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The 'emerged' market: the numbers make a compelling case for where industry growth will come from in the future. A segment of borrowers with the moniker "emerging markets" is the focus of many lenders today, and their needs are different from the cookie-cutter borrowers of the past.

SI USTED SABE LEER, LAS POSIBILIDADES FUTURAS DE TENER EXITO EN LOS NEGOCIOS SON MEJORES. Readers unable to understand this opening sentence in Spanish may be at a growing disadvantage, as the fate of many in business today increasingly is linked to what euphemistically is called "emerging markets." These are markets made up of minority consumers and the burgeoning immigrant population in the United States.

Largely composed of Asians, Hispanics and blacks, the tide of newly arrived immigrants (both legal and otherwise) to the United States is approaching flood stage.

Categorically, Asian-American households are expected to grow 94 percent by the year 2020, while Hispanic- and African-American households also are estimated to rise dramatically by the year 2020-111 percent and 64 percent, respectively.

David Stevens, senior vice president of mortgage sourcing at Freddie Mac, predicts that in the coming years nearly two-thirds of all household growth will come from minority and immigrant families.

All this new household formation, of course, represents plenty of potential new business for the mortgage industry, given that fewer than half of Latino or Hispanic households own their homes (in some urban areas like Los Angeles, that number is only 25 percent).

Statistics on minority homeownership have improved but still trail the homeownership rate for whites by a significant amount. U.S. Census Bureau data show minority homeownership in first-quarter 2005 moved up to 51.6 percent--meaning 15.7 million minority families owned their own homes--compared with nearly 70 percent of whites.

While some mortgage firms will be positioned to take advantage of the new market expansion, many may not.

"We've been talking about demographic changes since the mid-1990s," says Tom Lund, executive vice president of Fannie Mae's single-family mortgage business, "but the industry has been too busy dealing with the refi boom to really commit to the changing demographics." Lund serves as interim head of the single-family mortgage business for the government-sponsored enterprise (GSE).

Those who are positioned to benefit from these new demographics must be pleased by all the signs of change that abound. These include statistics showing immigrants head more than one in three new American households and that more than 1.2 million immigrants have arrived here annually since 2000 (according to Harvard University's Joint Center for Housing Studies, Cambridge, Massachusetts), to Los Angeles-based KB Home's new Spanish-language Web site and the growing number of public places where one notices Spanish or other foreign tongues wafting through the conversational air.

Citing U.S. Census Bureau data, Wendy Marlett, KB Home senior vice president of marketing and communications, notes that, "Hispanics are the fastest-growing population segment in the U.S., and the nation's largest minority group at 12 percent."

U.S. Rep. Xavier Becerra (D-California) of Los Angeles puts that slice a notch higher at 13 percent and says Hispanics (aka Latinos) "represent the largest, fastest-growing and youngest minority group in the nation." By 2008, the California-born congressman says the aggregate number of Hispanics in the United States will swell to 53 million people "wielding $1 trillion in annual buying power."

It is that economic power that has many in the mortgage business taking keen notice of "emerging markets," a term considered already outmoded by some like Gary Acosta, chairman and co-founder of the National Association of Hispanic Real Estate Professionals (NAHREP), San Diego. Acosta says, "This is not a niche or emerging market--it's an 'emerged market.'"

The 5-year-old NAHREP, which claims a membership of 12,000 mostly Hispanic real estate professionals, is lobbying for removal of existing barriers that keep so-called non-documented immigrant families from purchasing homes in the United States--a green light that would produce a whopping $44 billion in prospective mortgage originations, according to the group.

The issue has split opinion between those who stand to gain financially and others who would benefit politically.

Mortgage Guaranty Insurance Corporation (MGIC), Milwaukee, a national private mortgage insurance firm, puts the number of undocumented residents in the country at 10 million to 12 million, with half a million more added each year. The company is going after this large group of potential customers, says Geoffrey Cooper, MGIC's director of emerging markets.

