Subprime Lender Made Problem Loans On Regulators’ Watch
Federal officials heap much of the blame for the subprime mortgage mess on lenders, claiming they recklessly made too many high-cost home loans to borrowers who couldn’t afford them.
It turns out that the U.S. government itself was one of the lenders giving out high-interest, subprime mortgages, some of them predatory, according to government documents filed in federal court.
The unusual situation, which is still bedeviling bank regulators, stems from the 2001 seizure by federal officials of Superior Bank FSB, then a national subprime lender based in Hinsdale, Ill. Rather than immediately shuttering or selling Superior, as it normally does with failed banks, the Federal Deposit Insurance Corp. continued to run the bank’s subprime-mortgage business for months as it looked for a buyer. With FDIC people supervising day-to-day operations, Superior funded more than 6,700 new subprime loans worth more than $550 million, according to federal mortgage data.
The FDIC then sold a big chunk of the loans to another bank. That loan pool was afflicted by the same problems for which regulators have faulted the industry: lending to unqualified borrowers, inflated appraisals and poor verification of borrowers’ incomes, according to a written report from a government-hired expert. The report said that many of the loans never should have been made in the first place.
FROM THE CASE FILINGS
• Beal Bank laid out its legal case in a Nov. 19 filing in the U.S. District Court in Washington, D.C.
• The FDIC filed this response to Beal’s suit at the same court in late April 2008.
• In an undated internal FDIC assessment. that Beal Bank obtained and filed in court in June, the FDIC acknowledged “numerous appraisal deficiencies” in the portfolio it sold to Beal and discussed its legal vulnerability. Points of interest: Pages 8-11 summarize the final report of an outside expert; pages 16-17 pages 16-18 discuss appraisal, fraud and other problems; pages 26-27 consider the FDIC’s “poor” legal situation. The handwritten notes were in the version filed in court; it’s unclear who added them.
• One exhibit filed in the case by Beal Bank was a May 2004 report to the FDIC from an outside expert reviewing the portfolio sold to Beal.
• The FDIC filed an excerpt of what it said was a final version of the 2004 expert’s report, which concluded that almost 19% of the loans sold to Beal contained material breaches of the warranties (pages 16-24).
• Another internal legal analysis shows the FDIC recognized problems with fraud in some loans sold to Beal.
Hundreds of borrowers who took out Superior subprime loans on the FDIC’s watch — some with initial interest rates higher than 12% — have lost their homes to foreclosure, data on the loans indicate.
Banking regulators are grappling with a new round of woes related to subprime mortgages, which were generally made to people with poor credit histories. This month, the FDIC took control of the IndyMac Bank, a major lender that specialized in higher risk loans, after it failed. The FDIC intends to keep IndyMac open, as it did with Superior, but it doesn’t plan to originate any new mortgages.
At the time the FDIC was running Superior, subprime lending hadn’t yet emerged as the national disaster it since has become. But some lending experts already were faulting industry practices and warning about rising delinquencies. The FDIC’s problems with Superior could fuel criticism that bank regulators were slow to heed warning signs.
The FDIC, one of the chief U.S. bank regulators, manages a giant insurance fund that compensates customers of failed banks, and it takes charge of banks seized by the government. It has taken over hundreds of failed banks over the years, and generally has a good track record handling the difficult job.
The Superior situation could be costly for the FDIC. Texas-based Beal Bank SSB, which bought a portfolio of Superior loans, about half of them originated under the FDIC, is suing the agency in U.S. District Court in Washington. The suit claims many of the loans were made improperly and are plagued with problems.
An internal FDIC legal assessment, obtained by Beal Bank and filed in court last month, acknowledged “numerous appraisal deficiencies” in the portfolio and a “small number of loans that appear to be fraudulent from inception.” Calling the FDIC’s legal position poor, the undated 26-page assessment suggested that the agency’s liability could be as much as $70 million. Another FDIC official, in a deposition, estimated that the cost of settling the case could be less than one-third that amount.
In a recent court filing, the FDIC estimated that about 1,500 of the 5,315 loans it sold to Beal either have defaulted or are nonperforming. The FDIC already has bought back another 247 of the mortgages, most of them for violations of federal anti-predatory-lending laws intended to protect borrowers from unreasonably high fees or deceptive practices. Beal Bank has said in court filings that 73 of the repurchased loans were originated while the FDIC was running Superior.
