Burned by “fancy” subprime and exotic mortgages, home buyers look to traditional lenders and plain-Jane products. Four community banks tell their storie
By Melanie Scarborough, freelance writer, and former managing editor of Community Banker magazine
Burned by subprime and exotic mortgages, home buyers look to traditional banks and plain-Jane products. The experiences of four community banks tell the story
It may be premature for all community banks to stock up on fatted calves, but anecdotal evidence suggests prodigal consumers are returning to hometown lenders. Borrowers lured away by the fancy offerings of nonbanks and specialty players now seem to realize that those cheap loans came at a very high price.
Subprime lending wreaked havoc from which the housing market still suffers. Irvine, Calif.-based RealtyTrac reported 2.8 million foreclosure filings in 2009, up 21% from 2008 and 120% from 2007. Residential mortgage originations dropped 17.7% in the third quarter of 2009, according to the Mortgage Bankers Association. Commerce Department figures show that new home sales fell in December to an annual rate of 342,000, a greater decline than economists had predicted.
Yet regulated banks and savings institutions made very few subprime loans; most local community banks made none. An ABA survey conducted among 248 community banks in the fourth quarter of 2007 found that most were focused on prime lending, principally conforming loans. Respondents held 68.5% of their loans in portfolio, with the remainder sold into the secondary market. Fixed-rate loans accounted for 76% of loan production.
Having eschewed toxic debt, community banks are well positioned to assume business previously lost to free-wheeling lenders—as even federal regulators implicitly concede. Last year, the FDIC established an advisory committee on community banking, which met earlier this year to discuss “Community Banks as Growth Engines.”
Have more of them taken advantage of the vacuum as customers sidelined specialty players? The most compelling evidence is first-hand accounts from community bankers themselves. In this report, we present the experience of four community banks—some commercial, some savings institutions—in the mortgage origination business.
1.FIRST SHORE FEDERAL Maryland
A niche player grabs share
The local residential real estate market for First Shore Federal Savings and Loan Association, Salisbury, Md., is fairly flat in property transfers. Yet the $330 million-asset thrift grew its business in 2009. “Our total loan growth was about 10% for the year,” says Martin Neat, president and CEO, “and that was certainly not from a lot of refinancing and not from growth in the local market. Without question, it’s from getting a bigger piece of the pie.”
Neat says more and more customers seem simply to recognize the value of community banks. “I think they’re getting the message—more than perhaps they did in the last few years,” he observes. He also mentions that he has received comments from customers who say that in the past, the bank would not have gotten a shot at a loan because the customer would have gone to a broker instead.
First Shore Federal attributes much of its success to being a niche lender. “We hold our loans; we don’t sell them,” Neat explained. “So we’re not going to make a lot of 30-year, fixed-rate loans at current rates because that’s just not good business. We tend to look for shorter-term loans.” First Shore Federal does a brisk trade in jumbo loans, which investors mostly stopped buying after the credit crunch, as well as 10/1 hybrids (fixed for ten years, then adjustable annually). “We look for places in the market that we can compete in without having to guarantee the present rate for 30 years,” he said.
When other segments of the industry relaxed underwriting standards, First Shore Federal did not—a decision that proved wise. “At the end of last year, we had five properties either in foreclosure or in-substance foreclosure out of 1,600 loans, and that actually reflects some deterioration,” Neat said. “Earlier in the year, we had only one. I don’t consider five to be alarming.”
What he does find alarming is that the bank may be forced to change its practices to accommodate regulatory changes. Neat cites as an example First Shore Federal’s Community Reinvestment Act work with an organization that originates loans and sells them to local banks. “Because of some of the requirements for disclosure of settlement costs [required by recent changes to the Real Estate Settlement Procedures Act], we have to be very careful when dealing with brokers because we now have to live by that disclosure, and that’s not always going to be acceptable to us,” he said. “So we won’t be able to buy that loan without somebody having to pay those settlement costs. It complicates those sorts of partnerships immensely.”
Nonetheless, Neat is confident that community banks’ business will continue to grow as appreciation grows for the banks’ stability. “I suspect we’re not the only ones who have experienced this demand,” says Neat.
2. HOME STREET BANK Washington State
Discipline pays off for mortgage specialist
HomeStreet Bank in Seattle has also enjoyed growth while subprime lenders faltered. Richard Bennion, executive vice-president and residential lending director for the $3 billion-asset bank, says their total mortgage production for last year was $2.85 billion. Almost all of that —$2.73 billion—was residential. “During this time of stress for the financial markets in general—and I’m going back to 2007—our single-family mortgage business has grown year after year,” he says. “We grew 11% in 2008 over 2007, and that was not a refinance year; that was regular home purchase.” The 11% is particularly remarkable because the bank’s market began declining that year. “There were fewer transactions available, and yet our business grew.”
HomeStreet had even more of a growth spurt last year, with business increasing by 57% over 2008.