"They come to work, build a life for their families, [have] kids in school. They're most commonly moms and dads who have ITINs [Individual Tax Identification numbers], and their children were all born here," Cooper says.

Yet, Cooper notes that seven of 10 Hispanics in the United States have not been here very long, and concludes, "This is a key demographic that needs to be considered."

The ITINs referenced by Cooper are fairly easy to obtain from the Internal Revenue Service (IRS), which does not report illegal aliens to immigration officials.

Among lenders serving these would-be homeowners are Birmingham, Alabama-based New South Federal Savings Bank, which is launching its Casa Mia mortgage program in Phoenix, Houston and Atlanta as well as its home state, according to a company press release.

This type of lending has drawn the ire of some special-interest groups and elected officials opposed to the acceptance of ITINs as minimally sufficient documentation for lending.

In Wisconsin, for example, Republican State Senator Glenn Grothman sought this year to block the state's Housing and Economic Development Authority from buying mortgage loans issued to illegal immigrants. They proposed legislation that would put an end to the 18-month-old mortgage loan pilot program, which buys from banks home loans made to people assigned ITINs rather than Social Security numbers. The bill is still being considered by the Republican-dominated legislature, and would likely be signed into law by the governor, if sent to him. To date, the program has provided 142 loans worth $15.7 million to borrowers.

The state's public housing authority, which finances loans through tax-exempt bonding, has partnered with several banks to provide mortgages. Lenders in this program and elsewhere seem eager to serve this growing market of minority and immigrant groups, and are looking for new ways of reaching them.

"We have to be a little more creative as far as how to move those potential homebuyers into homeownership roles," says Edward Gotschall, vice chairman of New Century Financial Corporation, Irvine, California, a large nonprime lender.

Gotschall, one of New Century's founders, recommends prudence. "We must really work on our statistics to prove that these are viable borrowers ... and that delinquency rates will support the level of borrowing," he says.

That will take testing and product innovation, according to Gotschall, as well as new relationships. "We're looking at certain types of alliances with home builders to get into the emerging markets and actually offer selective type products where we both share risk," he says.

This represents a shift in strategy for New Century, according to Gotschall. He says, "Once we got started we did it differently--going to the grass-roots level."

Now, Gotschall says, the company is very active with many faith-based organizations, explaining that "many in emerging markets are very faith-based borrowers and [are] accessible through relationships with those organizations." (Indeed, faith-based organizations, such as Faith Community Coalition for Homeownership in Rhode Island, are developing homeownership programs of their own.)

There is no one, single route to success, advises Todd Hempstead, senior vice president of single-family mortgage business at Fannie Mae, who says each cultural and ethnic community requires its own business approach.

"There are differences in the way the Hispanic community thinks about financial institutions and a difference in the way African Americans think about financial institutions, and so you have to be willing to align your business model to deliver your product in a way that makes sense to those communities," Hempstead says.

Alignment may not be the crucial issue as much as an entre--especially with lower-income Americans, according to Federal Home Loan Bank executive Bill Batz. He reports that in his geographic area, among minority and immigrant households with incomes below $40,000 a year, "only 40 percent have banking relationships."

Batz is executive vice president and chief operating officer, FHLB of Pittsburgh (one of 12 districts in the system), representing the states of Delaware, Pennsylvania and West Virginia. Using an increasingly popular term, he notes that often low-income, minority and immigrant households are "'unbanked' [and] not acculturated to using all the financial institutions," placing them outside the normal reach of the existing mortgage business.

"A lot of emerging borrowers use money pooled among family members," says Kirk Smith, president of SouthStar Funding LLC, an Atlanta-based wholesale lender. "There is no traditional bank account, and they can't show a [usually required] 90-day trail of seasoned funds."

Rodolfo Saenz goes further, acknowledging that these groups "don't really know what questions to ask, how to select the best product, what papers and questions will be part of the application." Saenz is executive vice president of multicultural markets at Countrywide Financial Corporation, Calabasas, California.