In a statement, FDIC spokesman Andrew Gray said the agency was “prepared to immediately work with Beal” to fix any additional mortgages originated under its watch that violated consumer-protection laws or the FDIC’s own subprime-lending guidelines. As for the loans it has already acknowledged were predatory, Mr. Gray said the FDIC has provided recompense to affected borrowers and instructed its servicing contractor to avoid foreclosing.
Mr. Gray added that the FDIC “remains deeply concerned about consumer-protection issues. Though these loans with relaxed lending standards were commonplace during this period, time and experience has shown that the long-term interests of borrowers were not always served well by them.”
Meanwhile, a separate portfolio of Superior subprime loans that the FDIC sold to Bank of America Corp. — which the bank in turn sold to investors — also has been troubled. As of April, investors had suffered “realized losses” — which generally occur after foreclosures — on 511 of the 3,964 loans in that pool, according to data provided to investors. The vast majority of the loans were originated when the FDIC was running the bank, the data show. In May and June, two ratings agencies downgraded some securities backed by the mortgages, with one citing a large number of severely delinquent loans and other problems. A Bank of America spokesman declined to comment.
Subprime mortgages typically carry high interest rates to reflect the greater likelihood of default. For years, the government encouraged lending to low-income borrowers as a way to increase home-ownership rates. But the market got out of control after some lenders started doling out more aggressive loans, relaxing collateral requirements, and paying less attention to the ability of borrowers to pay.
FDIC Chairman Sheila Bair has been unusually forthright in putting part of the blame for the mortgage mess on regulators, who she has said should have acted earlier. But Ms. Bair — who took office in 2006, long after the FDIC ran Superior — also has faulted lenders, criticizing them for “lax lending standards,” making “poorly underwritten” loans, and placing borrowers in “products that create financial hardship rather than building wealth.”
Brister Hightower, a retired high-school teacher, lost his rural home near Athens, Ga., to foreclosure after he fell behind on a high-interest mortgage taken out from Superior when the FDIC was running it.
Twenty years ago, Mr. Hightower had purchased what he calls a “small, run-down house” with a tin roof adjacent to a trailer park. He worked with a cousin to fix up the interior, and added insulation, vinyl siding and a second bathroom. In December 2001, he refinanced it with a $120,700 mortgage from Superior, using the proceeds to pay off an earlier loan and some other debt. The 20-year mortgage carried a 10.75% fixed interest rate, compared with the roughly 7% rate then available to borrowers with good credit.
Some subprime problems have been blamed on lenders giving out mortgages for more than a house is worth, immediately putting the borrower in a financial hole. The appraisal used by Superior valued Mr. Hightower’s home at $142,000. The three “comparable” properties used to justify that appraisal were well-tended houses situated miles away in neighboring counties. Two were close to the center of Athens, where county officials say property values in general were much higher than in Mr. Hightower’s area. County records show the fair-market value for tax purposes of Mr. Hightower’s home was less than $84,000.
His loan was among those sold to Beal Bank by the FDIC. Mr. Hightower, now 68 years old, says he tried to keep up payments, but couldn’t after “it got to the point I could hardly eat.” Beal foreclosed, and in 2005 sold the property at auction for $76,000.
Told that the FDIC was running the bank when it gave him the loan, Mr. Hightower says: “I wouldn’t expect the government to rip me off…Can I get some money back?” The FDIC didn’t respond to questions about Mr. Hightower’s loan.
Superior Bank, based outside of Chicago, was 50% owned by the Pritzker family of Chicago, which also controls the Hyatt hotel chain. The bank had just 18 branches, but grew rapidly in the 1990s by making subprime loans nationwide through a subsidiary, Alliance Funding. When Superior failed in July 2001, regulators faulted it for “poor lending practices” and overly rosy valuations of assets related to its securitization of subprime loans.
When the FDIC learns a bank is about to fail, it tries to locate a buyer ahead of time to assume its deposits and loans. With Superior, the agency had little warning. A private-sector rescue plan had fallen apart at the last minute. The agency decided that the best way to maximize the value of the failed bank was to continue operating it under a new name while it searched for buyers.
