12/13/2002 Nehemiah and the Copycats or 'Non Profit' but Big Business *

It was not an especially comforting week for the rose-colored glasses crowd, with stocks and the dollar faltering as gold moved to five-year highs. For the week, the Dow, S&P500, and Morgan Stanley Consumer indices declined about 2%. The Transports and Morgan Stanley Cyclical indexes dropped 3%, while the Utilities rose 4%. The broader market was also under pressure, with the small cap Russell 2000 and S&P400 Mid-Cap indices declining 2%. The technology sector had a rough go of it, with the NASDAQ100 and Morgan Stanley High tech indices hit for 5%. The Semiconductors dropped 6%, The Street.com Internet index 5%, and the NASDAQ Telecommunications index 7%. The Biotechs were slammed for 5%. The financial stocks generally performed with the broader market, as the Securities Broker/Dealer and Bank indices declined 2%. With bullion up $6.70, the HUI Gold index jumped 10%.

With the dollar under pressure, sinking equities didn’t provide their usual kick to Treasury, agency, and mortgage-back prices. We will watch to see if this marks a significant change in market perceptions. For the week, two-year Treasury yields slipped two basis points to 1.85%. Five-year yields dropped five basis points to 3.04%, while ten-year yields dipped two basis points to 4.07%. The long-bond saw its yield decline three basis points to 4.95%. Benchmark mortgage-back yields dipped two basis points, while the implied yield on agency futures dropped four basis points. The spread on Fannie’s 5 3/8% 2011 note narrowed two to 44, while the benchmark 10-year dollar swap spread was about unchanged at 46. The dollar index dropped better than 1%, falling to the lowest level against the euro since January 2000. The CRB index rose to its highest level since 1998, with heating oil at a 20-month high and crude at an eight-week high. Commodity price strength has been broad-based.

Broad money supply rose $8.8 billion last week, with (M1 components) Currency up $4.3 billion, Demand Deposits jumping $16.9 billion and other Checkable Deposits up $5.3 billion. (M2 component) Savings Deposits added $3.5 billion, while (M2 component) Retail Money Fund deposits declined $8.0 billion. (M3 component) Institutional Money Fund deposits dropped $18.2 billion, while (M3 component) Repurchase Agreements added $6.5 billion. Commercial paper (CP) declined $7.8 billion last week, with non-financial CP actually increasing $4.0 billion to $163.1 billion. Financial sector CP borrowings dropped $11.8 billion to $1.192 Trillion. Bank Credit declined $6.3 billion last week, with Loans and Leases down $7.1 billion. Commercial and Industrial loans dropped $4.6 billion, Consumer loans dipped $2.7 billion, and Security Loans declined $11.0 billion. The old stalwart, Real Estate Loans, added $13.1 billion. Total Bank Assets dropped $50.7 billion last week after rising $36.2 billion the week before.

Third-quarter Current Account data was again dismal. At $127 billion, the deficit was up 39% y-o-y. Total exports were up 1% y-o-y to $312.9 billion, while total imports surged 10% to $426.7 billion. Indicative of how out of whack the trade situation has become, third-quarter goods imports of $298.9 billion were 70% larger than the $175.7 of goods exports. And while our Investment Receipts were down 5% y-o-y at $63.5 billion, Investment Payments were about unchanged at $66.4 billion. It may also be worthwhile to look at prices. Total y-o-y import prices were up 2.4%. By category, Capital Goods prices dropped 2.6%, while Industrial Supplies prices (led by the 35.3% jump in Fuels & Lubricants) increased 15%. Food and Beverage prices were up 5.9% y-o-y, and Autos and Parts nudged up 0.5%.

Last week saw 29,477 bankruptcies, down 3% y-o-y. This afternoon New Jersey’s treasurer announced that the state must prepare for a spending freeze, as “Revenue for November falls 6.8% below budget" (business tax and sales tax were 3.7% and 7.4% under estimates). The Mortgage Bankers Association Refi application index dropped 9% last week to the lowest level since July. The Purchase index declined 7%, with the level now only 5% above the year ago level.

