Lawsuits, Regulation and A Skewered Public Image Beset OC Subprime Lenders
The volatile subprime lending industry is in another one of its downturns, and this one’s a doozy.
Not only are higher interest rates putting a damper on activity, but there’s been a rash of highly publicized problems at some companies and a public clamor against alleged improper lending practices.
The result has been a rash of legislation around the country, more regulatory scrutiny and an increase in lawsuits that target subprime lenders. Early this month the Department of Housing and Urban Development staged a five-day nationwide hearing, including a session in Los Angeles, examining proposals to reform subprime lending.
And all of that has made Wall Street investment houses and investors leery, threatening the secondary market in mortgage securities that is the subprime industry’s lifeblood.
Industry critics say the “anti-predatory” laws and lawsuits are necessary steps to rein in a runaway industry. But the lenders and brokers themselves say the measures are an over-reaction that could undermine an industry that is an important source of credit for people who can’t otherwise obtain financing.
“I am afraid we will overreact and over-legislate,” said Philip Gatton, a senior loan officer with Dallas-based CTX Mortgage Co., a division of Centex Financial Services.
“The legislation in place now needs to be enforced,” said Mike Buck, executive vice president of the mortgage division of the Bank of Yorba Linda. “The fear is the pendulum will swing too far and hurt us.”
Still, Rick Ainsworth, president of the California Association of Mortgage Brokers, conceded that all of the activity has had at least part of its intended effect: “It is putting the industry on alert. People are looking at predatory lending seriously.”
Subprime loans are home mortgages and other consumer financing that offer people with low incomes or poor credit histories access to borrowing. Shunned by commercial banks and other traditional “prime” lenders, the loans typically come with high interest rates and fees, and often with balloon payments.
In recent weeks, several OC-based players in the subprime market have been in the news:
n Irvine-based First Alliance Corp. filed for bankruptcy liquidation on March 23 amid investigations of its lending practices in several states and an inability to securitize its loans on Wall Street. The company then reported a $14.5 million quarterly loss on a 71% drop in revenue.
n In April, Irvine-based Platinum Capital Group closed its 38-person subprime-lending subsidiary. Platinum president Mark D. Moses said the fledgling unit had trouble bundling its loans to investors, because the outcry over abusive loan practices had made Wall Street investment houses more leery about securitizing subprime loans.
n Ditech.com of Costa Mesa was rocked on May 1 by the resignation of founder and Chief Executive Paul Reddam, on the same day the FBI arrested three of his top officers on extortion charges. Ditech’s parent company, GMAC Mortgage, itself a unit of General Motors Acceptance Corp., the finance arm of automaker General Motors Corp., purchased Ditech.com from Reddam in early 1999. GMAC officials have put their own management team in place and say they’re trying “to keep moving the business in the right direction.”
n Orange-based Ameriquest Mortgage Co. faces litigation accusing it of predatory lending practices.
n An Irvine law firm, Mower Nebeker Carlson & Haluck, has filed class-action lawsuits alleging predatory lending practices in Orange County by five subprime lenders. Named are Anaheim-based National Pacific Mortgage, as well as Los Angeles-based Aames Financial Corp., Dallas-based AccuBanc Mortgage and Burlingame, Calif.-based Provident Funding and Carmel, Ind.-based Conseco Mortgage. Troubled Aames Financial has seen its stock drop to the dollar level, down from its 52-week high level of 9 and miles below the 61 high point hit in October of 1996.
The Squeeze Is On
Anti-predatory legislation already has been passed in eight states, squeezing fees and rates for subprime lenders. California hasn’t joined the list yet, but it has put the subprime lenders under increasing scrutiny.
The local industry just dodged a bullet in Sacramento this month when an anti-predatory lending bill was withdrawn by its author, Sen. Hilda Solis of El Monte.
The legislation would have prohibited many of the practices that subprime lenders say are vital to their ability to provide credit: negative amortization loans, balloon loans, debt acceleration, advance payment fees, modification or deferral fees and increased interest rates after default. The bill also would have sharply limited prepayment fees and introduced a number of consumer-protection measures, including credit counseling.
Tom Borcich, a regional director for the California Association of Mortgage Brokers, said the bill would have eliminated credit to about 40% of subprime customers. Yorba Linda’s Buck said the bill would have left lenders with “not enough to pay the rent.”
But the drive to clamp down on the industry in California isn’t over. The legislature is continuing to consider measures, while Solis has amended her SB 2128 and handed it over to a task force. And Gov. Gray Davis plans to pick a committee to evaluate predatory legislation and the subprime industry.
New York regulators, meanwhile, also have put lenders on alert, recently writing guidelines for financial firms securitizing subprime loans.
Lawsuits Proliferate
Trial lawyers also have been zeroing in on subprime lenders. Patrick Carreon, a partner at Mower Nebeker Carlson & Haluck, said the firm came across its suit against lenders by accident: the firm was investigating one of the lenders on behalf of clients who alleged unpaid overtime. Along the way, it realized there were grounds to accuse the company of cheating loan customers. Shortly after, the Consumers Against Lenders Abuse was formed, and it has brought charges against OC lenders.
Perhaps more ominously for the subprime industry, lawsuits now are taking aim at its lifeblood: the secondary market, where the loans are packaged and securitized by big investment banking houses for resale to institutions and other investors. This process refills the lending bucket to allow for new loans.
Lehman Brothers Holdings Inc. is involved in a lawsuit for securitizing loans from First Alliance.
Rick Ainsworth, CAMB president, said such suits are without merit since the buyers of the securities aren’t a party to any alleged irregularities in the making of the loans themselves. But he expressed concern about such suits having a chilling effect on the industry.
“Naturally the lawsuits are going to the deeper pockets,” he said.
And the pressure is being put on Wall Street in other ways. In March, a group called the Association for Community Organizations for Reform Now shuttled in about 400 protesters to the Washington, D.C., offices of Salomon Smith Barney Inc., one of the securitizers of Ameriquest’s loans.
William Lobel, an attorney with Chicago-based Irell & Manella LLP who is representing First Alliance, said the company filed for bankruptcy protection because of mounting lawsuits against the company and because of legislation passed in several states, both of which squeezed off revenue, he said.
“There are a lot of subprime lenders that are going out of business,” Lobel said.
The First Alliance bankruptcy filing came after the TV news show “20/20” aired an investigation of alleged predatory lending practices that focused on the company.
“They could no longer operate with all the bad publicity,” said CAMB’s Borcich.
But Lobel said the TV show merely added insult to injury. “They would be out of business anyway,” he said.
Local Roots
The high-risk, high-reward subprime industry has its roots in Southern California, dating back to the late 1980s when the aerospace decline put many people out of jobs, causing foreclosures and bankruptcies and giving subprime lending a catalyst to expand.
“The industry grew like crazy in California,” Gatton said.
OC-based finance companies such as Irvine’s New Century Financial Corp., Orange’s Long Beach Financial Corp. and Ameriquest, banks including Downey Savings and Loan and Bank of Yorba Linda and online mortgage brokers like LoansDirect.com and Ditech.com make OC a leading region for the subprime industry. While some of these companies are not primarily focused on subprime lending, they have sizeable subprime operations.
The subprime industry, barely existent a decade ago, now accounts for about 20% of the U.S. mortgage-lending industry, according to the Department of Housing and Urban Development.
“They are filling a significant niche that was under-served eight to 10 years ago,” Borcich said. “That’s why there was such radical growth.” n
