STOCKTON, Calif. -
But despite the fact Stockton has spent a lot of time over the past two years at or near the top in listings of “Foreclosure Capitals,” the city’s credit unions have done a remarkable job of avoiding taking possession of their members’ homes.
According to 5300 Call Report data, the three largest real estate lenders among credit unions based in San Joaquin County are: Central State CU ($142 million in assets; $52.7 million in total real estate loans), Premier Community CU ($104 million in assets; $28.7 million in RE loans) and Financial Center CU ($280 million in assets; $28.2 million in RE loans). Central State CU and Financial Center CU combine for an amazing zero foreclosures.
In fact, Central State’s vice president of lending told Credit Union Journal he has been with the CU since 1983, and the credit union has yet to have a foreclosure during his tenure.
“At the beginning of my career, that had to do with the member-credit union relationship; a member would do anything to maintain a good relationship,” said Michael Hausenfleck. “In later years, some people have gone into survival mode–they’ll file for bankruptcy if they have to. But we have always kept our traditional underwriting standards: we always document income and employment. Also, we did not get into the exotic loan types, such as interest-only and payment options.”
Despite Central State’s 25-year streak of zero foreclosures, Hausenfleck sounded a cautionary note regarding competing in today’s rocky real estate marketplace. He said the No. 1 issue his CU is going to have to deal with going forward is members who went to other lenders and obtained a “pick-a-payment” mortgage, or other exotics that eventually reset to a higher payment.
“When the payment on that loan increases, they will have problems with other loans,” he pointed out. “A $900 increase in a home payment is more than enough to knock the typical Valley family into the hole. People might have to decide to not pay their car or signature loan payment. And then we will have to decide how to help our members and not take a loss because of decisions by other lenders.”
For Once, Happy To Say We’re No. 2
Michael Duffy, CEO of Financial Center CU, gleefully reported seeing RealtyTrac, a company that follows the foreclosure market, recently dropping Stockton to No. 2 from the top spot it had held for a while.
“We’re no longer the No. 1 Foreclosure Capital,” he said with a laugh. “Normally cities want to be No. 1 on a list, but not that list.”
Despite the turmoil in the marketplace, Duffy said San Joaquin County’s largest CU by asset size has zero foreclosures on its books.
“We have a $28-million real estate lending portfolio, and a grand total of two loans that are 45 days delinquent,” he reported. “In one, there was a death and we are going through the process with the family and expect to have it caught up soon. The other is just a chronic slow-payer.”
How is Financial Center avoiding the trouble affecting so many other mortgage lenders? Duffy said it simply is part of the CU’s long-term strategic plan. He said going back to the last major economic slowdown, from 2000 to 2001, Financial Center has looked at real estate “a little differently” compared to other financial institutions.
“We never deviated from our traditional underwriting standards,” he said. “During the appreciation boom of 2003-2005, when values around here were increasing by an average of 15% year over year, others were writing loans to anyone. That was the time to say ‘hell no’ to lowering our standards.”
Duffy recalled Financial Center’s management had several conversations during the 2003-2005 period regarding the possibility its hard stand on underwriting meant missing out on business. In the end, he said, it was more important to miss out on booking some loans versus missing out on safety and soundness.
“We embarked on a strategy of doing real estate loans and having a correspondent lending relationship where we sold our loans on the secondary market. We stuck with our traditional underwriting, cherry-picked the best loans to keep, and we did not do risky loans. ‘Risky’ does not necessarily mean someone scoring in the subprime; but people using piggyback loans–80% loan with a 20% second–to avoid paying mortgage insurance.”
Warning Signs That Should Have Been Noticed
According to Duffy, if people had been paying attention to the competition in the mortgage lending market taking on unsustainable credit risk in the middle part of the decade, the eventual housing market problems would not have been unexpected. He said the industry was following typical procedures of creating mortgage-backed bonds and spreading the risk over many investors, but the mistake was in assuming the risk then would be non-existent. That belief, combined with relaxed underwriting standards and loans with no money down, should have triggered the “smell test,” he insisted.
“If something sounds too good to be true, then it is too good to be true. It was unsustainable.
“I truly believe we should not call it a subprime crisis,” he continued. “It is not a subprime crisis. Subprime might have led us into it, but it is a credit crisis that goes to the fundamentals of underwriting, the terms of the loan and the actual product. I believe we will see more individuals who appear to have good credit that are going to be foreclosing, also. They won’t be able to keep up with their ARM loans and interest-only loans repricing. People with good credit bought too much house on speculation and the belief there would be credit available for them to refinance and maintain what they had. It doesn’t take a rocket scientist to figure out this wouldn’t work, because price appreciation was not going to go on forever.”
Duffy said he believes the “cheap money” available in past years made it so prices for the product and demand would go up. The two factors then “fed off each other.” He said lenders created products that made it possible for buyers to make a payment at a temporary price so they could afford a more expensive house. “People got in above their heads, and then they become so deep underwater it doesn’t matter, so they walk away from the house. They treat an interest-only loan they’ve been paying on like rent. When the loan reprices, they just walk away.”