“There are two components to that: One is we did well in capturing more of the purchase business—and there was less of it out there in 2009 because the market was weaker,” Bennion says. “But last year started out with a big refinance boom. The first half of 2009, in particular, we were flooded with refinancing because rates dropped sharply at the end of ’08.”
That phenomenon was industry-wide, Bennion pointed out; and, as a servicer, HomeStreet tends to do well when its own customers want to refinance. “But I can tell you anecdotally that we know we captured a lot of refis from customers who had their mortgages with big banks or other companies that had been absorbed,” he says. “I get a lot of comments from our staff that they have been able to capture business—refi in particular—from some of the big banks because the people customers used to deal with there are gone.” Shrewdly, HomeStreet hired some of the former employees of those failed institutions.
Certainly, it helps to have less competition. “A few years ago, there was a broker on every corner. Now there’s not,” Bennion says. But HomeStreet’s greater advantage is that the bank never allowed itself to be a one-trick pony. “If you were a lender primarily doing portfolio lending or brokering products that went away, what do you do?” Bennion asked. “When all that stuff went away, what was left was what we do—Fannie Mae, Freddie Mac, VA, FHA. That has helped us in the purchase market as well as refinance. We know how to execute, process, and close those products in a timely and efficient manner, and it’s really benefited our business.”
HomeStreet has never used brokers or taken third-party originated loans. It doesn’t warehouse loans for mortgage banks and is not a wholesale lender. However, it did alter its business approach slightly in recent years. “Until about 2008, we had a few portfolio products that we offered in the market, mainly for jumbos,” Bennion says. “We discontinued those because of balance sheet management issues.”
The bank’s underwriting standards mirror secondary market guidelines and agency requirements and change when those do—if not before. “Going back to about 2007, we started tightening a few things—credit scores, payment-to-income ratios—before [the agencies] did.” HomeStreet sells its conventional mortgage-backed securities in Fannie Mae and Freddie Mac pools, a market that has been challenged in the past couple of years. “There isn’t much of a market, however, for MBS backed by jumbo loans,” he says. “That’s where the illiquidity is.”
Because property values in the Northwest did not inflate as much in recent years as those in other parts of the country, HomeStreet’s market suffered less turmoil and is recovering more readily. “In general, house values are down from two years ago, but they’ve started to firm up—especially in entry-level prices—for many years in a row around here,” Bennion says. “I’m cautiously optimistic. We see lots of signs that it’s improving: more transactions, firmer prices—we’re even hearing reports of multiple offers and houses selling above list price.”
The bank’s foreclosure rate today is slightly higher than its usual rate of less than 2%, but still far below the national and regional averages. “That’s a function of two things,” Bennion says. “We’re good originators and servicers, and the economy and housing market in the Northwest have stayed stronger than the ones that make all the headlines. The whole housing market isn’t Las Vegas.”
3. FIRST NATIONAL BANK Nevada
A bright spot in the worst state
As the hardest hit city in the hardest hit state—2009 marked the third consecutive year in which Nevada had the highest foreclosure rate—Las Vegas may qualify as the epicenter of the housing crisis. According to First American CoreLogic Inc. in Santa Ana, Calif., 69% of all mortgaged properties in Las Vegas are worth less than the amount owed on them. Many of the state’s other markets are struggling as well. RealtyTrac’s numbers show more than 10% of residential properties in Nevada were subject to at least one foreclosure filing in 2009—up 44% from 2008 and 226% from 2007.
With Nevada’s record-high unemployment rate of 13%, and residents gusting out of the state like desert sand, the glut of vacancies continues to rise and further drive down home prices. Yet not all mortgage markets or mortgage lenders in the Silver State are tarnished. Nevada’s oldest bank, First National Bank of Ely, has seen its mortgage originations rise.
The $75 million-asset bank serves a small community largely unaffected by the economic problems facing Las Vegas and Reno. Ely is a mining town, and the industry there is thriving. Another factor primarily accounts for the increase in mortgage purchases: Not everyone born in Vegas stays in Vegas. “Our real estate lending has picked up a little in the past month or two, but a lot of that is people from Vegas coming in and buying secondary homes,” says President John Gianoli. Because of its higher elevation, Ely is cooler than Las Vegas. It doesn’t have urban congestion and crime. “The older generation who knew Vegas before it got so big are looking for excuses to get out,” he says. Having discovered Ely and found it appealing, they are buying and restoring homes there. Gianoli says their total real estate lending was just over $12 million, which includes everything from construction to farm-secured loans to 1-4 family residences.
Still, customers have options in choosing a lender. Ely has other commercial banks—one a megabank—and a credit union. Yet the 103-year-old First National Bank of Ely holds its own and then some, perhaps because it clung to traditional practices when insurrection infiltrated the industry. “We do only conventional loans—very generic fixed-rate,” Gianoli says. “We don’t get involved in a lot of points, extra fees; we take a very straightforward approach.” That includes not participating in any government lending. “We’ve had people over the years ask us to get involved in programs like VA, but the paperwork is a little too draconian for us.”
