Bruce Norris is joined this week by Cary Pearce. Cary is the current sales production manager for Provident Loans. As a production manager, he has closed almost 2500 loans for about $350 million in his career as well as supervised another $1 ½ billion in other closings. Cary started in the business in 1985 when he worked at Coldwell Financial. He later went to work for Acu Bank Mortgage, where he first met Bruce. Here he was promoted to a position of branch manager. He has been with Provident as their production manager since 2009.
Bruce appreciates having someone he can trust in the loan business since there is a lot of concern, although things are also loosening up. Since Cary has thirty years of experience in the industry, Bruce went back to see if there are any trends that would exist when prices go up or down to where lenders end up being aggressive or pulled back. Bruce asked if from 1985 to 1989 Cary noticed any trends in the business where lending got progressively easier or with more aggressive programs. Cary said when he first started, rates were around 12-12 ½%. The loan that became popular was the graduated payment mortgage. They did a lot of these through FHA back then where the five-year payment plan slowly went up, but it also had that amortization and there was a slight negative side to it. This was a vehicle a lot of people used to help get them in the door.
Bruce asked if there was a product on the conventional side for this. Cary said there were some ARM products, although he does not remember them being that aggressive. Typically ARMs run 1 ½-2% below fixed rate on a starting basis. They were around, they just did not do a lot of them back then. Bruce asked when he was qualifying for the FHA ARM if he was qualifying at the teaser rate or fully qualify. Cary said this is the advantage now and has been the case for some time now where FHA allows you to qualify at the starting rate. On a conventional, they make you go fully indexed or start rate plus 2, whichever works. On a 7-year or greater, they will let you qualify at the start rate.
Usually in the Inland Empire, FHA’s loan limits progressed rather slowly while our prices aggressively went up. Bruce wondered if it ever became a factor where FHA did not have the number of dollars available for a loan. This was a huge problem in the early 2000s. This is where the 80/20s were running rampant and were popular. In Riverside, the FHA volume fell off the face of the earth because they were priced out of the market. Their loans were too low, and the prices had gone way above to where the FHA loan did not make sense to anyone. Bruce wondered if this was true in ’85-’89 as well, to which Cary said it was not since the subprime loans were not around back then. There were some with the savings and loans, such as the World Savings and Home Savings, that had their ARM products that were pretty aggressive and would go as low as 5% down. On their side, they did not have anything ultra-aggressive.
There are two sides of the lending world. Bruce asked about when World Savings was creating a product and if whether it was a portfolio loan or they were selling it off as well. Cary said it was a portfolio loan, as well as Home Savings. These people were a sizeable enough lender that they could be competition for FHA. When they rolled out the 5% down on their ARM product, that definitely took a bite out of the FHA buyer. Bruce asked if he was working as a mortgage broker at the time or as a banker, which Cary said he had been a banker his whole career. The difference between the two is a broker will do wholesale, which includes packaging and sending the loan to underwrite. They will then fund the loan for this. Provident, being direct, does everything within their own branch. They will process the loan, underwrite, draw the docs, and fund it. Overall, they do everything internally. Bruce asked if it would be fair to say that 100% of the business that he writes is intended to be resold and not kept in a portfolio. Cary said their servicing portfolio is about $1 billion and a half, and this is small when you think of the big boys like Bank of America, Wells Fargo, and Chase. These people service over $100 billion, but Provident will typically sell 90+ percent of the loans coming in the door.
Back in the ’85-’89 range, Bruce asked how prevalent the FICO score driven decisions were. Cary said there was no FICO score when he started since this did not come about until the mid to late 90s. Bruce asked how decisions were made and if it was based more off common sense. Cary said this was the case and that everything was manually underwritten. When he first got into the business, they had to take FHA loans down to Santa Anna and wait 2-4 weeks for an underwriting decision on a loan. For a VA it was the same thing. They had to send the loan to VA in LA and wait for them to underwrite the package, which could run anywhere from 2-4 weeks as well. They did not actually have signing authority back then with the company he was at.
When they had the price increase from ’85-’89, Bruce wondered what percentage of the market was going to be funded by Fannie, Freddie, or FHA. He said it was probably still a high percentage when you combine everything, around 70-80%. There will always be the places like Home Savings and World Savings who will take up their piece of the puzzle, but there was still a big chunk of FHA and Fannie/Freddie. The modern day equivalent to Home Savings and World Savings don’t really exist today as there aren’t really any big wholesale portfolio lenders other than B of A and Wells Fargo. Like Provident, they originate most of their loans to sell on the secondary market. The savings and loans have pretty much died out.
