moneybox
The Subprime Good Guys
These mortgage lenders loan to poor people, strengthen communities, and
are still making a profit. How do they do it?
By Daniel Gross
Posted Saturday, Nov. 15, 2008, at 7:42 AM ET

In recent months, conservative economists and editorialists have tried
to pin the blame for the international financial mess on subprime
lending and subprime borrowers. If bureaucrats and social activists
hadn't pressured firms to lend to the working poor, the story goes, we'd
still be partying like it was 2005 and Bear Stearns would be a going
concern. The Wall Street Journal's editorial page has repeatedly heaped
blame on the Community Reinvestment Act, the 1977 law aimed at
preventing redlining in minority neighborhoods. Fox Business Network
anchor Neil Cavuto in September proclaimed that "loaning to minorities
and risky folks is a disaster."

This line of reasoning is absurd for several reasons. Many of the
biggest subprime lenders weren't banks and thus weren't covered by the
CRA. Nobody forced Bear Stearns to borrow $33 for every $1 of assets it
had, and Fannie Mae and Freddie Mac didn't coerce highly compensated
CEOs into rolling out no-money-down, exploding adjustable-rate
mortgages. Banks will lose just as much money lending to really rich
white guys like former Lehman Bros. CEO Richard Fuld as they will
lending to poor people of color in the South Bronx.

But the best refutation may come from Douglas Bystry, president and CEO
of Clearinghouse CDFI (community-development financial institution).
Since 2003, this for-profit firm based in Orange County—home to busted
subprime behemoths such as Ameriquest—has issued $220 million worth of
mortgages in the Golden State's subprime killing fields. More than 90
percent of its home loans have gone to first-time buyers, about half of
whom are minorities. Out of 770 single-family loans it has made, how
many foreclosures have there been? "As far as we know," says Bystry,
"seven." Last year Clearinghouse reported a $1.4 million pretax profit.

Community-development banks, credit unions, and other CDFIs—a mixture of
faith-based and secular, for-profit and not-for-profit
organizations—constitute what might be called the "ethical subprime
lending" industry. Even amid the worst housing crisis since the 1930s,
many of these institutions sport healthy payback rates. They haven't
bankrupted their customers or their shareholders. Nor have they rushed
to Washington begging for bailouts. Their numbers include tiny startups
and veterans such as Chicago's ShoreBank, founded in 1973, which now has
$2.3 billion in assets, 418 employees, and branches in Detroit and
Cleveland. Cliff Rosenthal, CEO of the National Federation of Community
Development Credit Unions, notes that for his organization's 200
members, which serve predominantly low-income communities, "delinquent
loans are about 3.1 percent of assets." In the second quarter, by
contrast, the national delinquency rate on subprime loans was 18.7 percent.

Participants in this "opportunity finance" field, as it is called,
aren't squishy social workers. In order to keep their doors open, they
have to charge appropriate rates—slightly higher than those on prime,
conforming loans—and manage risk properly. They judge their results on
financial performance and on the impact they have on the communities
they serve. "We have to be profitable, just not profit-maximizing," says
Mark Pinsky, president and CEO of the Opportunity Finance Network, an
umbrella group for CDFIs that in 2007 collectively lent $2.1 billion
with charge-offs of less than 0.75 percent.

What sets the "good" subprime lenders apart is that they never bought
into all the perverse incentives and "innovations" of the bad subprime
lending system—the fees paid to mortgage brokers, the fancy offices, and
the reliance on securitization. Like a bunch of present-day George
Baileys, ethical subprime lenders evaluate applications carefully, don't
pay brokers big fees to rope customers into high-interest loans, and
mostly hold onto the loans they make rather than reselling them. They
focus less on quantity than on quality. Clearinghouse's borrowers must
qualify for the fixed-rate mortgages they take out. "If one of our
employees pushed someone into a house they couldn't afford, they would
be fired," says CEO Douglas Bystry.

