During the past five years or so, Southern California became to subprime lending what Silicon Valley is to technology. It was a big very big industry. How quickly the picture has changed. Liquidity shortages have forced several Southern California subprime lenders to shut down or curtail operations. WMC Mortgage, a Burbank-based subprime lender, in April announced plans to lay off more than 700 workers, about half of its staff. In view of these dire circumstances, what’s the future for subprime loans? Some readers may be thinking, “Those lenders got what they deserved. They caused a lot of grief for homeowners and for investors. Subprime lending should be outlawed.” But it shouldn’t be banned, and it won’t be. Look at the subprime crash this way. In every capital market segment that evolves rapidly, there will always be some excesses. Inevitably, these will result in corrections which, in turn, will cause the afflicted sector to become a stronger, larger and more important part of the overall capital structure. It’s not hard to spot the excesses that got subprime lenders into trouble. “Don’t have the money for a down payment and the house you’re looking at needs some fixing up? No problem, we’ll lend you 125 percent of the house’s value.” Or: “Can’t prove the income you claim? That’s OK, we’ll just take your bank statements for the last twelve months, add them up and call that your income; we won’t worry about how much your expenses reduced that income.” Or even more flagrantly: “Just state your income. We know you’re too honest to lie about it.” It got to the point where just about all a loan applicant had to do was fog a mirror to qualify for a loan. From now on, it’s going to take a lot more than heavy breathing on a reflecting surface for applicants with shaky or poor credit to come away with a mortgage. Before the recent upheaval, a FICO score as low as 600 was good enough to get a subprime loan; now that number is more like 670. But as one who was closely involved with a Southern California lender that made subprime loans and survived the shakeout I believe that the economic facts of life will cause the remaining lenders to raise their standards beyond merely increasing the required FICO. There will continue to be tough competition among lenders in Southern California and elsewhere. Loans of the types I cited earlier will be rare or most likely things of the past. Borrowers will have to prove the income they claim, down payments of significant size will be demanded, and interest-only loans will become extremely rare. Does this mean that lenders’ doors will be closed to the less-than-affluent? Not at all. The 1977 Community Reinvestment Act encourages lenders to make loans to low-income people, and every recent President and Congress in memory have strongly favored home ownership for Americans. Subprime lending made that dream come true for countless numbers of people and doubtless will continue to do so. And what of the thousands of workers who’ve lost their jobs at subprime lenders? The loss of a job is a blow for anyone, but Southern California has such a strong, vibrant economy that most of the victims of the subprime slaughter are almost certain to find other employment within a few months. How about the people who bought stock in subprime lenders that have failed or have faltered badly? They will just have to lick their wounds and look a lot closer at the lenders whose stock they are considering for purchase. There are plenty of good lenders in Southern California and elsewhere whose stocks are or will become good buys. It will just take a little more diligence,more homework on the part of prospective investors to separate the wheat from the chaff in the lending field. It’s worth noting that subprime lenders’ sources of funds haven’t dried up completely. For example, shortly after filing for bankruptcy, Orange County subprime giant New Century Financial Corp. won a judge’s approval for a bid to secure up to $150 million in interim financing so it could continue operating. And San Diego’s Accredited Home Lenders eased a severe liquidity pinch by obtaining a $200 million loan from a hedge fund, easing its liquidity pinch. So the black clouds that have been hovering over the subprime field are clearing, gradually brightening the outlook for this lending specialty. William J. Battison a resident of La Canada-Flintridge, is president of Angeles Capital Group LLC, a Los Angeles investment bank that provides advisory services and represents middle-market companies in mergers and acquisitions.
