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FirstFed reduced loan risk early on

It raised standards in 2005 but has seen a leap in delinquencies.

August 04, 2008|E. Scott Reckard | Times staff writer

California home prices reached astonishing levels in 2005, but getting a loan was a snap at lenders offering low initial payments. At FirstFed Financial Corp., for example, the vast majority of borrowers weren't required to produce pay stubs or tax returns to prove they earned as much as they claimed.

FirstFed executives say they started worrying as the year wore on. Rivals were giving "piggyback" second mortgages to stated-income borrowers, in effect wiping out down-payment requirements. By the end of 2005, FirstFed began tightening lending standards at its savings and loan, First Federal Bank of California.

"We thought housing prices had gotten a little out of control," the thrift's chief executive, Babette Heimbuch, said recently at FirstFed's headquarters near Playa Vista. "Everyone was in such a frenzy of doing stranger and more exotic loans that we just felt it was time to back away."

As former rivals have tumbled this summer -- Countrywide Financial Corp. swallowed by Bank of America Corp., IndyMac Bank seized by federal regulators -- FirstFed has found itself walking a tightrope. Can it unwind the damage from loans made three or four years ago in time for less delinquency-prone mortgages to take their place on its books?

Heimbuch and her executive staff point to the thrift's monthly operating reports as evidence it will survive and that, as she put it in a recent open letter to investors and depositors, "FirstFed is not currently in any danger of being taken over by the FDIC nor do we foresee any scenario that could even put us in that position."

The operating reports, the latest released last month, show newly delinquent loans stopped rising four months ago and appear to be trending lower. Investors will get a better look at the books this week, when FirstFed releases quarterly financial results. Analysts will want to see whether capital levels, which were twice what regulators required as of March 31, have fallen as a result of loan losses and estimates of future troubles.

Certainly, depositors and investors have reason to be on edge, given the struggles of other banks and thrifts that overdosed on lending during the boom years and the recent spate of bank failures.

FirstFed never waded into subprime mortgages -- higher-cost home loans to the riskiest borrowers. Indeed, 30% of its loans were made to owners of multi-unit apartment buildings, mortgages that so far have held up well. The problems have come from its biggest business: cash-out refinancings for California homeowners, many of whom then extracted additional money from the homes by getting second mortgages from other lenders.

FirstFed's specialty was the "pay option" adjustable-rate mortgage for people with decent credit scores, most of whom were not required to document their incomes.

The so-called option ARM gave customers the choice during an initial period of paying enough each month to retire the loan in 15 or 30 years, paying only the interest as it came due, or paying even less than the interest that accrued each month, so that the loan balance rose.

Most borrowers picked the last option. They are now finding that the easy payments run out after three or four years, with sharply higher payments kicking in, often after falling home prices put the loans "underwater."

FirstFed executives say they are trying to rework borrowers' loans, if possible giving them an affordable fixed payment for five years before the interest rate becomes adjustable. Some of these replacement loans require interest only at first, but none of them allow the loan balance to rise.

Despite the efforts, loans on which payments are late or have stopped accounted for 8.2% of the bank's loan and investment portfolio on June 30, a nearly tenfold increase in a year.

Yet the decrease in new delinquencies suggests light at the end of the tunnel, according to the bank's executives.

Option ARMs held by FirstFed that hadn't reset to higher payments totaled about $4.8 billion at the end of June 2007, Chief Financial Officer Douglas J. Goddard said. A year later, there were $2.4 billion of such loans, down 50%.

The biggest problems stemmed from 2004 and 2005, when FirstFed originated $3.9 billion and $4.8 billion of loans, respectively. After the company adopted more stringent lending standards, its loan volume fell to $2.2 billion in 2006 and $1.1 billion in 2007. In those years, the riskiest loans were originated on behalf of large banks that put the mortgages on their books.

FirstFed's first-quarter lending this year totaled $285 million, more than half of it multifamily loans and the rest in fully documented single-family-home mortgages to well-qualified borrowers, with no option for the loan balance to rise, Heimbuch said.

"We're making loans like we did 15 years ago," she said. "You get to look at what people make, and they make a real down payment."

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