Gauging the damage ahead in the region is anyone’s guess.   6/3/2007 by Wayne Nelson

Just as we’ve learned to look for telltale signs of a tsunami every time the sea floor shakes, the region’s bankers are watching for spillover from the national subprime mortgage debacle.

The ballooning foreclosure rate took a breather in April, actually dipping 1 percent to 147,708 foreclosure filings from March, according to RealtyTrac, the Irvine, Ca-based researcher of foreclosure data.

Still, the April number — which includes default notices, auction sale notices and bank repossessions — was up 62 percent from April 2006.

James Saccacio, RealtyTrac’s chief executive, noted the foreclosure rate subsided last year during spring and summer months, due partly to increased interest from buyers.

“Whether the decrease in April is the beginning of a similar trend this year remains to be seen, but we expect foreclosure activity to at least stay above last year’s levels for the remainder of 2007, fueled by a combustible mix of risky loans taken out in the last few years — many in the subprime market — and slowing home price appreciation,” he said in a statement.

Runaway real estate markets, fueled by injudicious use of subprime and other adjustable-rate mortgage products by both lenders and borrowers, were the principal catalysts in the bust, now taking down some of the biggest subprime lenders, among them, Ameriquest and New Century Financial.

Some corners of the nation have been virtually untouched, among them, Wyoming, Vermont, North and South Dakota, Mississippi, Delaware and Washington, DC. These real estate markets in the Great Plains generally weren’t part of the bubble.

Those in the frothiest markets — generally where lender and borrower discipline took a holiday as real estate prices superheated and then crashed in 2006 — are getting hammered the hardest.

The big losers

Six of the 10 cities with the nation’s highest foreclosure rates in April are in California, which also is among the Top 10 states hardest-hit.

Other with the highest foreclosure rates (number of foreclosures per household) were Nevada (Las Vegas was a Top 10 city); Colorado (Greeley and Denver); Connecticut; Florida, Arizona, Illinois, Michigan and Ohio (Akron) and Georgia.

While the collapse of real estate values is a cornerstone of the foreclosure story, some of the hardest-hit markets also are home to industries in trouble. Massive layoffs in the auto, auto-related and other industries are at the heart of the pain in Michigan and Ohio.

It’s also part of the story in the Minneapolis-St. Paul market where closure of the Ford plant and other major employers, and wage and benefit cuts at Northwest Airlines as it’s moved through bankruptcy have lowered family incomes and softened the real estate market.

Actual foreclosure rates during April in Minnesota and Wisconsin reported by RealtyTrac, were in the lower half among the 50 states, Nos. 32 and 35, respectively. But in each state, the trend is worsening.

In Wisconsin, Foreclosures.com reported foreclosures through the first four months statewide ran 23 percent ahead of the pace in the same period last year.

And in Minnesota on May 25, there were 2,870 properties in foreclosure or pre-foreclosure, 56 of them in St. Louis County, according to the online tracking firm.

These numbers seem all but certain to grow in the months ahead. Before the bust, subprime lenders nationwide were issuing about 10 percent to 15 percent of all mortgages. No one has a handle on the actual number of active subprime mortgages — originations or refinancings — on homes in Northeastern Minnesota and Northwest Wisconsin.

Wells Fargo, U.S. Bank and several other big national financial services institutions operate subprime mortgage subsidiaries. But none of the major subprime lenders are based here.

Nevertheless, the Foreclosures.com data suggests subprime lending activity here has been typical, as will be the ultimate fallout.

With little or negative equity in their homes in a real estate downturn, and lenders generally tightening their loan standards, these marginal borrowers no longer can hold the line on their payments by refinancing their mortgages once again.

Many of these borrowers either bought homes or refinanced existing mortgages with subprime loans offering artificially low introductory “teaser” rates. Facing the first re-pricing, those borrowers are seeing their payments double or triple, or facing “balloon” payments beyond their reach, just as their home values are declining.

Another subprime lending analyst, the Center for Responsible Lending, predicts 2.2 million of those subprime borrowers will lose their homes before the real estate market recovers. Its latest assessment in May concludes much of that pain will come in markets where real estate prices soared through 2005, encouraging subprime and other risky borrowing.

For example, it predicts 22 percent of the homeowners in greater Los Angeles who used subprime financing in 2006 will lose their homes. In the Minneapolis-St. Paul MSA, it predicts the foreclosure rate for those mortgages will hit 20 percent.

The center gauges the failure rate in the Duluth/Superior area a little lower, at 16 percent.

