Richard Bitner recently released a book about the mortgage meltdown from the perspective of a mortgage originator. The book entitled, Greed, Fraud & Ignorance: A Subprime Insider’s Look at the Mortgage Collapse, gives investors some food for thought when considering the faults in the originate, securitize, and issue-to-investors chain that mortgages went through. The Prince is intrigued by Mr. Bitner’s book mainly because he seems to confirm much of what investors assumed and observed about originators, once mortgage securities began to plummet in value.
Richard Bitner spent 14 years in the mortgage industry. He spent five years as the President of Kellner Mortgage Investments, a subprime mortgage company. In addition, he was a Director for GMAC Residential Funding and the National Training Manager for GE Capital Mortgage Insurance (Genworth Financial).
He is an accomplished public speaker, having spoken at numerous industry conferences. As an author he has published articles relating to all facets of the mortgage industry and penned the monthly "Subprime Forum" column for the Mortgage Press. He has a master’s degree in communications from Cornell University and a bachelor’s degree in public relations from Northern Arizona University. He currently serves on the board of directors for Family Gateway, a Dallas-based transitional housing facility.
Certainly Mr. Bitner hits on some of the problems that The Prince has harped on about regarding the mortgage crisis. For example, he discusses stated income loans given to those with high FICO scores, occupancy fraud, teaser rates, NegAm loans, Option ARM loans, the lack of skin in the game for originators or rating agencies, fraudulent loans and, finally, incentives that did not reward originators for saying no to prospective borrowers who presented dubious risk/reward profiles. We would all do well to learn from the mortgage crisis we are going through now by studying accounts like Mr. Bitner’s so we can figure out how to fix the industrial organization of the mortgage financing industry, to prevent another meltdown. A recent post by Mr. Bitner entitled "FICO - The Late, Great Credit Score?" sheds some light on what we can learn from the mortgage meltdown by looking at how originators used FICO scores.
Here are some excerpts The Prince has selected from Mr. Bitner’s recent blog post on FICO score use by originators (bold added by The Prince):
It’s been 12 years since Fannie (FNM) and Freddie (FRE) began requiring FICO scores on every loan they purchased. Interestingly, the subprime industry took much longer to completely wrap itself around the use of credit scoring. Some of the early subprime pioneers, guys like Vince DiMare at Equity Secured Investments, were skeptical of FICO, and for good reason. As he mentioned to me on numerous occasions, “Why do I need a score to tell me what is an acceptable level of risk, when I already know how to underwrite these loans.” No truer words have ever been spoken.
Having worked for GMAC Residential Funding Corporation in the late 1990’s, I saw enough performance reports on billions of dollars in loans to become convinced that FICO was a reliable indicator. But even given the volume of data, RFC took years until it moved away from a traditional subprime underwriting methodology to one that was FICO based. I remember a three-year span in which the company had two underwriting manuals for subprime, one for the traditional method and one for the FICO approach. RFC was reluctant to pull the trigger on FICO because even with all the performance reports to support its use, the old-line risk guys weren’t completely bought in.
The erosion in loan performance we’re seeing is not a fault of a poor scoring model, but an industry that forgot it was not an absolute. Even when RFC had two underwriting manuals, they were still very similar in structure. While the traditional method didn’t pay attention to credit score, both manuals still understood the importance of how all the other credit factors fit into the picture – down payment, performing trade lines, etc. Whether FICO was part of the picture or not, the loan still needed to make sense at every other level and that’s where the industry went askew. It may be the most overused term in the business, but common sense underwriting meant putting borrowers into loans they could afford. FICO wasn’t needed to tell us that.
However, when all of the other credit factors were held constant, FICO was dead nuts on, and that’s perhaps the most critical part of this discussion. The failure was on the part of the industry taking FICO as gospel and forgetting that it was still necessary to underwrite the file as if we really were mortgage bankers. Ironically, Equicredit, the former subrime division of Bank of America (NYSE:BAC), experienced six years ago what the rest of the industry is now going through. When I opened my subprime company in 2000, they were the most FICO driven company around. Putting all of their eggs into the FICO basket and ignoring the fundamentals of underwriting meant their loan performance tanked. What’s interesting is that their performance stunk at a time when property values were rising and interest rates were dropping. If this strategy fails under optimal circumstances, what makes anybody think it will work under abysmal conditions like we’re seeing today?
Last week I wrote about a 2007 Alt-A pool of loans from Washington Mutual (NYSE:WM) that is performing horribly – 15% foreclosure rate with 8 months of seasoning. I was taken aback by how a pool of 705 loans could deteriorate so quickly. But I was reminded by readers that I had forgotten the very things I wrote about in Greed, Fraud & Ignorance: A Subprime Insider’s Look at the Mortgage Collapse, the same things I’ve written about in this paper. Somehow I deluded myself into thinking that scores in this range couldn’t perform this poorly (and so quickly). But the loan characteristics were indicative of just how far we’ve fallen as an industry. Most of the loans were stated income (90%), CLTVs north of 90%, likely closer to 100% but we can’t tell for certain, and mostly pay option ARMs with of course, super-low teaser rates. How many were investor loans and were they really stated income loans or something akin to NINAs? I don’t know but I’ve got a strong suspicion this played into it.
So is FICO still relevant to the mortgage industry? I think it all depends on whether the industry and the securitization process function as they are supposed to. If the rating agencies have a vested interest in the loans they rate (e.g. they rate them with some level of competency so investors all over the world don’t buy the bonds believing they’re something that they’re not) and the rest of us remember the basic fundamentals we learned in Underwriting 101, then yes, FICO is still relevant. If not . . . well, maybe it’s time to fire up the snow cone machine. After all summer is just around the corner.