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Banks Moving Into Subprime Lending Arena

TIMES STAFF WRITER

Lured by the promise of higher profits, banks and traditional lenders are making an unprecedented push into subprime lending--the business of making loans to borrowers with spotty credit records or shaky finances.

Banks that once did everything they could to weed out high-risk borrowers are today jumping into the scrappy sector, buying subprime companies, launching new divisions from scratch or actively courting customers they once politely turned away.

* This spring, Minneapolis-based U.S. Bancorp rolled out its first loan for borrowers with credit problems, a byproduct of the company’s recent purchase of a 19% stake in Irvine-based New Century Financial Corp.

* Newport Beach-based Downey Savings & Loan Assn., one of California’s biggest thrifts, said in April that its loans to customers with checkered credit could account for up to 20% of its business by the end of the year.

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* Chase Manhattan Bank and Norwest Mortgage Corp., which quietly started offering these subprime loans a few years ago, today are actively marketing to consumers with credit problems. Chase recently slashed the rates and fees for customers on the West Coast in an effort to build market share, while Norwest is launching its first-ever direct-mail and television ad campaign this summer.

“We’re finding the subprime business is a good one,” said Les Biller, chief operating officer at Wells Fargo Corp., parent of Norwest.

But as banks turn their attention toward this lending arena, so are regulators. Concerned about putting federally insured deposits at risk, the nation’s top banking regulators--including the Comptroller of the Currency, Office of Thrift Supervision, Federal Deposit Insurance Corp. and Federal Reserve Board--joined together to issue a bulletin in March, warning national banks and thrifts to be cautious as they move into the high-risk business.

Regulators have noticed a surge in applications from banks wishing to enter the subprime market, as well as serious credit problems and losses at institutions that already have been making these loans, according to David Gibbons, deputy comptroller for credit risk at the Treasury Department.

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“Many of the banks didn’t understand what they were getting into,” Gibbons said.

Though profits on these loans can be higher, expenses for underwriting, servicing and collecting these debts are also above average. Subprime delinquency rates averaged 5.3% last year, compared with 1.2% for traditional mortgages, according to Mortgage Information Corp. in San Francisco.

Gibbons declined to say how many banks have stumbled in the subprime market or to identify specific institutions. But he said problems at some banks are so serious that regulators are worried about their soundness.

In Southern California, a foray into subprime credit card lending proved disastrous for Fidelity Federal Bank. The experiment cost the bank’s parent, Los Angeles-based Bank Plus Corp., $60 million in the third quarter last year. Its delinquencies shot up to 32%, compared with an industry average of 6% for standard credit cards. Regulators from the Office of Thrift Supervision promptly tightened their supervision of the institution, which is up for sale.

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The reason traditional lenders are turning to this market is simple: money.

“Subprime used to be a fringe business, but today this is where the profit opportunity is,” said Norman Katz, managing partner at MCS Associates, a bank consulting firm in Irvine.

Competition in the traditional 30-year mortgage market is so intense these days that lenders are lucky if they can eke out a premium of one-quarter to one-half of 1%, Katz said. As a result, only the largest lenders can generate enough volume to make a meaningful profit.

By contrast, profit margins on subprime loans average about 3%. That’s because these borrowers must pay interest rates that range from 8% to 11% and fees as high as 10% of the loan amount, compared with traditional 30-year fixed rate loans, where interest rates currently average about 7% and loan fees are about 1%.

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That’s the math that officers at Downey Savings faced recently. Though the thrift made more home loans last year than ever before, it sold most for a slim 0.5% profit, according to Jane Wolfe, chief lending officer at Downey.

“It’s been very tight,” Wolfe said.

But higher yields on Downey’s growing subprime loan business--which could hit $1 billion this year--already are helping its performance. Net interest income rose 15% in the first quarter and return on assets climbed to 0.98% at the end of the year, up from 0.79% a year earlier.

Lenders also say they need to get into riskier lending because they’re losing potential customers to rival finance companies. “We want to be able to serve all our customers, not just those with perfect credit,” said Joe Harvey, president of Full Spectrum Lending, a subprime subsidiary of Countrywide Home Loans in Pasadena. About one-third of Full Spectrum’s customers are referred by Countrywide branches, Harvey said. Before the unit was created, those customers would have been lost.

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Nationwide, the business of making home loans to borrowers with bad credit exploded to $150 billion last year, more than four times the total five years ago.

The push into this lending by banks gained speed last year after First Union Corp., the nation’s sixth-biggest bank, purchased Money Store, an ailing subprime lender in Sacramento. Last summer, Freddie Mac, which buys many of the loans that banks make, said it would start buying these loans on the secondary market for the first time. That made it easier for banks to sell their risky loans and get them off their books.

Then in October, global economic problems spurred a credit crunch that forced many finance companies out of business or into the arms of buyers, including banks.

Though the prices banks are paying for subprime companies may be attractive, regulators remain concerned about the timing.

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Mainstream banks and lenders are entering this business when the economy is strong, which might give them a false sense of security. Real estate values are rising and interest rates are low. But during an economic slump, subprime loans are far more likely to default.

“Very few banks have lived through a recession with these types of loans,” Gibbons said.

Times staff writer Edmund Sanders can be reached at edmund.sanders@latimes.com.

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High-Risk Lending

Banks and traditional lenders, which once avoided borrowers with bad credit, are now courting the high-risk niche.

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Subprime Mortgage (in billions)

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The explosive growth rate in lending to mortgage borrowers with poor credit (also known as subprime lending) is one of the reasons banks and traditional lenders are getting into the market. Subprime loan volume has risen more than 300% in the last five years.

‘98: $150 billion

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Serious Delinquencies

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Though subprime mortgages can be more profitable for lenders, they can also be more expensive. Here’s a look at the delinquency rates for home loans in 1998, based upon a borrower’s credit grade.

Subprime grades D: 17.69%

NOTE: Though underwriting standards vary by lender, “A” borrowers typically have no recent history of late payments. Borrowers with credit grades of “A-" and below are considered subprime. The lower the grade, the more serious the problem.

Source: Inside Mortgage Finance, HUD, Mortgage Information Corp.

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