Lutheran Social Services provides foreclosure and pre-bankruptcy counseling statewide in Minnesota and in Douglas County.

In the city of Duluth, 28 homeowners scheduled foreclosure prevention appointments with the agency’s financial counseling office here during the first quarter of 2005. In the same period this year, that number rose to 51.

Dan Williams, senior program manager at the LLS Financial Counseling Service, views the untold story of subprime lending as the damage it already has done not to borrowers, but to local banks and communities.

The subprime initial “teaser” rate often provides the cover for huge closing costs that at least in theory, allows the marginal borrower to consolidate an existing mortgage, a car loan, even pay off higher rate unsecured debt, into a larger mortgage with a payment no greater. But when the teaser rate is replaced by a significantly higher interest rate and payment, or a balloon payment looms just as the real estate value falls, it all crashes down on the borrower.

Meanwhile, a local bank has lost a mortgage, a car loan and unsecured loan, and the equity the borrower had in the property has left the community permanently, Williams said.

“Subprime lending takes away the prime loans in a community — mortgages, car loans and lines of credit. Essentially, (subprime lending) steals business from smaller entities,” he said.

Reacting in large part to the wave of subprime lending foreclosures in the Twin Cities — more than 3,000 so far this year — Minnesota is beefing up the penalties for predatory mortgage lending practices.

Separate bills passed by both houses, and signed by Gov. Tim Pawlenty on May 14, will become law on Aug. 1. With these changes:

• Anyone helping to commit mortgage fraud, knowingly misrepresenting or omitting important information in the lending process, is guilty of a felony, punishable with up to two years in prison. Mortgage fraud has been charged under other statutes more difficult for prosecutors, including mail fraud, money laundering or theft by swindle.

• Violators also must pay restitution to their victims.

• Victims of dishonest mortgage lending or inflated home appraisals also will have the right to sue violators in civil court for damages and other costs.

Minnesota Attorney General spokesman Brian Bergson, said the tougher penalties apply to mortgage brokers as well as lenders, but don’t apply retroactively to previous criminal activity. “It’s about prevention, to stop the offering of ‘liar’ and no-documentation loans, and to limit ARM (adjustable rate mortgage) lending,” he said. “It’s going to be mortgage fraud if you know the borrower can’t repay.”

There’s no similar legislation pending in the Wisconsin Legislature.

The other subprime lenders: Superior mayor wants to raise the heat again on payday, auto title lenders.

New Mexico enacted legislation regulating payday loan businesses last year, leaving Wisconsin with the dubious distinction as the only state in the nation that sets no limits on the interest rates they can charge.

Now one of the industry’s fiercest critics who helped engineer a failed regulatory effort in 2004 — Superior Mayor David Ross — is ready to raise the heat once again.

Ross and the Wisconsin Department of Financial Institutions — which views payday lending as an unhealthy drain on the economy — tried to convince the Republican-led legislature to include interest rate caps in a bill that went to Gov. James Doyle who vetoed it.

That bill — which the industry supported — for the first time limited to four the number of times that payday lenders could “roll over” or refinance a loan, and it restricted their rights to criminally prosecute delinquent debtors.

But Doyle, Ross and the regulatory agency opposed the measure for not going far enough.

With the Senate and governor’s office both in the hands of Democrats, Ross, a Republican, thinks the timing is right for another reform effort in 2008. He’s mulling the resurrection of the “payday” loan citizen committee he appointed shortly after his first election in 2003 to advise the mayor and city council.

That committee’s recommendations led to zoning rule changes that limit the operations of the city’s payday and title loan lenders. The changes set a limit of 1 payday or title loan store per 5,000 residents, which translates to five of the operations citywide. Presently, there are eight outlets in Superior. That rule effectively has stopped further expansion because four will have to go out of business before a new storefront is permitted.

Another zoning restriction prohibits an operation within 300 feet of a residence, and limits hours open to 8 a.m.-10 p.m.

Payday and title lenders typically make very small “bridge” loans, ranging between $200 and $600. The payday loans are unsecured; the title loans are secured with a car as collateral.

They contend they have virtually the same overhead as a bank lender, and have to charge a higher interest rate because the loans are small, also reflecting the marginal creditworthiness of many of their customers. They also note their fees are not out of line with those banks charge for overdrafts.

Opponents counter that after several rollovers in which borrowers make only the minimum payment due, the effective interest rate can hit 500 percent.

“People show me where after 10 weeks, a person owes $270 on a $100 loan,” Ross said. “I think they can makes loans for a reduced interest rate and still be profitable.”

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