Lots of people forwarded me this week’s NY Times story tracing the careers of Herbert and Marion Sandler, a husband and wife banking team that founded World Savings in 1963, introduced Option ARMs in 1981 then sold their firm to Wachovia in 2006 and made about $2.6 billion. Option ARMs are mortgages with many payment options—some Option ARMs have an option to pay less than the interest due, which if chosen, causes the principal balance to rise.
Now that Option ARMs from the last few years are going bad at all banks, the Sandlers are called pariahs. Harsh words for a team that hand built a banking empire over 45 years—an empire that included an Option ARM portfolio that was healthy for nearly 27 years. Any loan portfolio (or bank for that matter) that lasts as long as the de facto mortgage term has something going for it despite what critics might say in this 20/20 Hindsight phase of the crisis.
What the Sandler Option ARM (and overall loan) portfolio had going for it for more than two decades was rigorous underwriting. Very conservative loan-to-value ratio requirements. Qualification standards based on strict analysis of a borrower’s income, assets and employment. And a boutique style where bank officials actually understood their borrowers—especially when it was a more sophisticated client who wanted or needed a loan with payment options.
Unfortunately frenzied competition in a scorching real estate market caused underwriting standards a most banks (including most of the big firms) to crumble from 2003 to 2006, and led us into our current crisis. I wrote about this Wachovia Option ARM issue earlier this year, and at the time, said that maybe JP Morgan Chase might buy them. Turns out it was Wells Fargo. Now a firm that never did Option ARMs has to sort out an Option ARM mess. Let’s hope they add a 30yr fixed rate option for Option ARM holders who want that, and also hope they let those who want a more conservative product get one—right now, many banks won’t even talk to borrowers about different product options until they have defaulted on their current loans.
I also made a few points defending Option ARMS and led, of course, with rigorous underwriting. It’s just not that complicated: know everything about who you’re lending to. But now the damage is done—at Wachovia and elsewhere—so the pariah hunt is on.
I am not cheerleading for negative amortization Option ARM loans. My loan portfolio speaks for my position on negative amortization. But I am cheerleading for custom underwriting and product innovation. There are today, and always will be, client profiles that are the right fit for a loan with various payment options. But until this all shakes out, those borrowers are unlikely to have options.
Basis Point of Disclosure: The author of this post is a practicing mortgage banker, and loans with negative amortization payment options comprise about 0.7% of his total client portfolio.