To mitigate this problem, the company offers an Optimum Loan program, which includes a low- or no-down-payment feature, supplements applicants' credit records with "nontraditional" credit and gives recognition to cash income and rent from housemates.

Countrywide also has teamed with a nonprofit community development corporation called TELACU (The East Los Angeles Community Union), Los Angeles, to provide Latinos in the area with flexible underwriting that overlooks traditional credit histories or income sources and offers loan financing with the lesser of 1 percent or $500 down.

Outreach like this can pay off in more ways than one.

"If you can market products that produce results, you'll get trust returned to you in the form of brand loyalty," says Rep. Becerra. From a revenue stand-point, he calculates that immigrants on an annual basis send $30 billion earned in the United States to family members in their countries of origin.

"That's money kept under a mattress or not invested longer term the way it could have been--like buying a home and building equity to send more money back home," says Becerra.

Connecting the two issues--homeownership and remittances to home countries--the National Council of La Raza (NCLR), which bills itself as "the largest national constituency-based Hispanic organization and the leading voice in Washington, D.C., for the Hispanic community," reports that seven in 10 Hispanics in the United States who send remittances use costly wire-transfer companies.

Only 11 percent remit funds through a bank and 2 percent through a credit union, despite the fact that these financial institutions provide a wider menu of services at a lower cost, according to NCLR.

Janet Murguia, president and chief executive officer of NCLR, blames a lack of visible competition from banks and credit unions as the source of this lack of choice for Hispanics.

Her organization claims a "lack of a physical presence by major lenders within Latino communities" for making Hispanic borrowers "more vulnerable to unscrupulous lenders." A study by the group finds that greater than 40 percent of mortgages written to Latino borrowers in 2002 were "high-cost subprime products, even though as many as half of those buyers may have been eligible for prime-rate financing," according to NCLR's analysis.

The group reports the median net worth of Hispanic households in 2002 was $7,932, compared with $88,651 for white non-Hispanic households. In 2002, 25.4 percent of Hispanic households did not own any assets other than a vehicle or unsecured liabilities, compared with 6.3 percent of white house-holds, based on statistics from the Pew Hispanic Center, Washington, D.C.

Pew also counts nearly 11 million illegal immigrants living in the United States, and notes that more lenders are looking to provide home financing for this "undocumented" segment of the population.

"To be fully part of America's 'ownership society,' Latinos must retain ownership of the money they earn so they can save, build assets and participate in the American dream through homeownership, a college education for their children and a comfortable retirement," says NCLR's Murguia.

Sounding a related theme, David Berenbaum, executive vice president, National Community Reinvestment Coalition, Washington, D.C., says his "major concern today with predatory lending is not the overt predator who is charging absurd fees and points or yield-spread premiums," but rather "the issue of pricing and risk-based pricing and product choice. That's where the market needs to be going."

Protection from predatory lenders

On this theme, Jason Spence, legislative assistant/counsel to Rep. Bob Ney (R-Ohio), sympathizes, observing that "Emerging markets are breeding grounds for predatory lending practices.

"People who are unbanked are pushed into areas of lenders who would take advantage of them," says Spence, who argues that a new, federal lending bill known by its initial sponsors' names, Ney-Kanjorski (Rep. Paul Kanjorski, a Pennsylvania Democrat), contains a provision "to prevent lenders and brokers from steering borrowers into loans that are more costly than what they're otherwise qualified for."

Spence says the bill has "an entire section on financial literacy and education, because that's half the battle in a lot of these emerging markets. The reason that people can be preyed on is nobody has told them there's an alternative."

Countering some of the charges about the prevalence of predatory lending are the findings of a report done by two University of Virginia researchers, Professors Richard DeMong and James Burroughs. They concluded that the mortgage interest rate offered to borrowers is based on risk.

An analysis by DeMong and Burroughs of more than 961,000 mortgage loan applications at multiple lenders in 2004 shows that lenders priced their loans based on risk characteristics such as:

* FICO[R] score,

* lien position (first or second lien),

* monthly income,

* documentation of income,

* loan-to-value ratio (LTV) and

* whether the loan included a prepayment penalty.