These lenders put into practice the types of bromides that
financial-services companies like to use in their advertising. "We're in
business to improve people's lives and do asset building," says Linda
Levy, CEO of the Lower East Side People's Federal Credit Union. The
7,500-member nonprofit, based on New York's still-scruffy Avenue B,
doesn't serve the gentrified part of Manhattan's Lower East Side, with
its precious boutiques and million-dollar lofts. The average balance in
its savings accounts is $1,400. The typical member? "A Hispanic woman
from either Puerto Rico or the Dominican Republic in her late 40s or
early 50s, on government assistance, with a bunch of kids," Levy says.
Sure sounds like subprime. But the delinquency rate on its portfolio of
mortgage and consumer loans is 2.3 percent, and it's never had a
foreclosure.

Ethical subprime lenders have to look beyond credit scores and
algorithms when making lending judgments. Homewise, based in Santa Fe,
N.M., which lends to first-time, working-class home buyers, makes credit
decisions based in part on whether borrowers have scraped together a 2
percent down payment. "If customers build a savings habit to save that
money on a modest income, it says a lot about them and their financial
discipline," says executive director Mike Loftin. Of the 500 loans on
Homewise's books in September, only 0.6 percent were 90 days late. That
compares with 2.35 percent of all prime mortgages nationwide.

Since ethical subprime lenders know they're going to live with the loans
they make—rather than simply sell them—they invest in initiatives that
will make it more likely the loans will be paid back. Faith Community
United Credit Union, which got started in the basement of a Baptist
church in Cleveland in 1952 with members saving quarters on Sundays, now
has $10 million in assets. In addition to making loans, "we teach people
how to manage their finances and accounts," says CEO Rita Haynes.
ShoreBank, as part of its energy-conservation loan program, offers free
energy audits and a free Energy Star refrigerator when upgrades are
completed. The theory, reducing energy bills makes it more likely people
will stay current with their mortgages. Today, only $4.83 million of
ShoreBank's $1.5 billion loans are in foreclosure, or just 0.32 percent.

Ethical subprime lenders are now expanding beyond mortgages. Ed Jacob,
manager and CEO of Chicago's North Side Community Federal Credit Union,
was alarmed to learn that many of his 2,700 members, most of whom have
less than $100 in their accounts, were relying on the "second-tier
financial-service marketplace": check-cashing outlets and payday
lenders, which charge exorbitant fees. So he rolled out a Payday
Alternative Loan, $500 for six months at 16.5 percent. The delinquency
rate on the more than 5,000 PALs extended thus far is 2.5 percent. "For
payday lenders, it's a success if customers keep taking out loans. To
me, it's a success if they don't have to anymore," Jacob says. He
believes such loans can build a credit history and help "move people to
better products for them and us—auto loans and, eventually, mortgage loans."

**********Lending small amounts of money carefully and responsibly to
working-class people isn't a recipe for riches or grand executive
living. At the headquarters of ShoreBank, which occupies a former movie
theater built in 1923, the window in one founder's office looks out onto
a brick wall. Bystry, the CEO of Clearinghouse CDFI, earns a salary of
$190,000—a pittance compared with the compensation of larger lenders.
(Angelo Mozilo, former CEO of Countrywide Financial, was paid $22.1
million in 2007.) For all the growth, this remains very much a niche
industry.**********

Still, the mortgage crisis has provided an opportunity for ethical
subprime lenders to expand. ShoreBank has added staffers and in August
2007 rolled out a Rescue Loan program, which aims to move borrowers out
of expensive adjustable-rate mortgages into fixed-rate loans. "We really
believe we can help people caught in these bad mortgages," says Jean
Pogge, executive vice president of consumer and community banking at
ShoreBank. And with plenty of lenders having failed or pulled back from
markets, new customers are flocking to their doors. "We're getting
demand for regular co-op loans for the first time," says Levy of the
Lower East Side Credit Union. In California, the news on housing may be
unrelentingly grim, but through the third quarter, Clearinghouse CDFI
made 161 loans for $48.4 million, up about 50 percent from the total in
the first three quarters of 2007. Doug Bystry says, "This may be a
record year for us."

A version of this article also appears in this week's Newsweek. Andrew
Murr in Los Angeles and Hilary Shenfeld in Chicago assisted in the
reporting.
Daniel Gross is the Moneybox columnist for Slate and the business
columnist for Newsweek. You can e-mail him at . He is
the author of Pop! Why Bubbles Are Great for the Economy.

Article URL: http://www.slate.com/id/2204583/



Apparently, if you use good business principles and are not greedy, you
can make money in the mortgage business and still get paid decently,
too. Imagine that.