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Rick Pollack · Loan Origination Basics

October 23rd, 2008

I figured it might be helpful to describe the structure of the loan origination process used in my previous post. Understanding 1990s era subprime loan origination offers a baseline for comparison with subprime offerings over the last few years.

This example was typical of actual lending at The Associates (TA) during the mid to late 90s. TA, the largest publicly traded finance company in the U.S, was acquired by Ford in the late 80s and then spun off again in the mid-90s and was then acquired by Citi in 2000. http://www.citigroup.com/citi/corporate/history/associates.htm

Account executives, commissioned employees of TA, solicited deals from independent mortgage brokers. The brokers found borrowers (the end consumer) through a number of channels including bulk mail, cold calls, advertising, etc. The broker worked with the borrower to structure a deal – this involved gathering the necessary information to meet the requirements of a particular loan type (financials, debt, etc). The deal was then shopped around to different lenders (TA account executives routinely visited the brokers to keep them up to date on products and rates. The account executives could also do pre-approvals in the broker’s office). If TA was selected; the deal was then submitted to TA for underwriting. The underwriters were located in a small number of centralized, regional offices.

Brokers are independent operators and they get paid a commission when a deal closes and therefore have a financial interest in the deal closing. Account Executives, as TA employees received both a salary and commission based on deal volume and meeting sales goals, as such they also had a financial interest in deals closing. The underwriters were salaried TA employees who did not get compensation based on deal volume. There was a running battle between sales and underwriting – sales pushed for deals to be approved while underwriting pushed back as they were the gatekeepers and charged with maintaining deal quality. Senior management had to balance the often competing objectives of meeting sales goals while maintaining quality standards.

These TA loans were considered subprime and non-conforming as the borrowers had credit problems, excessive debt and other credit-worthiness issues. Most of these deals did not meet the GSE (Fannie/Freddie) underwriting requirements. Once the deals closed they were held by TA and serviced in-house. (As far as I know, and this is by no means certain, these deals were not being packaged and sold as mortgage backed securities.)

Also, it is my understanding, that underwriting was taken seriously. The underwriters were professional, they were aware of fraudulent activity and they actively sniffed-out questionable material. Deals that did not meet underwriting standards were turned down. I don’t know about the soundness of the TA risk models but the interest rates on these subprime loans were several percentage points higher than prime loans – meaning the risk of the loan was expressed through higher interest rates. (I mention this as underwriting standards and interest rate spreads play a significant role in the future meltdown – I will get into this later.)

I learned most of this from a family member working in operations for TA. From my vantage point, TA was a legitimate company providing a needed service to credit-challenged people in a fraud ridden environment. My understanding of predatory lending and all of the associated ills and issues developed much later. (I will get into more fraud issues later.)

The following links provide a rather different portrayal of TA:

From Tearing Down the Walls by Monica Langley:

After Citi acquired TA – they suspended 3,600 independent brokers of subprime mortgage loans – about 60 percent of the Associates’ contractors-for having inadequate licenses, using questionable tactics, or failing to sign a code of conduct…

Google Books p. 367-369   http://tinyurl.com/5r7wlh

Shareholder Resolution Follows Associates First Capital to Citigroup

http://www.socialfunds.com/news/article.cgi/440.html

Citigroup Settles FTC Charges Against the Associates

Record-Setting $215 Million for Subprime Lending Victims

http://www.ftc.gov/opa/2002/09/associates.shtm

http://www.innercitypress.org/citiafcc.html

http://www.federalreserve.gov/boarddocs/press/enforcement/2004/20040527/attachment.pdf

FTC subprime lending cases since 1998

http://www.ftc.gov/opa/2002/07/subprimelendingcases.shtm

Last 5 posts by Rick Pollack

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5 Responses to “Loan Origination Basics”

  1. Carole Cohen Says:

    So far the red flag to me is the % spread. But that was not illegal. I have one client who would not be deterred from buying a house in 2005. She got a loan for 10% financinc and 3300 dollar closing costs. House was much less than 100k in sale price; way too costly. I had already gotten her away from a lender who had higher interest rate and almost 5k in closing costs. Our company lender had said she wasn’t ready, advised her to go with our credit counseling wing for free for a year and get things cleared up so she could purchase a home in 12 months on much better terms. She went ahead anyway.

    I can’t wait to hear more and i love the links already read three! Thanks Rick

  2. J Murray Says:

    Rick, interesting posts and links. I have said it before, and I’ll say it again: predatory lending was largely a local practice engaged in by small, local businesses–even though the media and political focus is on the big, bad wolves of Wall Street. Once big banks like CitiCorp step in, as public corporations with public shareholders and public profiles, they have to clean up the bad practices.

  3. Rick Pollack Says:

    That’s a good point Jonathan but I think the evidence indicates that it is only partially true. There is no question that predatory lending was done by independent, local businesses.

    However, The Associates was the largest publicly traded finance company and held a $30B portfolio when they were acquired by Citi. Yes, Citi did move to clean up problems – either by their own doing, government enforcement or shareholder activity. But before the acquisition, The Associates had a target rate of adding credit insurance to 30% of their loans. From the ‘record setting’ $215M settlement noted above, ‘The complaint charged that The Associates engaged in deceptive practices designed to induce borrowers unknowingly to purchase optional credit insurance products, a practice known as “packing.”‘

    What is kind of interesting is that the credit insurance was sold by the loan processors. I skipped over the loan processors in this piece since they have a low-paid administrative role (putting the paperwork together for underwriting and closings). It was during the pre-closing call with the borrower (where a loan processor reviewed the terms of the loan) that credit insurance was offered. I’m not sure what was deceptive about it but I haven’t looked into it and maybe the practice varied by district.

  4. Carole Cohen Says:

    J Murray, very true that it was lenders more than Fannie and Freddie but Wells Fargo and Deutsche Bank and Citi Mortgage were big box out of town lenders who now own more than half of the foreclosures in our area. If you read Bill Callahan regularly (and I know most of you do!) you can get all the stats. I think the point is that there was a local face on this, meaning the potential home buyers didn’t have to think about who was going to hold their mortgages, all they knew is that a local mortgage lender hired by an arm of those big boxes were offering them deals.

  5. J Murray Says:

    Carole, my point is and was that the Wall Street firms that are attacked in the press and Washington were not the ones engaging in the objectionable practices. The local, independent businesses were the ones engaging in these practices.