I recently got an email from Sean Colclough, CEO of NeighborborhoodLoan.com, a website that provides marketing leads to mortgage companies. He was commenting on my previous article about subprime lenders. Thinking he might be a useful source of information regarding the current chaos in the subprime market, I emailed him back, and we set up a phone conversation. I'd like to share that chat with you today. Notes in italics are my own commentary.
Emil Lee: Tell me about yourself and your company.
Sean Colclough: I started in Internet advertising around 2001, when the refinance boom was happening. I saw tremendous opportunity and very little barrier to entry, so [with a partner] I started an Internet advertising company from my bedroom. We set up a website, constructed an online affiliate network, and got involved with larger lenders like Ameriquest, New Century
A lot of the subprime lenders were our biggest clients, spending a ton of money on Internet marketing, taking in our leads, and then hammering the consumers with risky, option-ARM [adjustable-rate mortgages] or interest-only type mortgages for huge profits.
EL: Describe your company.
SC: We're very similar to LendingTree. Our mission is to provide consumers with a free online service where they can shop rates, compare lenders, and maximize savings. We connect consumers to a nationwide network of more than 100 lenders, brokers, and banks. Our website is specifically designed to empower both consumers and lenders, and simplify the mortgage process.
LendingTree is a unit of IAC/InterActiveCorp
EL: Who do you think is the most disciplined among subprime lenders?
SC: Through my experience, I always liked the way Accredited Home Lenders
As far as stability goes, I like Accredited and Countrywide. Accredited had to absorb the acquisition of Aames [Investment], but I think in the long run, that merger will really solidify their retail operation.
Accredited acquired Aames in late 2006.
EL: What about the goodwill impairment Accredited will likely have to take for Aames?
SC: On a long-term basis, I think they'll have enough presence in the subprime market to really make something happen [with the Aames merger]. Seems like their management is pretty good.
EL: Where are we in the subprime cycle, in your opinion?
SC: I actually think that 2007 will continue to be pretty poor for the sector. In order for the subprime market to come back, the housing market has to come back first. Until that happens, it'll trend downwards. I think [housing] may start to pick up by 2008. There will be a lot of ARM mortgages from 2003, 2004 that'll have to be redone.
EL: Do you have any opinions on who you think will do well besides Accredited?
SC: From a nonpublic point of view, Quicken Loans is actively trying to grow even in this type of market. They're the No. 1 online lender. I know they just opened new office space in Arizona. They're trying to expand despite these tough conditions.
EL: What loans in particular are you worried about?
SC: I think the sad thing is, the public isn't educated enough to know which mortgage to choose and why. The typical subprime borrower isn't educated enough in the loan process; they are just happy enough to be approved. So a lot of times, these consumers have no idea what they're getting into. Negative-amortization loans and pay-option ARMs are ruining people's lives, and you can see it in the number of defaulted loans. I know I've had some friends in the lending business say they're going to stop offering those types of loans.
What we are seeing is a horrific domino effect. First, interest rates rise and house values flatten. Then, many of the households that were out buying cars and boats off equity lines they secured during the run-up are standing there wondering why they can't get any more money out of their home. Everyone just assumed their property would continue to go up and up and up. It's a complete disaster for our economy.
Unfortunately, many people were overvaluing their homes and the amount of equity they really had. Now these same people, who had terrible credit but plenty of equity, are defaulting on loans they should have never received in the first place.
You really have to blame the mortgage companies, the government, and the regulators for allowing this to happen. The consumers are really the victims in this situation.
EL: Do you see a difference in underwriting standards in 2005 versus 2006?
SC: I think the standards are just starting to change in 2007. A few years ago, every lender wanted someone with fair credit -- that was the golden egg in the mortgage industry, because you could hammer the borrower on interest rates and upfront charges, but the number of defaults wouldn't be high. A lot of the advertising that was going on was "bad credit OK, you'll be approved." You don't see that type of advertising anymore, because the underwriting standards are changing.
EL: What do you think will happen to the people who need to refinance some of those terrible loans?
SC: For the most part, you will see an increase in foreclosures. I know states like California and Massachusetts are going to get hit extremely hard. There will also be hard- money loans for people who still have equity in their houses. Those who don't might run into serious problems. Hard-money lending is happening all the time now, and it'll increase that much more. That's how some of these people are going to try to save their houses. There will not be many options with traditional lenders.
EL: Anything else you'd want to mention here?
SC: You hit on some great points in the article. It's a cycle situation -- it went up so fast and furious that now it has to level off and come down. Everyone in this business realizes that there was a spawning effect from 2001 to 2005. Employees who were working at mortgage companies as loan officers were leaving and starting their own companies every day. I'd personally get calls from mortgage brokers, who used to work for one my clients, who'd say "Hey, Sean, I just left Such-and-Such Mortgage; can you sell me your leads?" We don't get those calls anymore. That game stopped.
For a time there, everyone thought they could do it on their own, because they saw how much money was being made in the subprime market and they were all leaving to start up their own shop. I just read that 50 mortgage companies are going out of a business a day right now. I wouldn't doubt if that number is higher. Only the strong will survive. But talk to me in five years, 'cause I'm sure the cycle will turn around again, and everyone will be racing around trying to figure out new ways to sell bad mortgages to risky borrowers. The game may slow down, but it will never end.
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Fool contributor Emil Lee is an analyst and a disciple of value investing. He own shares in IAC/InterActiveCorp. Emil appreciates your comments, concerns, and complaints. The Motley Fool has a disclosure policy.