Lending lessons learned from Lehman’s loss
Has your credit union’s lending department learned its lesson from Lehman Brothers? At a very high level, the demise of Lehman Brothers is simple: The company took on an extraordinary amount of mortgage loans, a good portion of them in the Alt-A market. Whereas subprime mortgages are considered extremely high risk loans due to the poor credit history (or lack thereof) of the borrower, Alt-A is a classification of mortgages where the risk profile falls between prime and subprime. The borrowers behind Alt-A mortgages typically have clean credit histories, but features of the mortgage itself (higher loan-to-value and debt-to-income ratios, or inadequate documentation of the borrower’s income) will generally have some issues that increase its risk profile. However, the higher interest rates the bank garnished from these loans made them especially appealing, and Lehman Brothers took on the risk in extraordinary numbers.
From 2004 to 2006, Lehman accumulated such large volumes of these higher risk loans, that when the real estate market bubble collapsed in the summer of 2006, and the riskier borrowers started to default, rather than curtail their mortgage portfolio, Lehman made the detrimental mistake of pushing forward. In 2007, Lehman underwrote more mortgage-backed securities than any other firm, accumulating an $85 billion portfolio, or four times its shareholders’ equity.1 It wasn’t long before these risks, and the failed recovery of the housing market, forced Lehman to file for bankruptcy.continue reading »