Bruce asked Cary what his sense was on the existence of Fannie and Freddie five years from now. The government is trying to phase them out and would if they could, but he does not see that happening. This would cripple the housing market. They had the chance to be in a meeting at Fannie Mae, and everyone in the room knew they were going to be unemployed at some point. The stark recognition for him was they actually believed that ten years from then they would not exist. The government’s goal is they would love to get rid of them, but he does not see who could step in and take their place. The sad thing is they took bailout money, but they have paid it all back and the government has still not put them back into absolvent. They have already paid back $180 billion. Every time they look at a quarterly report, it is phenomenally profitable. The model, as it is, seems very successful.
The problem with our market and the ability to have liquidity is the number starts with a T called a trillion. We think it is a big deal when a hedge fund raises $5 billion and raises the fray of either buying 10,000 homes or loaning to investors. This is a drop in the bucket when you are talking about the occupant loan volume. This year they are predicting about $1 ½ trillion. In this case, you also have to have the holding power since you have nowhere else to go with this. Once you find a 30-year loan, you could be holding it for 5-10 years. This is why there has to be the secondary market to hold these loans. Most of the investors do not want to buy it without the guarantee from Fannie, Freddie, or FHA.
During the downturn from 1990-1996, one of the things he remembers is how different it was the way they dealt with their REO inventory. There were legitimate auctions held to where the final bid was the winning bidder. It was not absolute, but in a net result it was in a way. Lenders were taking some hits for the first time that Bruce could recall having been in the industry since 1980. Whatever aggression might have existed from 1985-1989, Bruce wondered what the mood was between 1990 and 1996. Cary said there had to be a tightening. It always will come back to bite them when they loosen up, just like the Alt-A and subprime did when the market collapsed in 2007. They had to pull back on all the loose lending standards because it was too easy. Bruce wondered what lending standards were loosened between 1985 and 1989 and where they had to draw back and make changes. Cary said he was not sure, but the FICO scores from ’90 to ’96 were not a factor. The choices are things like debt ratios, which Bruce asked if they change.
Bruce asked if this is something that radically changes, specifically what people owe in the front and back ends. In their manual, FHA has the ratio to be 29% and house payment plus debts (car payments, credit cards) at a maximum of 41%. This is something that has been in their guidelines forever. They did see a loosening when automated underwriting came into play, and there were FHA buyers 8-10 years ago who they were seeing get approved with a 56-57 back-end ratio. Today, we are not seeing it that loose, although we could go up to 55 on an FHA 680 credit score. It is still fairly decent, but everything today is full doc whereas back before the market collapsed you had all the 80/20s, stated incomes, and all the crazy programs that were out there. Bruce wondered how much of this information is verified before or after the loan closes by a third party.
Cary said they send out IRS 4506 to verify the tax returns and make sure what the client gives them is what they filed. Rarely will they ever have a problem, but occasionally you will have a client giving you a bogus return. They also verify social security numbers and have a third party to verify it to make sure they have a legit buyer. The rest of it you have to take at face value, including bank statements. In the computer age you can pretty much forge anything you want, but at Provident they still make them explain their deposits. As long as they can document where their money is coming from, they should be fine.
From 2001-2007, Cary had already been involved in the business 15 years by this point. Bruce asked how different the environment was for lending during this time. Cary said it was huge. Up until 1998/1999, he was shied away from doing any brokering out or any kind of subprime loans since they did not trust the sources that offered them that they would deliver. Their reputation was on the line. They already had one lender in play prior to this in the ’90-’95 range who was starting savings. It seemed like every time they would send him a loan, they would cut the appraised value, realtors would get upset, and the deal would ultimately fall out. This was why he always shied away from them.
When 1998 came along, Franklin documented what they came up with, in this case the stated option, but most people would go full doc with that program. They were very liberal on their ratios, roughly 50-55%. The rates were very competitive, almost as good as the Fannie/Freddie rates. They put a lot of people into these instead of putting them into FHA loans because there was no mortgage insurance. These were loans which were in somebody’s portfolio and not being resold. Bruce wondered how the products changed after 2000.
Cary said when they started doing the stated incomes then rolled out that Option ARM where people were qualifying for a starting payment at 1%. This sucked a lot of people in when they saw they could buy a $1 million house and have a $2000 a month payment. This is not the real payment; and when you break it down and show them what the real payment should be. Most educated buyers would shy away from this, but there were always those few who only focused on the starting payment. They got rewarded for this; if the home went up 20% this was a profitable decision. It was when the market was appreciating that this loan made sense. When the market collapsed, this was one of the first products that went upside down before it went back to the lender.
