by Calculated Risk on 8/10/2005 10:33:00 PM

Here are two stories on mortgage lenders. The first story, from the WSJ, explores the financials of Downey Financial.

As of June 30, $12 billion, or 87 percent of Downey's ARMs are option ARMs. Its customers have racked up $72 million in additional balances on those mortgages by choosing to make minimum monthly payments. That's called negative amortization.

Right now, Downey's negative amortization is a mere 0.6 percent of its ARM portfolio. But that measure understates its significance. Its negative amortization balance is accelerating, from $51 million in the first quarter and $37 million in the fourth quarter of 2004.

These noncash earnings were 20 percent of Downey's earnings per share in the second quarter. If that trend continues, more than 40 percent of Downey's current-quarter earnings would be noncash. Analysts already expect earnings to decline to $1.79 a share in this quarter, so it would be a bigger slice of a smaller pie.

In other words, the bank's earnings are being increasingly driven by sales of a product to inherently risky customers. Downey Finance Chief Tom Prince says concerns about option ARMs are exaggerated and that his bank previously has had even more exposure to them without problems. "I'm not particularly concerned about it," he says.

This is the "good" story. It doesn't appear that the risk from option ARMs puts Downey at risk, but it does show the speculation using leverage in the California housing market. As the story points out:

At Downey, disclosure is good; it's the exposure that's bad.

The second story, Wolves in Small Print, details the predatory practices of some apparently unsavory lenders.

Garcia went with the bigger loan, one he thought was going to be for about $70,000 with about the same interest rate. But when closing day arrived, the figures had changed, he said.

"The final figures came out to around $100,000 with all the fees and closing costs, and when I read the papers a few days later, I said ‘Goll-ee,’ " Garcia said this week. "The new loan payments were about $900 a month. With my original loan I was paying insurance and taxes in the loan, but with the new loan I found out that that stuff wasn’t included. They told me it was a fixed interest rate, but I found out later it was variable. So every few years my interest rate was going to go higher. I found out I was going to be pricing myself out of my own home."

This story gets even more bizarre. Apparently Garcia only received $2800 from the proceeds of the new $100K loan, even though his previous loan balance was just over $60K.

Garcia never got the $7,200 in the new loan to fix his foundation; according to the court documents, he got only $2,800. He thought he was getting a fixed interest rate of 8.7 percent, but the fine print said it was a variable loan that’s now up to 12.4 percent. What is even more amazing is the bottom-line amount that Ameriquest loaned, compared to the value on his house and his equity in it. Texas law limits home equity loans to 80 percent of the appraised value of a home. For him to get a loan of $100,000, Garcia’s house would have to be worth around $140,000 — more than double what Garcia paid for the house just eight years earlier.

The second story sounds like fraud and I doubt it is widespread, although the story has some alarming numbers and other anecdotes. And it does show the naivete of some borrowers. There is also an interesting section on the "charities" that donate money to FHA buyers (really the money comes from the seller with a higher selling prices). I've written about these DAPs earlier with a chart on their growth. It appears to be getting worse:

...the increased use of "down payment assistance" programs that give mostly first-time buyers a "charitable" gift of the down payment money needed to close the loan under Federal Housing Administration loan rules.

Here is how it worked on a recent loan deal, coincidentally, just down the street from Felipe Garcia’s house in Edgecliff Village. According to documents sent to the buyer and obtained by the Weekly, the asking price on the home was $85,000. But the proposed buyer had bad credit, and the lender wanted a hefty down payment. So the Genesis Foundation, based in Indiana, was brought in to "give" the buyer the $7,200 down payment in return for a $595 fee that was rolled into the loan. In return, the company selling the house gave Genesis a tax-deductible "gift" of equal value and paid Genesis a $750 transaction fee.

It’s illegal for a home seller to give down payment money to a buyer, under federal lending rules. But in this case, the down payment technically came from a charity. In reality, it was just a way to move the money from one pocket to another. The new purchase price for the house was $93,000. So, in the end, the FHA (which requires at least a 3 percent down payment) was backing a higher loan with no real down payment. And instead of an $85,000 loan, the buyer now had a $93,000 loan.

The DAP story is worrisome. And the first story on options ARMs is concerning since that appears to be a systemic problem.