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In February, Reuters reported that Wells Fargo (NYSE:WFC) is slowly reentering the subprime home lending industry, lowering its qualifying FICO score for a federally backed mortgage from 640 to 600. Rebranding the loans as “alternative mortgage programs,” Wells Fargo, America’s largest mortgage provider, hopes this return will boost revenue enough to compensate for a nationwide decline in home lending volume.
So far, no other large institution has followed in easing mortgage requirements as sharply, presumably due to industry reforms introduced in the Dodd-Frank Act, which outlines minimum qualification standards set for home loans insured by the Federal Housing Administration (FHA). The restrictions, combined with market pressure to pass the Fed’s annual stress tests, has resulted in the large banks shying away from extending mortgages to applicants with a FICO score under 640.
Smaller firms, though, have been eager to loosen eligibility requirements for borrowers seeking to obtain FHA loans. Some have dropped their acceptable credit score threshold as low as 500 in order to qualify otherwise ineligible borrowers in a market that has seen a 37 percent decline in lending volume in the past year. However, despite the recent uptick in subprime lending, tougher federal regulation has diminished some investor risk and reduces the likelihood of another housing bubble that contributed to 2008’s crisis.
Wall Street’s overall reluctance to reduce lending standards did not mean it withdrew from the housing market, instead focusing its attention to investing in and securitizing rental properties. Following the surge in foreclosure cases, banks and other lending institutions examined opportunities in cities from Seattle to Palm Beach, especially as rising unemployment rates further limited the pool of acceptable mortgage borrowers.
Profit margin on the rental of these properties increased due to a sizable number purchased through foreclosure auctions and more recently, non-performing loans, making investment in rental-backed bonds more attractive. Per Bloomberg, over the last two years, more than 200,000 single family homes have been purchased by institutional investors under this plan.
The clear leader in this expanding industry is Invitation Homes, a division of the Blackstone Group (NYSE:BX), which has reportedly spent $7.5 billion since 2012, adding 40,000 homes to its portfolio. Focused on 14 markets with a simultaneous glut of foreclosures and demand for rental units, Invitation is twice the size of its closest competitor, American Homes 4 Rent.
Participating firms view the investment securitization of the rental market as a long-term strategy and are poised to dominate the market through a combination of increased mortgage rates and expected demand following the slow growth in new home building following the economic downturn. The rental-backed bonds, underwritten by giants such as Credit Suisse (NYSE:CS) and graded by Moody’s, Kroll, and Morningstar, were presented to investors as a low-risk, higher-yielding prospect than government-backed mortgages.
Given the massive investment of both capital and effort required to bring the untested bonds to market, much attention was paid when Blackstone offered up its $480 million bond late last year, and again when Morningstar released its report, indicating a decline in the bond’s collateral when collected rents dropped 7.6 percent between October 2013 and January. The decrease in payments were attributed to early tenant departure and expired leases.
Despite the payment shortfall, the rate of renewals shot 12 percentage points and was higher than expected. The potential for the profitability of both rental-backed mortgages and subprime lending should be clearer with the release of this quarter’s performance data, due out sometime next month.
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