Lewis Ranieri, once known as the father of mortgage finance, is daring to revisit the most infamous sector of the mortgage market—subprime lending.
Four years ago, sky-high defaults on subprime mortgages—used mainly by borrowers with weak credit profiles—touched off the global financial meltdown, wiped out hundreds of financial institutions world-wide and destroyed billions of dollars invested in mortgage-backed securities. Today, lawsuits against Wall Street firms from investors burned by souring mortgage securities continue to meander through the courts.
Yet Ranieri believes now is the time for nontraditional lenders to enter the market. While the bank-lending standards that created the mortgage crisis were too loose during the housing boom, they are now too tight, Ranieri says, reducing the supply of mortgages to average borrowers and opening a door for lenders like Shellpoint Partners LLC, a mortgage-finance company he recently founded with two partners.
"The pendulum has swung too far in the other direction," Ranieri, 64 years old, said in an email comment. "Former traditional prime borrowers with good credit scores who could comfortably make mortgage payments are being precluded from home ownership due to banks' rigid criteria."
Few on Wall Street are as closely tied to the mortgage market as Brooklyn, N.Y. -born Ranieri, a onetime star bond trader at Salomon Brothers who helped to pioneer mortgage-backed securities in the 1980s. More than two decades later, the market developed by Ranieri and a handful of financial whiz kids came to a screeching halt. As mortgage bonds, which are backed by millions of Americans' home-loan payments, defaulted in droves, the ripple effects spread through the global economy, ushering in a devastating financial crisis. Ranieri also faced a setback in 2008, when a Texas bank he had acquired failed and was seized by regulators.
Since 2007, he has headed Ranieri Partners, a private-equity fund that helped to raise $100 million in equity last year to start Shellpoint. Earlier this month, Shellpoint acquired New Penn Financial, which originates conventional mortgages backed by Fannie Mae and Freddie Mac, the government-sponsored mortgage giants. New Penn plans to begin this month to also originate nonprime loans.
It isn't clear whether Shellpoint can raise the large amounts of capital needed to play a big role in the nonprime-loan market. But there is little doubt that consumer demand for alternative mortgage financing is growing as traditional banks shut out all but the most pristine borrowers.
"What Ranieri is doing is exactly what is needed in the market today and serves an important policy need," says Kenneth Rosen, who worked with Ranieri at Salomon Brothers in the 1980s and is now chairman of the Fisher Center for Real Estate & Urban Economics at University of California at Berkeley's Haas School of Business. "We should be loosening credit at the bottom of the markets."
Shellpoint says it has no plans to bring back the most discredited forms of subprime loans, including the infamous no-documentation mortgages, often dubbed liar loans, which allowed borrowers to obtain loans without proof of income or employment. And forget about those exotic mortgages with the complicated structures, such as negative amortization or balloon payments.
The aim is to target borrowers whose credit profiles prevent them from obtaining conventional mortgages in the tight market but who are nevertheless good credit risks and can make a down payment of at least a 15%. The company said a typical borrower could include self-employed contractors and other professionals who have assets and a steady income stream. The self-employed have been the hardest-hit by bank credit-tightening trends.
The attraction for nontraditional lenders are the high interest rates that borrowers pay, which can result in high profits as long as defaults remain low. Currently, mortgage rates on nonprime loans can exceed 9%, compared with 4% to 5% for prime mortgages.
One of the biggest hurdles for subprime lenders is that the securitization market for the mortgages still hasn't recovered. That means companies that originate subprime loans must keep the mortgages on their books or create entities to hold the mortgages.
Indeed, Shellpoint has raised just $100 million in equity so far to begin financing home loans, barely a blip in a market that originated $1.5 trillion in mortgages last year. However, the company says it is in final negotiations with a number of banks regarding additional financing, after which it expects to have more than $500 million on its balance sheet.
Another company wants to test the subprime waters. Last month, Fortress Investment Group said it plans to sell $500 million in an initial public offering for Springleaf REIT Inc., a real-estate investment trust that will buy subprime mortgages. Fortress is headed by Daniel Mudd, former chief executive of Fannie Mae who was forced out when the U.S. government took control of the mortgage giant in 2008. A separate Fortress unit, Springleaf Financial, will originate residential subprime mortgages and sell them to Springleaf REIT, which will hold the mortgages on its balance sheet.
Both Shellpoint and Springleaf are betting that the securitization market will eventually return, which will allow them to sell their mortgages to investors, raising fresh capital to grow the companies.
Some mortgage-industry analysts believe the companies will have a long wait. "It's unlikely you'll see much of a market for securitization of subprime loans occurring anytime soon because investors won't touch the product," says Guy Cecala, publisher of trade publication Inside Mortgage Finance. "Without a secondary market, it's hard to originate many subprime loans."
Originations of subprime loans peaked at $625 billion in 2005, according to Cecala's data, then collapsed to just $4 billion in 2009 and 2010. Subprime's share of the mortgage market rose slightly last year to 0.3% of all loans from 0.2%.
A.D. Pruitt is a reporter for the Wall Street Journal, where this story originally appeared. Write to her here.