There's a simple truth to be learned from VA residential real estate loans: it's not who you know, it's how much you know about them.
The Department of Veterans Affairs' loan guarantee program — which requires no down payment — has performed much better than, say, the troubled Federal Housing Administration program. That's to be expected; many consider VA loans an anomaly due largely to the inherent creditworthiness and reliability of military borrowers.
But a closer look at the agency's loan-performance data suggests that underwriting — not the type of borrower, military or otherwise, not whether there is a down payment — is the reason some lenders in the program have succeeded while others have struggled.
Buried inside the agency's rapidly expanding portfolio in recent years are a small number of lenders that have underwritten so poorly that their loans to military veterans perform like those made to troubled alternative-A borrowers. Among the recent underperformers in the VA program are not only the now-cratered Countrywide and Taylor Bean & Whitaker, but also JPMorgan Chase & Co.
By the same token, even as these companies have performed poorly, loans issued by mortgage heavyweights like Bank of America Corp., U.S. Bancorp, PHH Mortgage and Wells Fargo & Co. have performed well by any standard.
"It's extraordinary what's gone on," said Brian Chapelle, a mortgage industry consultant who formerly worked for the FHA. "All of D.C. is talking about [borrowers having] skin in the game. [But] it came down to underwriting and verifying income."
The subpar lenders have not been terrible or prolific enough to seriously throw off the VA Guaranty Program's overall stats, particularly at a time when the VA is ramping up volume. And even while the VA's worst lenders were writing mortgages that racked up 15%-plus default rates in less than two years, the performance of the overall portfolio improved relative to prime mortgages. Five percent of the VA's 1.3 million active loans are at least 90 days behind on payments, up by two-thirds from five years ago. In that same period, serious delinquency on prime mortgages ballooned to 6.3%, increasing by a factor of seven.
But poor underwriting is taking its toll, with many banks blaming brokers for lapses in quality control.
Of the 7,400 VA loans JPMorgan Chase wrote in fiscal year 2008, 15.4% are already at least 90 days past due — nearly double the VA's average for the year, and about the same as Taylor Bean and Countrywide.
Presented with the VA data, a JPMorgan Chase spokesman said that the company weaned itself off the use of independent mortgage brokers at the end of 2008, though it still uses correspondents. Since that change, JPMorgan Chase's performance relative to peers has significantly improved — its 2009 numbers are better than the VA and FHA averages.
"The initial read is that the 2009 numbers are better and that reflects our exit from the broker channel," he said.
Default numbers like the ones that JPMorgan Chase posted for 2008 are an "anomaly" within the VA program, representatives of the agency said. That zero-down VA loans in 2007 and 2008 performed every bit as well as prime conforming mortgages "indicates the loans that we are making are good loans," a VA official said. "Industry data is where we benchmark ourselves."
To prevent bad loans from getting into the system, the VA inspects 10% of the loans it guarantees at the time of origination, and reviews lender performance every one to three years, depending on size and performance. The VA can seek indemnification for "egregiously underwritten" loans or suspend a lender from the program, but said it is extremely rare for it to seek penalties beyond indemnification.
Even its use of that tool has been limited. In 2008, it forced lenders to indemnify it on $3.7 million in guarantees; in 2009 that number was $6.7 million.
For a core of VA lenders, the underwriting has gone well, and so has loan performance.
Wells Fargo is the single biggest issuer of both FHA and VA loans, yet its average default numbers are far lower than the average in both programs. Only 1.2% of the outstanding VA loans it wrote in fiscal year 2009, for instance, had become seriously delinquent as of this January — compared with around 3.6% for the overall VA program.
Dennis Geist, Wells' head of government lending programs, said those results were merely the results of sticking to the VA's lending rules and guidelines. Wells will not make a loan for more than 41% of a veteran's verifiable income unless the borrower can demonstrate an extenuating circumstance from a VA-approved list, such as a recently paid off car loan or a proven track record of earning overtime. The only additional requirement Wells imposes on its VA lending is a minimum credit score.
"The guidelines are pretty simple," Geist said. "If you exceed the 41% debt ratio, you've got to have compensating factors."
After that, the process comes down to quality control. Wells checks for eligibility at the point of sale, again while the loan is being processed, and what Geist calls a "prefunding audit."
Though the program's rules are "open to some interpretation," Geist said, Wells limits its lending to loans that it's "comfortable with," rather than with loans that are simply permissible.