Central State’s Hausenfleck also expressed disgust with the practices of other lenders during the appreciation boom.
“Many people were caught in something that, if it wasn’t outright deceit, it was a fast blurring of the issues,” he declared. “Some of these people were not very well educated as to the process and were confused by the volume of paperwork they had to deal with.”
One CU Exec Sees Another Risk On Horizon
Financial Center’s Duffy said housing prices in the Stockton area still are declining, and he predicts they probably will further decrease as more foreclosed houses hit the market. In 2006, he said, there were about 5,000 new home permits issued in the Stockton area. “In 2007, that number was about 500, so it is not new houses hitting the inventory, it is the houses being foreclosed on.”
The housing and credit crunch is dominating the industry’s attention, but Duffy cautioned there are issues on the horizon that must be watched carefully. He said employment is the “real” risk to the economy, along with rising consumer prices.
“Whether we officially are in a recession or not is academic; employment and inflation are risks we need to be evaluating,” he said. “Our philosophy is not to spend too much time worrying about the present risk. We are looking ahead to see what the risks are and what the future scenario will be under different unemployment and inflation scenarios over the next five years.”
Hausenfleck said Central State CU examines every loan situation very carefully before moving forward.
“What you have to try to do as a lender is verify and verify. You want to try to help your members, but you also want some sense that loan will be repaid. We snap our seat belt every time we get in the car and drive off. People who have been in lending forgot past experiences and didn’t realize that was a bad way to lend members mone,” he said.
Central State has been “very lucky” to avoid foreclosures, Hausenfleck said. Then again, he reasoned, the standards it used prior to the current housing crisis were “good standards.”
“The only thing we’ve added is, for people with a first mortgage we ask to see the paperwork to check if it is an interest-only loan or one of those esoteric loans. In some cases, we are not making a loan because of the probability of increasing mortgage payments on the first,” he said.
In many instances, borrowers had equity when they booked their first mortgage, but when they come to Central State for a HELOC, they are hurt by the drastic decline in home values in the area, he said. The homes that were appraising for $500,000 two or three years ago now are selling for $300,000. Many of the loans Central State is writing are for homes that originally appraised in the $300,000-to-$400,000 range. Hausenfleck said it is a problem finding someone with available equity on their home.
“At this point, because we can only do a certain percentage of our portfolio in fixed products, we would rather do HELOCs than long-term, higher-balance first mortgages,” he said.
Resets Dead Ahead! No Foreclosures
In March, April and May, there will be a “whole slew” of ARM resets in the Stockton area, Duffy said. This, in turn, will put additional risk and pressure on borrowers’ debt ratios. He said Financial Center CU has re-educated its lending staff to identify what type of mortgage loan a member has, so they are prepared. The credit union still wants to make “make good, solid character loans at the right price,” and serve its members well, he said.
“We are a heavy consumer risk lender. We have a higher-than-peer-group delinquency rate and charge-offs. We can do this because we price our products correctly, we have good underwriting practices, and we do an in-depth review of the stability and character factors in making a risk-based loan.
“With that being said,” he continued, “because we do character loans and know the member we are lending to, we still might do an auto loan for a member who had a foreclosure last month. You have to know how to risk-lend to do that.”
Duffy believes when the “hyperinflated” prices go out of the housing market, it will be a good time to lend for real estate again–as long as credit unions maintain their underwriting standards.
“We are more competitive now than we were two years ago. As long as we price correctly and do our ALM rate shocks, we can take on some good chunks of the real estate lending market.”
In January, Financial Center CU wrote approximately $6.5 million in gross loans; mostly consumer loans, about $500,000 in real estate. Duffy said credit unions must supply credit to their members as other sources of credit dry up. For example, he said Financial Center is preparing to launch a “consumer refinance program.” This will consist of refinancing auto loans and signature loans to take advantage of the recent short-term rate cuts by the Fed.
“Interest rates have come down, which gives us an opportunity to poach our competitors’ loans that people got last August. We are servicing our members’ needs, and we are ready to refinance our members’ loans because we are sitting in a different rate environment right now.”
The CU will launch a targeted direct mail campaign to its members announcing the consumer refinance program soon. Duffy said he hopes others in the CU movement similarly will use the troubled times to their advantage.
“It is a fantastic opportunity right now for credit unions,” he appraised. “The credit union brand should be one of safety and soundness. Other lenders did things all for their own benefit, and what better time for credit unions to juxtapose what we do versus what the other guys do. The banks are in the news every day for what they have done, and we are definitely different. We should be out there in full force, servicing our members, and really bringing our differentiation to light. Look at the failures and the consolidations of banks, and tout our difference. It is an opportunity for credit unions to get aggressive with their message and assert how they are different.”
