Q & A with Emily Hollis

Emily Hollis
December 31, 2007 | COMMENTS

Q: What do you think about the subprime loan situation and how will it affect credit unions?

We normally do not see credit unions issuing loans to subprime borrowers. Although the possibility does exist, the ramification of the subprime debacle will most likely affect credit unions by a potential slowing of the economy rather than industry defaults.

Regulators have been turning up the heat on financial institutions for more than a year and ultimately, credit standards in banks tightened late last year. The federal financial regulatory agencies (Fed, FDIC, NCUA, OCC, OTS) issued guidance on managing “potential heightened risk” from interest-only loans in December 2005 and more recently issued a “Proposed Statement on Subprime Mortgage Lending.” NCUA has issued several guidance letters to aid credit unions in the issuance of mortgage loans and specifically subprime lending*. Grabbing media attention is the fact that 20% of the industry that focuses on subprime has been shut down. Customers of these firms will indeed be displaced to other companies, but those lenders that remain in the business have announced tighter new rules and the rejection rate for loans is climbing.

The focus should really then be on loans issued in 2005 and 2006. The credit problems are concentrated not only in subprime but in a small category of “Alt-B” loans. Alt-A is also a concern; however, the default rate is only about one-tenth of the subprime default rates.**

Subprime loans make up about 15% of the outstanding mortgage debt market. Subprime mortgages are foreclosing at a rate of approximately 12%, which also means that 82% are performing! If this figures doubles, only 1% of the stock of homes (800,000 homes) will be foreclosed.

Only 0.07% of outstanding federally insured credit union mortgages were in the foreclosure process as of December 31, 2006, so there is not much affect to the credit union industry, outside of a potential slow-down in the economy. Given the tougher credit standards on new loans, economists are deducing that as much as 10% of mortgage originations are taken out of the market which will have some impact on slowing the economy. The natural lag in the market should cause foreclosures to occur in 2008 through 2010. Most economists are predicting that the subprime market debacle will result in a longer period of weakness rather than a recession. Given the strong growth in exports and business investment and trend-like growth in government spending, the economy should remain solid.

Emily Hollis is a CFA and president of ALM First Financial Advisors, LLC in Dallas, Texas. Contact Hollis at 800-752-4628 or ehollis@almfirst.com. Margot Strong, director of business development, may be reached at mstrong@almfirst.com.

* NCUA letter to credit unions 174, 99-CU-05, 04-CU-13, 05-CU-15, 06-CU-16.

** Alt A loans usually have a strong FICO score, but little documentation of income or assets. It is designed for self-employed and other individuals who are willing to pay a premium to avoid verification of income. Alt-B loans are Alt-A loans with lower credit scores; the lowest sector of the prime market.