Sub-prime lenders target the vulnerable: ThePost.ie


TCH Archives > Sunday Business Post > 2006/02/05 > Sub-prime lenders target the vulnerable

Sub-prime lenders target the vulnerable
Sunday, February 05, 2006 - By Kathleen Barrington
With a taste for a thick steak, Bennie Roberts couldn’t pass up a roadside meat stand in 1989. Along with a full side of beef, Roberts took home ‘‘half a hog, 30whole fryers, 30pounds of sausage and 30pounds of bacon. I had to make three or four trips,” he recalled.

To pay, he put down $20, ‘‘and they said I’d be hearing from the bank’’.

Sure enough, the following week a man from Associates First Capital Corp, the largest consumer finance company in the United States got in touch with Roberts. A meat loan of $1,250was arranged, and the Associates man, Donald McCauley, learned two things about his new client: Roberts owned ‘‘free and clear’’ a nice little three-bedroom house on the edge of downtown, and he signed the loan contract with an ‘‘X’’.

Roberts – a retired quarry worker – was illiterate. Friends and relatives read his mail to him. And he relied on other people – salesmen included – to explain contracts and documents to him.

So when – four months after issuing the meat loan – McCauley called and recommended that Roberts consolidate all his debts into one loan, Roberts agreed. And less than three weeks later, McCauley again recommended refinancing his debt, Roberts says. And he agreed.

‘‘I put my faith and trust in Don McCauley,” he said. ‘‘He was a wonderful friend.” That was the beginning of an extreme instance of a practice known as loan flipping, in which repeated and often unnecessary refinancings generate big loan fees for the lender while sometimes swamping the borrower in debt.

Roberts’ debt was refinanced ten times in less than four years, generating $19,000 (€15,700) in loan fees for Associates. Along the way, Roberts’ home became collateral for loans.

Loan proceeds to Roberts, meanwhile, were just $23,000, although he came to owe $45,000. By the time the last refinancing took place, Roberts, who was living on $841 a month in social security and retirement benefits, had a monthly payment to Associates of $633.28. The loan had a term of 15 years.

The above is an edited extract from an article published in the Wall Street Journal in 1997.*

Luckily for Roberts, things finally worked out after he took a case against Associates, charging that the multiple refinancing was a fraud calculated to lead to the loss of his home, that the salesman exercised undue influence over an unsophisticated customer and that the cumulative amount of the fees made the loan usurious. Associates settled - effectively forgiving the debt - so that Roberts again owned his house outright.

That article has since been widely cited by consumer interests in the US as a warning of the dangers posed to low-income borrowers releasing equity from their home especially if they are dealing with sub-prime lenders who specialise in high-interest, high-margin loans to poor people or people with poor credit histories.

And while Bennie Roberts’ story is certainly an extreme case, it is reproduced here as a cautionary tale at a time when there are predictions that Irish banks may be attracted to higher margin sub-prime lending as a way of growing their loan book profitably.

In a report published last week, S&P noted that there had been an increase in the pressure on bank credit standards, which was leading to an increase in industry risk in the Irish banking sector.

It said the most apparent example of this was the willingness of Irish lenders to offer 100 per cent mortgages compared with the traditional 92 per cent. S&P did not refer to the scale of equity release occurring in the mainstream Irish banking market.

But EBS reckons as much as 14 per cent of new mortgage lending in the Irish market this year is likely to be to borrowers who are releasing equity from their homes.

It is against this background that S&P predicted that ‘‘lenders may also become more attracted to the higher margins that sub prime lending offers’’.

Already there has been strong growth in the sub-prime lending market here, though it appears to be dominated by foreign-owned banks. Associates, the bank that lent to Roberts, is already active here, though these days it is known as Citi Financial, having been acquired by US banking giant Citicorp.

Other players in the market include HFC Bank, a division of the British giant, HSBC Bank. Sub-prime lenders offer loans to people with poor credit histories or people who would not necessarily qualify for a loan from a mainstream bank because they have an irregular income.

The advantage is that they make loans available to people who might otherwise have no other option than to turn to even more expensive moneylenders.

But the disadvantage is that many borrowers pay APRs of about 27 to 30 per cent on their sub-prime loans, while some have been charged rates in excess of 40 per cent. The casualties of this type of lending are now regularly turning up on the Show Me the Money programme on RTE as they seek advice on how to get out of the mire of debt in which they find themselves.

The sub-prime mortgage lending market - sometimes also known as the non-conforming mortgage market - is also growing in Ireland, albeit from a modest base.

Borrowers in this market typically pay interest rates of between 4.5 per cent and 8.5 per cent on their mortgages - on average almost double the normal mortgage rate. Sub-prime mortgage lenders offer customers - who may have been turned down by the mainstream banks - the opportunity to buy a home or to refinance expensive debt at cheaper mortgage rates.

Last week, Start Mortgages, the Irish subsidiary of the British Kensington Mortgages, reported results for its first full year in the Irish sub-prime mortgage market.

Start Mortgages did a higher than expected €309millionworth of mortgage business in its first year at what NCB analyst David Odlum described as ‘‘attractive margins of 3.8 per cent’’.

To put that in context, those margins are about three and half times greater than the margins on a standard prime mortgage - a fact that will not have gone unnoticed by the mainstream banks. Interestingly, as much as 78 per cent of the business was remortgage business.

Some of the business came from people consolidating more expensive debt, while others were remortgaging to fund home improvements or college fees, according to chief executive David Ingram.

The publicly quoted insurance company IFG also has a subprime mortgage lending division in partnership with US lender GE Capital. Overall, analysts estimate there could be as much as €4 billion worth of business to be written in the sub-prime mortgage market.

The US experience has shown that the sub-prime lending divisions of many mainstream banks are highly profitable. So it’s not hard to see why mainstream lenders would be tempted to go down this route. But while subprime lending may prolong the bull run in bank shares for those institutions that enter that market, the growth of the sub-prime lending market does give some cause for concern.

From a shareholder point of view, it is clear that sub-prime lending units have the potential to bring the bank into disrepute if they end up selling expensive loans to people who can’t really afford them - as happened in the case of Bennie Roberts.

The development is also worrying from an economic point of view as it may signal that large numbers of borrowers are already overstretched.

But most importantly, the phenomenon is worrying from a social point of view, as the people who end up paying dearest for their loans are generally the ones who can least afford it.

* A Man and His Loan: why Bennie Roberts Refinanced 10 Times. By Jeff Bailey, the Wall Street Journal, April 23, 1997