At the time this was all going on, Bruce asked Cary if he was familiar with mortgage-backed securities and if they were funding them ultimately. On the front end, Cary said they did not get too involved in the secondary side. However, just hearing from different sources they got the feeling that their company would pull together $10-$20 million in loans, then go and sell it to Wall Street. Wall Street would then package it up as mortgage-backed securities and sell it off to other investors. There are all kinds of instruments that came out in the 2000-2007 range, most of which Bruce had never even heard of until 2007. This was when he realized they had a bigger problem than he thought.
Bruce asked Cary what is going on at this point in time. Cary said securitizing loans is happening, but not in the way that they did back then. At an earlier time they were pulling different brackets of loans. They would have your 740 plus buyers, and they would slide in people who were in the 620 range in the same pool. The question would be how they would really know how good the pool is when you are mixing it with a lower-end borrower. These usually have a worse repayment history than one with a higher credit score. You should not try to implement everything just because you can think something up. Going forward, since there is money to made there will probably be things either starting up soon or is already starting.
Bruce asked Cary if he sees 2015 being much different from 2014 as far as the ease of getting a yes answer from someone. Cary said a little. Fannie and Freddie have ruled out the 3% down again, which they had pulled the plug on a while ago. They also rereleased My Community Program, which is a first-time buyer program, 3% down and has income limits. In addition, it also has lower mortgage insurance than a typical 3% loan. However, overall everything is still full doc. He does not think the stated income loans will ever come back like they were, at least not with the QM rules and everything else coming into play.
Bruce asked if all these rules are in place now, or if this is still up in the air as to what some of them are. Cary said the qualified mortgage is definitely in full force, and they basically look at a qualified mortgage and want the back-end ratio to be 43%. There are some exceptions to this since FHA allows higher approvals, up to 55, and even conventional loans coming in at 47%. As long as you have an automated approval, those agencies are excluded. Any time you go outside of this and over 417, like a jumbo loan, then the QM kicks in and they are dead serious on the 43. Bruce asked why an automated underwriting system would be more generous than doing it manually. Cary said he does not understand this himself since it does not make sense. Why would you take a 55 on a conforming and hold the jumbo to a 43. Everyone in the industry got this, so most of the approvals you get are automated responses. 90% of what they do at Provident has to have an automated approval since they do not work with jumbo loans.
Bruce asked how easy it is for a lender to make the mistake that allows them to have to buy the loan back. Would it have to be an egregious mistake or a default? Cary said no and that it does not even have to be a default. They have actually had a few of these recently, one example being a jumbo loan that was closed, and almost a year later the investor did an audit on it. They came back to a borrower and wanted 21 items from the borrower after the fact. The guy had already made his payments on time and everything. However, they did an audit and did not like some of the documentation that came in, and they wanted all kinds of things from the client. This person participated and helped to a degree, but at a certain point he said it was ridiculous and was not giving them anything else. They were stuck, and the investor made them take the loan back because of this. Bruce wondered if at this point it is a portfolio loan to be resold and take a hit. Cary said their two options are to refinance, get out of it, and find another investor who will take it. Usually when that happens they will do the loan almost for free in order to make it worthwhile for the client. If they cannot or it does not make sense, then they are stuck port folioing this loan.
Bruce asked about loan fraud, which he sees as the equivalent of walking into a bank with a gun since there is a limited number of chances they would get away with it. Bruce asked if everything is so automated and easy to catch that loan fraud should be almost zero or if it is something you have to watch for still. However, it is not nearly as prevalent as it was ten years ago. It was a lot easier back then to write up a tax return, give it to the lender, and if they did not process a 4506 then you would take it for face value. When you close the loan, you think you are fine; but when the person does not make the payments you start auditing the loan. At this point you start finding out all the problems, such as the returns not being real. However, because they now verify everything it is much harder to do. Most people would not want to try it, but this is not the nature of someone wanting to pull a fast one.
There are still straw buyer situations where you get somebody who has credit and qualifies, but they never move into the house. When the house gets flipped, some crazy things can happen. These kinds of things do exist, but at Provident they are isolated and don’t see too much of this occurring. Their problems are where the investor audits the loan, does not like the documentation, then kicks it back at them and says they will not guarantee it. Bruce asked how long they have this option since you are running a 30-year loan, so he wondered how long they have the right to go back. Cary said it is within the first year, possibly a little longer. If there are problems, then that is when they can push it back on them. This was one of the issues that got solved because up until recently this was in the vicinity of five years to where they can do due diligence and you have a loan that was funded many years ago. Cary has prepped some warrants on the loans they do, so as far as he knows it could be 3-5 years. However, he does not get involved on the backside to that extent and does not really pay attention to it and will probably not have to.
For more information, you can contact Cary Pearce at 951-256-3715 or email him at cpearce@myprovident.com.
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