or refinanced to avoid foreclosure. As one example, Hermance says that of 50,000 New Jersey mortgages his bank bought back just two properties during a recent 12-month period.

The “secret” to Hudson’s success is fairly simple: The bank has strict underwriting standards and requires a lot down: The typical loan has a 61.5 percent loan-to-value ratio meaning that the borrower has put in cash or equity equal to 38.5 percent of the property’s value. Interestingly, the bank’s delinquent mortgages have a 69 percent LTV, meaning that Hudson has very little risk even if a borrower fails.

The Hudson down payment numbers contrast strongly with national averages: The National Association of Realtors reports that in 2007 the typical first-time buyer put down just 2 percent, repeat buyers had 16 percent down payments and 25 percent of all purchasers bought with nothing down.

Hudson offers mortgages on special terms for borrowers with low and moderate incomes, however, it does not market option ARMs or subprime loans, nor does it originate FHA or

VA mortgages. The reason Hudson avoids government-backed loans is that such mortgages represent steep processing costs.

The situation with jumbo mortgages is different. Fannie Mae or Freddie Mac doesn’t buy jumbos, mortgages with loan amounts above the “conventional” mortgage loan limit of $729,750 this year. Hudson, however, readily makes bigger loans. Why? It doesn’t sell mortgages in the secondary market, thus Hudson doesn’t have to abide by conventional loan standards. It can make its own.

Because Hudson does not sell loans to the Fannie Mae, Freddie Mac or the secondary market in general it has no need to create “conforming” mortgages. Instead, it sets its own standards and then keeps the loans it originates. As Hermance points out, “we make loans we’re willing to live with.”

The performance at Hudson has not gone unnoticed: The stock is up 1,100 percent since the company went public ten years ago.

In 2005 the federal government moved to tighten bankruptcy rules in a way that would make debt forgiveness difficult if not impossible. At the time of that debate virtually all banks, credit card companies, student loan lenders, car financing firms and related businesses stridently supported bankruptcy “reform” — but one notable exception was ING DIRECT.

In a remarkable advocacy ad in The Washington Post, ING said “we believe that lending institutions should share responsibility with the people to whom they lend. Through aggressive marketing, irresponsible lenders create their own problems. When something goes wrong and irresponsible lending has played a role, lenders should shoulder their share of the consequences as surely as they do the profits of that lending. It’s only fair.”

That sounds pretty good, but what does ING do in practice?

“ING DIRECT has always made loans with the intent of holding onto the loans,” said Bill Higgins, chief lending officer at ING DIRECT USA. “Therefore, as we say, the risk we create is the risk we keep.”

Higgins says that “portfolio lenders” such as ING — lenders that originate and keep their loans — have become rare because today most mortgages are quickly sold in the secondary market. While it used to be that local lenders and borrowers shared risks under the traditional arrangement, today it’s loan originators and distant investors who do the risk-sharing. Unlike local lenders, originators and far-off investors are unlikely to have any relationship with the borrower beyond collecting monthly payments.

“Put another way,” says Higgins, “the human element of a borrower in distress is replaced by a mathematically modeled overlay of cash flows.”

ING DIRECT doesn’t have too many borrowers in distress: Of more than 100,000 loans just 96 foreclosures have been completed. That’s .096 percent compared with the .99 percent national norm. In other words, a typical mortgage lender would likely have almost 1,000 foreclosures.

How does ING do it?

“As a portfolio lender,” says Higgins, “ING DIRECT has consistently believed in the importance of borrowers having ‘skin in the game’, or equity in the property. We typically look for borrowers to have 20-30 percent equity. Volatile real estate markets such as today support such prudence.”

Even with such caution, Higgins says “still we aren’t protected in every instance where values can drop even more substantially.”

As part of its share-the-risk philosophy, ING reduces borrower exposure by limiting financing choices.

“We have NEVER offered option ARMs,” says Higgins. “We offer interest-only mortgages, but require more equity from such borrowers than is required from borrowers who will actively repay principal. It’s a financial instrument that may be right for some, but it wasn’t meant to be the mass merchandised product it became.”

Higgins points out that “ING DIRECT has kept every loan it has originated. That’s part of our business model.”

ING DIRECT is part of the ING Group, what Higgins describes as the “largest financial services company in the world.” He says the parent company supports a long-term business view, something which differs from most other mortgage lenders.

As Higgins explains, you can’t focus on near-term profitability when loans stay on your books for years. Instead, you have to think long-term — and shared risk. It’s an approach that seems to be working. While many lenders are underwater, for the second quarter of 2008 the ING Group reported net income of $1.9 billion.

What About The American Dream
No doubt there are other lenders out there who have practiced safe banking with the result that they are today profitable. But is the future of mortgage lending restricted to steep down payments or oodles of mortgage insurance?

Most likely the answer is yes and it means that homeownership percentages are likely to fall.

To some this will be seen as the erosion of the American dream, the idea that homeownership is for everyone, a natural right of sorts. But while universal ownership might be the dream, the reality is different and has always been different: The mortgage marketplace is open to those who prefer homeownership — and have the financial means to make it work.

The alternative is what we see today: Mortgages for everyone and the search for short-term lender profits, followed by a financial carnage that destroys home prices, devalues pensions, destroys jobs and undermines the value of the dollar.
Peter G. Miller is the author of the Common-Sense Mortgage and is syndicated in more than 100 newspapers.

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