Fannie Mae’s November Total Business Volume (total mortgage purchases) of $95.6 billion was an all-time record. Fannie’s retained mortgage portfolio expanded at a 16.1% annualized rate, the strongest growth since February. And with “Average Liquid Investments” jumping $12 billion during the month, “Average Total Net Investments” expanded at a 22% annualized rate to $826 billion. Fannie (and we will also assume Freddie Mac) has returned to aggressive balance sheet expansion, with significant GSE money market borrowings likely a factor in recent rapid money supply growth.

From Countrywide’s COO Stanford Kurland: “November’s average daily applications totaled $2.2 billion, up 78 percent over last year. This is the third consecutive month that average daily applications were approximately $2 billion. The mortgage loan pipeline increased 6 percent from last month, reaching a record of $55 billion.” Year-over-year, Purchase Fundings were up 61% to $7.7 billion, while Non-purchase (refi) fundings doubled to $24.5 billion. Total “e-Commerce Fundings” rose 75% to $14.3 billion. Home Equity Fundings were up 61% to $1.1 billion, while Sub-prime Fundings jumped 73% to $1.0 billion.

Things only get more fascinating by the week. And for those that missed it, we have linked on our home page to a report, Is MBIA Triple A? We will let Gotham Partner’s exceptional research speak for itself. Our macro view holds firm that Credit insurance and the ballooning Credit default swap market provide a critical weakening link for our troubled Credit system. It is worth noting that spreads for “synthetic CDO” structures with Credit default exposure have widened noticeably over the past month. In many ways, we see the current environment as one big confidence game, although a surging gold price and faltering dollar lead us to contemplate that we may be in the late innings.

We are increasingly of the mind that the Mortgage Finance Bubble is in the very final stage of terminal reckless excess. As we witnessed with the technology, stock market, and corporate debt Bubbles, ultra-easy money and Credit fuel eventually self-destructive speculation, imbalances, shenanigans and fraud, not to mention the final manic frenzy that entices the last of the remaining buyers. And, once again, the negligent Fed is asleep at the switch. Worse yet, when awake, the Fed apparently likes what it sees, as unprecedented excess runs out of control. We see only conspicuous support for our view that our system has created a Mortgage Finance Monster, with momentous ramifications for the mortgage-back marketplace, the financial system, the U.S. economy and dollar.

Apparently, we were not alone in being disturbed by Tuesday’s excellent Wall Street Journal article by Patrick Barta and Queena Sook Kim – Home Buyers’ Down Payments Are Now Paid by Some Builders - reporting on the proliferation of “Down Payment Assistance Programs” (DPAs). For those that read the story, I decided it was worth digging a bit deeper. For those that missed it, let me do a brief summary. The Federal Housing Administration (FHA) a few years back changed its provisions to allow “non-profit” organization gifts to be used as the 3% down payment required of qualifying home buyers. This loophole has spurred the creation of hundreds of “non-profit” groups, many funded by the homebuilders, which have become major providers of downpayments for scores of cash-short homebuyers. And while history tells us rather clearly that borrowers putting no money at risk are quite poor mortgage Credits, the government guarantee (along with an over-liquefied marketplace) allows today’s holders of the rapidly expanding quantities of these mortgages to sleep soundly at night. Still, this is one more extraordinary example of a dangerous mortgage market distortion that is progressive, self-reinforcing and, once unleashed, virtually impossible to reign in.