Their analysis of mortgage loans also showed borrowers with higher FICO scores were able to command lower annual percentage rates (APRs)--as well as borrow more and incur a higher LTV in the process. Similarly, borrowers with first liens had lower APRs than borrowers taking out a second-lien loan. A higher level of income also leads to lower APRs, all factors held constant.

At any rate, lenders will tell you that the growth in emerging-market mortgage customers appears to be driving--or at least helping to fuel--the remarkable growth in alternative-A lending (not a new category, but one that seems to be taking on new attributes).

Witness the meteoric rise in alt-A lending at wholesaler SouthStar Funding, which as recently as January 2004 had no alt-A product offerings and as of June did about $125 million a month in such lending, representing just under one-quarter of its entire business, reports Kirk Smith, president.

Most popular among SouthStar's alt-A products are the no-income, no-asset loans (affectionately known as NINAs) and stated-income loans, another no- or low-document-required mortgage. SouthStar is aggregating some $600 million per month in alt-A loans across 47 states, according to Smith.

Smith is quick to point out that despite the apparent leniency of some features of these loan programs, SouthStar's borrowers all have FICO scores in the high 600s, generally regarded as good credit risks by much of the secondary market, which has been powering the surge in such product offerings. Asked about the performance of such loans, Smith says, "[The secondary market] wouldn't be buying them if they weren't performing."

Smith says, "Sophisticated markets are putting more emphasis on score and less on more traditional methods for judging creditworthiness."

It's no coincidence that alt-A's growth at companies such as SouthStar is coming from states such as Florida, Texas and California, as well as cities like Atlanta, which Smith calls "a diverse international market." And, he notes, demand for alt-A loans is being driven by more than just immigrant or minority populations. "It's occurring in almost every major city, and it's not just Hispanic; it's anyone who is first-generation," he says, noting the maturation of earlier immigrant waves.

Smith says the most noticeable missing players are the GSEs, which have been eclipsed by private-sector buyers like Lehman Brothers Bank FSB, Goldman Sachs Mortgage Co., EMC Mortgage Co. and UBS Real Estate Securities Inc. Smith notes that the GSEs could be more effective in buying loan products that assist emerging market-type borrowers. He claims that "the products they offer [to emerging markets] are not effective."

In defense, Fannie Mae's Lund says, "We're seeing that begin to change. Institutions will be required to commit to understand the markets they're serving, how to penetrate those markets; I think that's partly why you're seeing the growth of the alternative markets, because they invested in these communities, understood the populations, their needs and how to sell to those communities. I think everyone needs to commit those resources."

Fannie Mae's Hempstead says, "As an industry, we have to be sure we are making as robust and flexible as possible the way we think about extending credit. Underwriting loans is becoming more creative with respect to non-traditional credit sources, those things that would allow us to extend credit to folks that haven't followed a traditional path."

To reach those markets, adds New Century's Gotschall, lenders must be willing to put training and financial education programs together. "It's not just in emerging markets that there's a lack of financial literacy--it's all throughout the country," he says.

"They don't teach it in schools today very well. We have to actually improve the level of financial literacy and be patient with emerging markets, because it's going to take a little bit of time to work with those borrowers and teach them how to run their financial and credit lives. That will result in product development over time, and that will result in a groundswell of support for the [Ney-Kanjorski] legislation that is being proposed," says Gotschall.

For those in the mortgage business not prepared for the results coming from demographic trends, in particular the growth of the Hispanic market, NAHREP's Acosta has this warning: "The Latino market may not be for everybody--just those of you that want to be in business in five years."

Neil J. Morse is an independent writer and mortgage industry consultant based in Newtown, Connecticut. He can be reached at
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Title Annotation:INDUSTRY TRENDS
Author:Morse, Neil J.
Publication:Mortgage Banking
Geographic Code:1USA
Date:Sep 1, 2005
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