Troubles for sub-prime lenders grow
The meltdown in the business of high-cost mortgages to high-risk borrowers accelerated Friday as one major lender revealed that it was under federal criminal investigation and a second said it would quit the business after regulators accused it of making too many loans likely to end in foreclosure.
As bankruptcies, forced sales, huge loan losses and tumbling stock prices have roiled this sub-prime lending industry, fears that its woes would infect the housing markets and the broader economy contributed to this week’s huge sell-off on Wall Street.
Federal regulators, meantime, on Friday proposed stricter guidelines for government-insured banks and thrifts that make such loans, to ensure that they go only to people who can afford them for the long haul.
“It’s about time, don’t you think?” Edward Leamer, director of economic forecasts at UCLA, said of the proposed rules.
Leamer expressed concern that the sub-prime sector’s troubles could spread to the prime loan market for more creditworthy borrowers. What’s more, the shrinking availability of sub-prime mortgages and rising defaults on existing loans will contribute to a likely decline in housing prices for the immediate future, he said.
The criminal investigation disclosed Friday focuses on how New Century Financial Corp. of Irvine accounted for losses when it was forced to buy back soured loans last year, and whether its executives profited by selling stock while misleading other shareholders.
The company disclosed the probe after the close of regular trading, during which its shares fell $1.20 to $14.65. Shares plummeted nearly 25% in after-hours trading to $11.02.
New Century, the largest independent sub-prime lender, shocked Wall Street last month when it said that it would restate results for the last year, erasing $268 million in profit it had reported.
Shareholder lawsuits accuse the company’s officers and directors of selling stock for more than $26 million at falsely inflated levels. A company spokeswoman had said Thursday that it would defend the civil suits vigorously. She declined to elaborate on a company filing with the Securities and Exchange Commission that described the U.S. attorney’s office criminal probe of its accounting and trading practices. The company said its own audit committee and the SEC also were investigating.
Federal regulators already have leveled civil accusations against the No. 2 independent sub-prime lender, Fremont General Corp. of Santa Monica.
Fremont disclosed Friday in an SEC filing that the Federal Deposit Insurance Corp. would sanction its bank subsidiary, Brea-based Fremont Investment & Loan, for failing to control the risks inherent in sub-prime lending and in its second major business, commercial real estate construction loans.
The company said it had decided to quit sub-prime lending entirely and was “engaged in discussions with various parties regarding the sale of the business.”
The FDIC said Fremont failed to make proper allowances for its “large volume of poor quality loans” and operated with inadequate capital. The regulator said Fremont had increased defaults by selling loans with low “teaser” rates without verifying whether borrowers could afford the eventual full payments.
Fremont announced the sanction after the close of regular trading, where its shares fell 39 cents to $8.71. Shares tumbled 19% to $7.03 after the bell.
The FDIC also criticized Fremont loans that it said would have to be refinanced repeatedly to avoid foreclosure, and loans at or above 100% of the home’s value.
Fremont said it expected to agree to a cease-and-desist order from the FDIC that would severely restrict its control over the sub-prime business. It said it would report a loss because of increased provisions for bad loans, but hadn’t yet determined the size of the deficit.
Both Fremont and New Century made their disclosures in formal notices to the SEC that they were unable to meet the deadline for filing their 10-K annual reports. Yet another big independent sub-prime lender, Accredited Home Lenders Holding Co. of San Diego, also missed the filing deadline, citing the difficulties it was having in digesting its acquisition of rival Aames Home Loans of Los Angeles. It said its earnings for the year would drop at least $100 million below the $155 million it earned the previous year.
The move to stricter standards by regulators mirrors a general tightening of lending standards that loan buyers have forced on the industry. This contraction follows several years in which sub-prime borrowers, often applying online, were able to get loans without disclosing their incomes or making significant down payments.
The tighter standards, increasingly demanded by Congress, would make it harder for lenders to provide these controversial loans, which helped make homes affordable for millions of Americans with weak credit in recent years. Last year, however, large numbers of borrowers began defaulting almost immediately on new loans, hammering lenders and fueling anxieties on Wall Street.
On Friday, New Century also announced that it would lay off 300 employees, more than 4% of its workforce, part of a contraction in industry employment that has created job losses in financial services in Orange County for the first time since 2000. Spokeswoman Laura Oberhelman cited the “turbulent environment that we’re currently facing.”
Against this bleak backdrop, consumer groups Friday applauded the regulators’ effort to stabilize the market.
“This is an important step toward a return to sensible lending,” said Martin Eakes, chief executive of the Center for Responsible Lending. High-cost sub- prime loans account for more than 60% of foreclosures, he noted in a statement.
The guidelines, if approved after a 60-day comment period, would apply to federally regulated banks and thrifts, such as Fremont. They also could serve as a model for state rules that would apply to nonbank lenders such as New Century.
“Lenders are going to be held to a higher standard when they qualify borrowers,” said Howard Glaser, a mortgage consultant and former U.S. housing official, adding, “It’s going to be very different from saying, ‘If you can afford the teaser rate, we’re going to make the loan -- and we’re not going to worry about what the loan costs three years from now.’ ”
Under the proposals released Friday, lenders would be expected to:
* Fully consider a borrower’s ability to repay loans after they rise to a fully indexed rate that might cost hundreds of dollars more a month than the introductory rate.
* Provide consumers with clear-cut disclosures on the prospects of “payment shock,” as well as features such as prepayment penalties that can make it extremely expensive for a borrower to pay off a loan early.
* Fully document a borrower’s income in most cases and not depend on the borrower’s verbal representations alone.
The proposals are the second big regulatory push in recent days to clamp down on abuses in the market for high-cost mortgages.
Government-sponsored mortgage buyer Freddie Mac said this week that it would stop buying loans with initial low teaser rates unless borrowers proved they could afford them over the life of the loan. Freddie Mac also said it would limit use of low-documentation mortgages.
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jonathan.peterson@latimes.com
Reckard reported from Orange County and Peterson from Washington.