Looking back, it didn’t take long before the idea germinated that these “Non-Profits” could fund their “Gift” pool with “Donations” from interested homebuilders and home sellers. Wow…what incredible profit potential! Cash-strapped renters are afforded the opportunity to rise to the status of proud homeowners. Builders would now enjoy an enlarged pool of prospective buyers, with the not insignificant benefit of having many so anxious at the opportunity of homeownership to be enticed by even the difficult-to-sell and least desirable properties (and they’re willing to pay asking price!). Anxious home sellers, as well, have an enticing avenue to attract a new class of “motivated” buyers. The “Non-Profits” would garner fees to the tune of between $800 and 1% of sales price per transaction. And, not to be overlooked, Wall Street would have more FHA mortgages to sell (and package into Ginnie Mae and other MBS, CDOs and various instruments). What could possibly add more fuel to the unfolding explosion of subprime mortgage lending and the blow-off stage of the Mortgage Finance Bubble? And, of course, what’s good for The American Dream is good for the economy! This is but one more frustrating and recurring Bubble dilemma of seemingly “What’s not to like?” … but eventual collapse.

Nehemiah, the “Non-Profit” highlighted by the WSJ, was the first to introduce the Downpayment Assistance Program (DPA). From National Mortgage News: “The non-profit was started in 1994 with $5,000 in seed money out of a small church in Sacramento pastored by the father of the founder…” But the DPA ball didn’t get rolling until 1996, reportedly after Nehemiah’s founder Don Harris received a call from a “frustrated real estate developer” facing difficulties selling foreclosed townhouses from a recently purchased complex. According to the American Banker (Erick Bergquist), “The conversation got Mr. Harris, who is also a real estate lawyer, wondering: What if he could help get people into homes through down payment donations, or gifts, from private industry? After researching federal law, he found a mechanism that lets charitable organizations make such gifts.”

From the December 2001 Dallas Business Journal: “…The biggest challenge is convincing buyers and real estate agents that Nehemiah is for real. ‘They think it’s a scam, that it’s too good to be true… Here you have the government, a faith-based group and industry all coming together to do good. It’s an ideal situation, but it doesn’t happen very often.’ Last week, Harris’ Sacramento congregation…dedicated its new $12 million (1,000 seat) mixed-use development, funded completely by the Nehemiah program it inspired.” The entrepreneur Mr. Harris has since moved on to real estate development, now partnering with Nehemiah.

Since its founding, Nehemiah has gifted downpayments for as many as 180,000 (another source recently had the number at 130,000) mortgages valued in excess of $13 billion (as of July). It did not take Harris or others long to recognize that this government loophole afforded an extraordinary Big Business opportunity, and to state that these programs have proliferated is an understatement. From the Salt Lake City Tribune (Lesley Mitchell): “Each program operates a little differently, but all are designed to help buyers find a way around a federal law that prohibits sellers from providing down payments to buyers.”

From Mortgage Banking, December 2002: “In a conversation with this columnist (Neil J Morse) at the MBA Annual Convention, (Nehemiah’s president) Syphax said the program’s founding philosophy has been widely embraced. ‘We went from being heretics to being imitated,’ said Syphax, referring to low- and no-down-payment financing programs now commonly offered by Fannie Mae, Freddie Mac and major lenders. However, Syphax said, there are still ‘pockets of opposition to our purpose’ from those ‘who continue to believe that if a prospective borrower does not have sufficient funds for a down payment, they must not be quite ready to own.’ According to Syphax, the issue boils down to ‘how much risk society is willing to take on to build its urban centers.’” Back in May, “The Federal Housing Finance Board…appointed Scott C Syphax, President and CEO of the Nehemiah Corporation of California, to the Board of Directors of the Federal Home Loan Bank of San Francisco.”

While data is sparse, the best I can gather is that the FHA insures about 1.4 million mortgages annually. Some in the industry believe that as many as 20% of new FHA loans are now using various DPA programs. So, taking 280,000 loans at, let’s say, an average of $150,000 (this is likely too conservative), comes up with $42 billion of new DPA mortgages each year. Big Business, indeed, as the taxpayer and the integrity of the mortgage marketplace absorb the considerable risk. Though it appears these programs are increasingly assisting conventional mortgage borrowers in supplementing required minimal (3% in the case of Fannie, Freddie and others) downpayments.

