Banking Law

As we said last October,

...[I]t's likely that some bad legislation will be enacted that will over-correct prior (and no longer persistent) market practices and exacerbate the current credit squeeze by making housing credit tougher to obtain and more expensive for prime, as well as "less than Grade A," borrowers. Trying to fine tune business practices is like trying to fine tune the hot and cold water in your shower. First it's too hot, then too cold, then too hot, then too cold, and on and on until you get it just right. That kind of tinkering is generally best achieved by market participants who've been scalded and/or frozen and are sensitive to all the "nuances."

No federal legislation has yet passed both houses that directly affects prime loans, but the market is in the process of an "overcorrection" of underwriting practices that is making prime home mortgages more difficult to obtain. That's what a Federal Reserve Senior Officer Opinion Survey released yesterday reveals.

In the January survey, significant numbers of domestic respondents reported that they had tightened their lending standards on prime, nontraditional, and subprime residential mortgages over the past three months; the remaining respondents noted that their lending standards had remained basically unchanged. About 55 percent of domestic respondents indicated that they had tightened their lending standards on prime mortgages, up from about 40 percent in the October survey.2 Of the thirty-nine banks that originated nontraditional residential mortgage loans, about 85 percent reported a tightening of their lending standards on such loans over the past three months, compared with about 60 percent in the October survey.3 Finally, five of the seven banks that originated subprime mortgage loans noted that they had tightened their lending standards on such loans, a proportion similar to that in the October survey.

[...]

About 60 percent of domestic respondents indicated that they had tightened their lending standards for approving applications for revolving home equity lines of credit over the past three months.

I can verify this trend by personal experience. I refinanced my home mortgage last month, in response to a solicitation made by my current home equity line of credit lender, who sent me a "pre-approved" solicitation for a cash-out refinance loan at a very favorable rate. I'm pleased to report that our FICO score was excellent, so the rate and points were "prime." However, in his first contact with me, the loan officer reported that the lender would not require proof of income (I assumed that this was because they had received it the previous year when the HELOC was originated, not that this was a "stated income" loan). He called me the next day to advise that underwriting standards had tightened and that documentary income verification and deposit verification would be required or I would have to pay some additional points. Providing documentation was no problem for me, other than that the time I spent collecting and faxing documentation could have been better spent punishing legitimately billing my clients.

When it came time for an appraisal, further surprises were in store. The appraised value of my house this spring was 4% lower than the appraised value last spring, even though I am lucky to live in an area of the country, in fact, in a specific neighborhood, where the average real estate sales price has increased 3% last year. Both appraisals were performed for the same lender. Amazingly, the latest appraised value, although lower than last year's value, was exactly what I needed in order to obtain the amount of the first lien loan I applied for and to retain a HELOC in the existing amount from the same lender, and yet not exceed the maximum loan-to-value limits imposed by state law. I was absolutely stunned by this coincidence...

I know as well as the next guy that appraisal practice is not an exact science, and I have no reason to believe that the appraiser didn't do his job properly. On the other hand, it's obvious that while some lenders may have been pressuring appraisers to "pump it up" during the peak of the subprime feeding frenzy, the worm has turned. Appraisers now appear to be much more conservative.

I don't think that it's coincidental that my lender, which also happens to be my personal banking institution, is a major "player" that seems not to have participated in the excesses of the subprime meltdown. Rather, it appears to be one of the big winners, and one that may very well end up acquiring less conservative institutions.

In the late 1970s and 1980s, there was a conservative federal savings bank in Colorado called First Federal Savings Bank of Lakewood. It was run by a man named Malcolm ("Bud") Collier. During much of that time, I was one of the attorneys who represented the Colorado Savings & Loan League, and I'd often see and interact with Bud. I recall that we also did some legal work for his thrift. Other, more "high flying" S&L managers would laugh about Bud, because he said that all he knew was the residential mortgage lending business and that was what he was sticking to, regardless of the pressure the regulators were putting on him to diversify into acquisition, development and construction lending (a topic for another time). Other S&Ls grabbed onto the riskier loans and rode them right into insolvency. Bud not only survived, he prospered. He eventually converted his mutual association to a stock association owned by a mutual holding company (one of the first in that region), then later sold out to a larger commercial bank holding company when it was time to cash in his chips.

Obviously, he had the last laugh.

We appear to be in the initial stages of the "hot/cold" fine tuning of the underwriting process, with the conservative institutions, those who didn't cause the problems, trying to get it "just right" for a post-subprime world.  It will likely take a little time, but the survivors will eventually adjust it well enough to keep the residential mortgage markets intact. That is, they will if Congress, state legislatures, or the regulators don't manage to overreact and throw a monkey wrench into the works.