Confessions of a Subprime Lender

by Richard Bitner

  It’s entirely possible that I was somewhat naïve. Until Kellner was formed, my world seemed fairly black and white. I viewed most things as being right or wrong, and seldom was there an in-between. What surprised me about subprime lending was that there were very few absolutes. Lending money to people with bad credit means living in a world of gray. The longer I stayed there, especially in light of the changes that took place in the market, the more difficult it became to distinguish what constituted a good credit risk.

  Johnny Cutter, our borrower from Chapter 1, taught me an interesting lesson. When I spoke to him one last time shortly before he moved out of the house, he thanked me for giving him a way out. His comment took me by surprise. Since I had just convinced him to hand over the keys to his home, I wasn’t exactly feeling like a philanthropist. I knew that most subprime lenders, especially the larger companies, wouldn’t have treated him as well given the circumstances, but the process still left me with a knot in my stomach.

  What Johnny’s loan taught me was to trust my instincts. I had deluded myself into thinking that somehow our decision to write more loans, make less money, and take on more risk would work itself out. My gut kept telling me something had to give since the business model was making less sense every day, but I couldn’t bring myself to do anything about it. It took my having to confront one of our borrowers, who never should’ve been given a loan in the first place, to realize I knew the answer all along.

  GLOSSARY

  automated valuation models (AVMs) Computer programs that rely on statistical models to provide value estimates for residential real estate.

  basis points (BPS) A unit that is equal to 1/100th of 1 percent. Basis points are commonly used for calculating changes in interest rates.

  broker price opinion (BPO) An estimate of a residential property’s probable selling price based on the selling prices of comparable properties in the area. Often used by a mortgage servicer as an alternative to a full property appraisal.

  credit score A measure of a person’s credit risk, calculated using the information from their credit report.

  collateralized debt obligation (CDO) A type of asset-backed security that divides the credit risk among different tranches (sections) of a securitized mortgage package.

  debt-to-income (DTI) The percentage of a borrower’s monthly gross income that goes toward paying debts.

  government sponsored entities (GSEs) The generic terminology used to describe the loan companies known as Fannie Mae or Freddie Mac.

  loan-to-value (LTV) A calculation that expresses the amount of the first mortgage lien as a percentage of the appraised value or purchase price, whichever is lower.

  mortgage-backed security (MBS) An investment product in which thousands of mortgage loans are bundled together and sold as bonds.

  mortgage insurance (MI) An insurance policy bought by the borrower to protect the lender against default of loans greater than 80 percent loan-to-value (LTV).

  piggyback mortgage A second mortgage taken out simultaneously with the first in order to provide funds for a down payment.

  prepayment penalty A specified percentage charged by the lender when all or part of a mortgage principal amount is repaid before a certain time period.

  tranche A French word that means slice, section, or series. It refers to one of several related securitized bonds offered as part of the same deal.

  RESOURCES

  Abelson, Alan. “After the Greenspan Put . . .” Barron’s, August 13, 2007.

  Cariaga, Vance. “Credit Agencies, Banks, Buyers Share Blame for Subprime Mess.” Investor’s Business Daily, August 16, 2007.

  Chomsisengphet, Souphala and Anthony Pennington-Cross. “The Evolution of the Subprime Mortgage Market.” Federal Reserve Bank of St. Louis Review, January/February 2006.

  Eggert, Kurt. “Role of Securitization in Subprime Mortgage Market Turmoil.” Testimony to the Committee on Senate Banking, Housing and Urban Affairs Subcommittee on Securities, Insurance and Investments, April 17, 2007.

  Hudson, Michael. “How Wall Street Stoked the Mortgage Meltdown.” RealEstateJournal.com, August 16, 2007. www.realestatejournal.com/buysell/mortgages/20070628-hudson.html.

  Levitt, Steven, and Stephen Dubner. Freakonomics: A Rogue Economist Explores the Hidden Side of Everything. New York: Harper-Collins, 2005.

  Mauldin, John. “Back to the 1998 Crisis, Subprime to Impact for a Long Time.” The Market Oracle, August 11, 2007. www.marketoracle.co.uk/Article1792.html.

  Mauldin, John. “The Ongoing Impact of the Housing Market.” Outside the Box, August 24, 2007. www.investorsinsight.com/otb_va_print.aspx.

  Roberts, Ralph, and Rachel Dollar. Protect Yourself from Real Estate and Mortgage Fraud. New York: Kaplan Publishing, 2007.

  Rosner, Joshua. “Stopping the Subprime Crisis.” Wall Street Journal, July 25, 2007.

  Tomlinson, Richard, and David Evans. “A Ratings Charade?” Seattle Times, August 12, 2007. seattletimes.nwsource.com/html/businesstechnology/200383227_subprime12.html.

  1 A quick note on the use of the word “broker.” The terms “mortgage broker,” “loan officer,” and “loan originator” are used interchangeably in the business and generally mean the same thing—a person who has taken the borrower’s application and originated the transaction with the subprime borrower. Brokers then arrange for a lender (like Kellner) to approve and fund the loan. A lender, however, can also act as a broker, which many of the smaller ones did, choosing to avoid the risk associated with funding a subprime loan.

  2 Since this was originally written, Cuomo, along with Fannie Mae, Freddie Mac, and OFHEO, have struck an agreement on appraisal reform. The two most significant pieces of this agreement will prevent brokers from choosing the appraiser and prevent lenders from having an ownership interest in the company that does the appraisals.