From a July 2001 Bloomberg story: “Wells Fargo, the No. 3 U.S. mortgage lender, says it uses about 600 different down-payment help programs. ‘It’s an extremely important avenue for us to get mortgage volume and also to reach consumers who wouldn’t have been able to afford a home,’ said… a vice president at Wells Fargo.” Also from the article: “Dan Kossak, a 31-year-old pharmaceutical salesman in Atlanta, was able to buy a $192,000 home in December and avoided making the 3 percent down payment out of his own pocket by using Nehemiah… ‘I didn’t want to be house poor,’ he said.”

The Department of Housing and Urban Development (HUD) recognized early on that it was facing a problem. Back in September of 1999, HUD expressed concerns that the FHA insurance fund was increasingly exposed to the risky lending and inflated prices the DPA programs were fostering. HUD proposed a rule to prohibit borrowers under the FHA program from using downpayment gifts provided “directly or indirectly” by builders and sellers. But HUD withdrew its proposal a few months later after pressure from Nehemiah and others. It was then off to the races, with the number of new organizations multiplying rapidly. The established groups moved ahead with more creative DPA programs for the high-end.

This past January Nehemiah formed a “strategic alliance” with Homebuilders Financial Network (HFN), a group associated (it creates and manages in-house builder mortgage operations) with “member builders throughout the nation which sell in excess of $5 billion of new homes annually.” “Yearning for a brand, spanking new home but don’t have the downpayment?” “The philosophy behind HFN is to provide services to builders that will increase the home builder’s control over the mortgage loan process, provide ease of 'one stop shopping' for the home buyer…” From National Mortgage News: “Under the agreement, the Nehemiah Corp. will offer downpayment assistance to cash-starved buyers who have their eyes on houses built by any of the 20 builders throughout the nation… Nehemiah will provide the seed money in the form of a grant that need not be paid back by the buyer. But the funds will come from the builder as a charitable gift to Nehemiah.” The CFO of HFN was quoted by National Mortgage News: “Downpayment assistance has become a huge aspect of our business…” and “downpayments for as many as 25% of the mortgages his company originates on behalf of its builder-clients come from grants from nonprofits such as Nehemiah.” The head of Nehemiah stated, “The users of the Nehemiah Program now will have access to thousands of new homes across the country.” HFN has relationships with Beazer Homes, Schuler, Dominion, Dura and others. Then in May, “Fidelity National Financial, Inc. the nation’s largest provider of title insurance and real estate related products and services, announced the purchase of a 75% interest in Homebuilder Financial Network…” DPA is both a Big and a growth Business.

Meanwhile, Nehemiah and the Copycats have been aggressively expanding beyond traditional DPA programs for FHA qualified borrowers. Notably sophisticated and created for those borrowing above FHA lending limits, Nehemiah has created “The Conventional Program”. “This product combines a first mortgage and a second mortgage which can be applied toward a downpayment and closing costs that is wrapped together and serviced on a single coupon. Specifically, the loan combines a 97% loan-to-value (LTV) first mortgage with a 5% LTV second mortgage to create a 102% loan with a maximum combined mortgage amount of $316,200.” A structure only Wall Street could conceive and love... “Developed jointly with First Nationwide (now owned by Citigroup) and Radian Guaranty, Inc. (mortgage insurer and joint owner - with MGIC - of C-BASS subprime mortgage-back conduit operator!), The Nehemiah Conventional Loan Program is one of the most innovative high loan-to-value products on the market.” The “Conventional Program” does require buyers to put 1% of their own money toward the purchase price, which recalls the reference to “one percent down payment loans” made a couple months back by Fannie Mae’s vice chairman.

But with the influx of new players, competition is increasingly tough and the established players – understandably – are getting nervous. Origination News in February quoted the president of Nehemiah: “Many of the programs out there don’t have the long-term concerns we have. They’re more a mechanism to drive the transaction…” (We stumbled across one program that “promoted its Down Payment Assistance Program that enables real estate agents to close more deals and sell more homes.”). And a representative from Neighborhood Gold, a major DPA provider, worries that similar organizations “don’t really give a darn” and “are acting unethically, if not illegally.”