The FDIC appointed one of its senior officials to be Superior’s chairman, hired a new chief executive, and installed agency employees to oversee day-to-day operations, agency documents show. But it continued to employ many of the bank’s workers who originated subprime mortgage loans. The FDIC sold Superior’s branches and its deposit-taking business for $52.4 million in late 2001, but no prospective buyers materialized for its subprime-lending unit. The FDIC stopped funding new loans in early 2002, and shuttered the operation by that May 31.
Both before and after the FDIC takeover, Superior relied heavily on a national network of independent mortgage brokers to locate potential borrowers. Some such brokers have been criticized for focusing more on the fees they collect from generating loans than on the ability of borrowers to pay. The FDIC says it was concerned about the dependence on brokers, and brought in “independent compliance examiners” to look at Superior’s lending standards. The agency says it changed some of the guidelines several months after it took charge.
But in a deposition in May for the Beal Bank litigation, a senior FDIC official suggested that fixing the bank wasn’t the agency’s top priority. “Our job was to go in and sell the assets of the institution, and not try to clean up the operations, per se, to make this a better bank,” said the official, Gail Patelunas.
Mitchell L. Glassman, director of the FDIC’s division of resolutions and receiverships, defended the agency’s oversight of Superior in a 2004 letter to FDIC’s inspector general. He said that mortgage applications submitted through brokers were first checked by 270 in-house underwriters, then rechecked by a staff of 21 quality-control auditors, who “effectively conducted due diligence” on all incoming loans using a 200-item questionnaire.
Beal Bank, based in Plano, Texas, sued the FDIC in 2002, not long after it finished paying the agency about $339 million for 5,315 Superior mortgages. Roughly half were “New Superior” loans originated when the FDIC was in control, and half were underwritten by “Old Superior.”
Although the FDIC usually sells such loans on an as-is basis, the agency backed the Superior loans with extensive warranties about their quality, including that there was no fraud or misrepresentation in their origination. The FDIC says it included such guarantees, in part, to give Beal Bank the ability to sell back to the agency any loans that had fallen through cracks in the oversight process.
In its court filings, Beal Bank claims that many of the loans weren’t as represented by the FDIC. It says some were based on negligent or fraudulent appraisals, and others were based on false or inaccurate information about borrower income. It also says that minority borrowers were given loans with higher fees and interest rates than similarly situated white borrowers, in violation of federal law.
“The FDIC has established high standards of ethical and legal conduct for mortgage lenders that it regulates, but has demonstrably failed to meet these standards in its lending activities at Superior and loan sales to Beal Bank,” says Andrew Sandler, an attorney at Skadden Arps Slate Meagher & Flom LLP, who represents Beal Bank. “This lawsuit is about requiring the FDIC to meet its own standards of accountability.”
An internal FDIC legal memo on the case that was turned over to Beal Bank’s lawyers refers to “gross discrepancies” in some loan files, including forged signatures or “wildly different signatures purporting to be that of the same person.” A single mother claimed two children in applying for a loan, but later cited the needs of five children when she failed to make a single payment, according to the memo, which is undated.
In 2004, the FDIC hired an outside expert, Silver Spring, Md., consultant Ronald L. Freudenheim, to assess the loans sold to Beal Bank. A version of the consultant’s report, recently filed in court by Beal, said that 13% of the loans showed no evidence that the borrowers’ incomes were verified, while in 16% of loans the borrowers had too little income for the debt they were taking on. Overall, he said, 56% of the loans violated Superior’s guidelines and “should not have been issued.” The assessment didn’t differentiate between Old Superior and New Superior mortgages.
The FDIC says that was a draft report. Last month, the agency filed a final version in court, which estimated that about 19% of the loans sold to Beal contained “material” breaches of the warranties — meaning there were significant problems with close to 1,000 mortgages. This version of the report blames Beal Bank for some of the portfolio’s lost value, saying it serviced the loans in an “inferior” manner.
Stephen Costas, Beal Bank’s general counsel, declined to comment on that. He said the Superior matter is an “isolated disagreement” with the FDIC, and that the bank looks forward to resolving it and continuing its “good relationship” with the agency.
Mr. Gray, the FDIC spokesman, said the agency has “worked in good faith to repurchase loans subject to our obligations.” He said Beal Bank hadn’t provided until recently enough information on the alleged problem loans for the agency to take action.
By MARK MAREMONT
July 21, 2008
Source: Wall Street Journal