The bank adjusts its rates according to market fluctuations and has changed the terms of its loans when necessary. “Terms on loans used to be fairly short because mines had ups and downs, and we catered to that income stream,” Gianoli says. “We’ve become more lenient on that if for no other reason than because the average real estate loan is on your books for seven or eight years before [the owner] moves on or buys another house.”
But down payment requirements and other measures of loan-worthiness remain the same. “The worst thing you can do is relax your underwriting standards to enhance volume,” Gianoli says. “That always comes back to haunt you.”
The specter of foreclosure has been raised in Ely, mostly on loans funded by outside entities. First National has none in progress and Gianoli says he can count on one hand the bank’s past foreclosures. That reflects his diligence in preventing such situations, believing banks bear a certain culpability when they allow customers to become overextended. “I moved here in 1978 after working for a bank in Reno,” Gianoli says. “Just before that was when they started marketing home-equity loans, and I thought, ‘This isn’t a good direction.’ We were enabling the idea of ‘get a second [mortgage] on your home and buy a boat’.”
No matter how conservative his philosophy or how prudent his lending practices, Gianoli cannot immunize his bank from Nevada’s dire economy. “People are sensitive to that even if it isn’t directly affecting their employment or pocketbook,” he says. “They’re tightening up a little, so we don’t see the demand for loans we would have seen a couple of years ago.” Contrary to the canard that banks won’t make funds available, Gianoli says he “would be more than happy to make quality loans—but the number of people applying is declining.”
Yet something causes customers and prospective borrowers to choose First National over other institutions. One possible explanation? The bank’s commitment to treating all customers equally. “Our fees are probably lower than anyone’s in town—including the credit union,” Gianoli says, referring to all types of fees, not just those related to mortgages. “I understand why some banks jack up fees to increase revenue, but fees are injurious to the little guy. If you’re a big business or a big depositor, you’re going to call up and get them reversed. But the little guy isn’t.” Accordingly, First National Bank of Ely applies low fees to everyone. “We fancy ourselves as what community banks truly should be about.”
4. PULASKI BANK Missouri
An island of stability
Because of its large mortgage-origination unit, Pulaski Bank, St. Louis, has an asset size atypical for a community bank. Even so, the $1.4 billion-asset institution could have expected a drop in business during the past few turbulent years. Instead, says Matthew Locke, president of the mortgage division, “We closed $2.3 billion in 2009—our biggest year ever and also probably the most difficult time to get loans approved.”
A high refi volume partly accounted for Pulaski Bank’s big year, but Locke also attributes growth to the trend of business returning to community banks. “What we have seen, especially from the real estate community, is the desire to do business with a bank—someone they can trust to get the loan closed,” he says. “After what transpired over the past few years with mortgage brokers, we have seen a transformation. People are looking more toward community banks, or banks in general, for stability.”
There is virtually no refi activity at this point because homeowners eligible to refinance have already done so, Locke speculates. Right now, it is mostly a purchase market—and a fairly robust one for homes in certain price ranges. “What we’re seeing in our own little backyard is that activity seems to be below the $250,000 mark,” Locke says. “People who might be buying $350,000 or $400,000 houses don’t have to move, and based on economic conditions, aren’t going to make that choice.”
Pulaski Bank did not change its business approach as the housing market spiraled. “Since we’re 100% percent retail, we don’t buy from other shops or brokers,” Locke says. “We’re originating and, after closing, selling to larger investors within 60 days. So we’re having to meet the ever-changing demands of the secondary market, which is a moving target.” Warehousing loans for mortgage banks is not on Pulaski Bank’s agenda because of the added risk.
Despite his bank’s success, Locke can envision a worst-case scenario for community banks. “There is reason to be concerned when you see mortgage brokers evaporate over the past two years because we now become the low man on the totem pole,” he says. “I don’t believe our channel is threatened, but I can’t help worrying that it could be the very big banks originating mortgages at the end of the day. We’ve had excellent years the past couple of years. But when Fannie, Freddie, and even Ginnie are having difficulties, it becomes somewhat of a risk or unknown factor.”
On the other hand, he says, it could be to community banks’ advantage that so many mortgage brokers have gone out of business—about two-thirds of those operating two years ago, with the remaining one-third grappling with warehouse funding issues. “Now that FHA is on record saying they’re going to raise their minimum net-worth requirement,” he says, “that could put the other one-third out of business and drive lenders to community banks or banks in general.”
Based on Pulaski Bank’s experience—as well as that of First Shore Federal, HomeStreet, First National Bank of Ely and others—the latter prospect appears more likely. Indications are that business previously lost to specialty players is returning to community banks. “We feel that we provide a high level of service to communities and can out-hustle or out-serve national lenders,” Locke says. His colleagues certainly agree, as do increasing numbers of customers. “We‘re seeing a flight to quality,” he says, summarizing the trend. “The real estate community wants to deal with someone they can trust and who’s going to be here in a year. That bodes well for community banks in general.” BJ
The electronic version of this article available at: http://www.nxtbook.com/nxtbooks/sb/ababj0310/index.php?startid=16