This past September a group of DPA providers formed the Homeownership Alliance of Non-profit Downpayment Providers (HAND). “HAND is addressing the downpayment problem in response to President Bush’s statement that it is ‘the single greatest hurdle to homeownership.’” With today’s WSJ article - Rising Home Prices Cast Appraisers In a Harsh Light - in mind, it is worth highlighting a brief excerpt from the trade group’s Downpayment Alliance News: “A new HUD plan to link appraisers with foreclosures on FHA loans has energized the appraisal profession to set up a coalition to defeat the idea.” One important aspect of builder/seller funding of downpayments through these DPA programs is that transaction prices are grossed up in excess of true market prices. How this is impacting appraisals for refis and home-equity loans around the country is unclear. But what is clear is that HAND and the Copycats will be preparing to defeat any opposition to their handsomely profitable “Non-Profit” enterprises.

The following were extracted from the various websites of HAND members:

Neighborhood Gold (formed in 1999, nonprofit status April 2000): “From Bank of America to Wells Fargo, we work with some of the largest lenders in the nation. We’ve earned their trust because we’ve never held up funds and we’ve made the process simpler than ever before. You just fill out the one-page application online or fax it in and Neighborhood Gold takes care of the rest.” GMAC reportedly also uses Neighborhood Gold. And the site provides the capacity to type in an area code and receive a list of local homes participating in Neighborhood Gold DPA programs (in my case, 135 properties were available).

“The Genesis Program is a National Down Payment Assistance Program that provides homebuyers with FREE GIFT MONEY to use towards the downpayment, closing costs, and other funds needed to purchase a home. Genesis will gift up to $22,500.” The Genesis program is reportedly “certified by some of the nation’s largest lenders, including Wells Fargo, Countrywide and J.P. Morgan Chase.”

From CDS Grants: “Operation ‘House a Million’ is moving ahead as scheduled. The program is targeting one million renters across the United States who should be able to purchase a home. Many of these people will qualify for a mortgage; they may just need a little help. Too many people wrongly disqualify themselves for homeownership. Our in-depth education on credit, debt and proper spending management will prepare these individuals and families for entry into the home market. When the obstacle is money for a down payment, our HomeGrants Program is able to provide the needed funds. HomeGrants can be used for down payment and closing costs. CDS is currently aligning lenders, in targeted areas, to service those that will qualify for a home purchase. Direct mail, radio and TV appearances are being used to “House a Million”!” A “House a Million” event is scheduled for next May in Las Vegas.

From Homebuyers Assistance Foundation: “After looking at the government sponsored down payment assistance programs, the Foundation discovered that the income limits placed on these programs excluded many prospective purchasers. We made the decision to help this segment of potential purchasers by forming a ‘non-government’ down payment assistance program in 1995; and HBAF received its IRS 501(c)(3)determination letter on our program in May 1997. Approvals from FHA, FannieMae, FreddieMac and GinnieMae soon followed in the summer of 1997. Today the Home Buyers Assistance Foundation provides financial assistance through a Gift for the down payment or a Gift for discount points, closing costs, or prepaids. This gift is not repayable. Several organizations began using the achievements the Foundation pioneered in the field of ‘non-government’ down payment assistance.”

“Often buyers simply prefer not to prematurely cash in their CD’s or mutual funds, stocks, etc. Instead, they now have the option of accessing Newsong’s pool of funds to ease the burden and maintain their financial stability. In any case, there are no income restrictions or price ceilings for Newsong funding. Buyers who are approved for their loans are automatically eligible to receive up to $25,000. Requests for larger gifts are considered on a case-by-case basis. Buyers typically access around $5,000-$15,000 from the Newsong fund.”

Recently established in Oregon, “The Dreamhouse Fund is currently seeking independent sales and marketing representation in all areas of the United States.”

