Subprime residential lending is in vogue again, except that none of the firms funding the loans call the product "subprime." Oh, and there’s one other catch: loan volumes are extremely small, but the profit margins are through the roof.
Take, for example, some of the recent loans made by Excelsior Management Group, Lake Oswego, Ore., a firm managed by mortgage "hard money" veteran Rick Baldwin. On average, the notes originated by EMG carry yields of 12% with five points.
As for the "risk factor" inherit in the loans, Baldwin isn't losing much sleep at night. EMG’s maximum loan-to-value ratio is 65%, which means if the borrower doesn't pay, his firm can seize the house and sell it, more than recouping the investment.
But Baldwin is quick to point out that although all this sounds nice on paper, this specialized niche isn't poised for a boom any time soon, though for the right lender, it’s a way to make a living while home prices slowly, but surely, improve from the Depression-like crater they've been in the past three years.
The chief problem he faces is raising new investor money. All of the active participants in the "new subprime"—at least the ones I interviewed for this column—are nonbanks that raise money from a mix of wealthy individuals, investment clubs/funds and institutional money. "I'm a mortgage banker," said Baldwin. "Raising money is something we're not so good at."
So, why would a somewhat wealthy individual put his money at risk?
As Mark Mozilo of Calcap Advisors, Pasadena, Calif., pointed out, "Just look at the yield you can get on CDs these days. It’s nonexistent."
EMG is currently living off of two funds that are used to originate loans: a $50 million pool, which is in wind-down mode, and a new one just gearing up.
Baldwin would be happy to do $1 million a quarter in new product. (Most of the new "hard money" loans are short term, five years or less.)
Mozilo, the son of Countrywide Home Loans founder Angelo Mozilo and a seasoned mortgage banker himself, has facilitated about 20 loans during the two years Calcap has been in business. Calcap’s paper carries a note rate of 10% with two points up front.
Again, the production volume numbers are not overwhelming, but the profit-margin figures look enticing enough that there’s been plenty of industry chatter about new entrants.
"I see other people looking at doing what I'm doing," said Mozilo. "But the nice thing about it is that banks won't be getting in this any time soon," which leaves the business wide open for the nonbanks.
One firm that is posting decent "private money" volume (decent compared to Calcap and EMG) is UniTrust Mortgage of San Diego. Ilan Awerbach, a partner in the firm, said the lender has produced $15 million in new loans this year, after doing almost $30 million in 2009.
UniTrust, he added, is looking at expanding into other Western states and is currently going through the licensing process. His company, like those managed by Baldwin and Mozilo, relies on private investors and concentrates on only making loans in the company’s home state.
All three executives told me the same thing: that demand is strong and the quality of borrowers is exemplary.
"The loans are excellent," said Baldwin, whose past companies have included Meritage Mortgage and Financial Center Mortgage, the latter of which was merged into Bill Dallas’ First Franklin many moons ago.
"The loans are out there," said Baldwin. "Our borrowers have FICOs of 700 but for one reason or another can't get a mortgage. The other problem is that borrowers don't even know there’s a source of funding out there for them."
As for semantics, none of the three men like the word "subprime," feeling it doesn't accurately describe the underlying paper. "We like to call it 'private money’ because that’s what it is," said Awerbach. "The LTVs are very low."
Also, the loans these companies make aren't always totally residential in nature. "We're making loans to borrowers who can't get credit because they're an investor—or they own too many properties and a bank won't touch them," said Mozilo. "
There’s this growing segment out there of people who won't or can't qualify."
Or as Baldwin noted, "Thanks to this downturn, the job losses and everything else, we have more nonprime borrowers than ever before."