Founded in 1999, AmeriDream is one of the more intriguing “Non-Profit” DPA players. Before HUD put an end to the practice, it was common for this group to “gift” money (in excess of required downpayments) that allowed problem borrowers to pay down debt – and thus meet minimum lender requirements. Today, “More than 4,000 homebuyers a month purchase their own homes using The AmeriDream Downpayment Gift Program, which provides down payment assistance of up to five percent or more of the home’s price.”

AmeriDream has quickly developed into very Big Business. The group provided 50,000 downpayments last year, and with fees of .75% of a home’s sale price, we’re talking serious money. AmeriDream achieved $146.5 million of “total operating revenue and other support” during 2001, up from 2000’s $36 million. “…AmeriDream Charity constantly seeks ways to make homeownership an obtainable goal for more families. Based on feedback from its many lender, builder and Realtor participants, AmeriDream recognized a need to bring more creative loan products and secondary market solutions to the marketplace. The best vehicle to address these needs was to create and help fund CRA Group. (Formerly known as Valao Mortgage). CRA (Community Reinvestment Acceptance) Group is an affiliate of AmeriDream, but is a stand-alone, for-profit entity.”

Monday from National Mortgage News: “Community Reinvestment Acceptance Group LLC has partnered with downpayment assistance provider The AmeriDream Charity Inc. in launching ADC’s S-200 Program. ‘We have enrolled three national lending institutions into the program, and they have already begun to offer the ADC S-200 Program to their customers,’ said Ned Perry, president and CEO of CRA Group. ‘CRA Group develops innovative mortgage products and secondary executions that support lenders’ affordable housing and Community Reinvestment Act lending activities.’ He noted that the partnership allows CRA Group to leverage AmeriDream’s expertise and downpayment assistance resources. Through its S-200 Program, AmeriDream grants homebuyers 3% of the purchase price of a home toward downpayment or closing costs. CRA Group pledges to provide an efficient FHA mortgage execution for lenders and charges almost 50% of the service fee normally assumed by a homebuilder or other seller when using a downpayment assistance program…” Well, well, looks to us like a rather clever maneuver to shift the millions (and growing) of fee income from the “non-profit charity” to the “for-profit entity.”

It’s rather obvious that this entire situation is out of control - a not insignificant aspect of the Great Mortgage Finance Bubble. It is also clear that it will be quite difficult to do anything about it. There is the “American Dream” issue, the minorities issue, the Wall Street issue, the economy issue, and the Credit Bubble issue. The only issues that don’t seem to count for much are sound money and a stable financial system and economy.

From National Mortgage News, December 2002 (Brian Collins): “The Department of Housing and Urban Development’s Inspector General (IG) is raising concerns again that the Nehemiah downpayment gift assistance program and other nonprofits like it are taking a toll on the performance of the Federal Housing Administration single-family program. In an update of a previous audit of Nehemiah-assisted loans, the HUD IG found the default rate had quadrupled from 4.6% in October 1999 to 19.42% in February 2002. ‘Allowing the continuation of seller-derived downpayments puts the FHA insurance fund at a greater risk and may result in higher mortgage insurance premiums to the detriment of homebuyers not receiving this type of assistance,’ the IG report says... In a March 2000 audit report, the HUD IG recommended a prohibition on home sellers and builders contributing to DPAs. The IG basically took the position that the seller-derived gifts are illegal... But the proposal ran into opposition from Nehemiah and others and HUD eventually withdrew it…” Quoting Bill Apgar, former FHA commissioner and currently with Harvard University’s Joint Center for Housing Studies: “‘When we were pushing reform ideas two year ago, there was a chance to get some control over the (DPA) programs.’ But now HUD has to deal with a bigger problem because the loan volumes are higher and ‘you can’t afford to make a mistake.’”

There is now no mystery surrounding the recent surge in FHA defaults. There is at the same time no doubt that this is a major festering problem. Like “zero interest and payments” auto finance, DPA has boosted demand and spurred Credit excess. We fear the cost of prolonging the Mortgage Finance Bubble is enormous and rising rapidly. Regrettably, we learned absolutely nothing from the stock market Bubble’s dangerous excesses.