A Bank That Does Not Offer FHA Loans

by Peter G. Miller
September 30th, 2008
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The news is filled with failing-bank stories just about every day, reason enough for me to write about two banks with ridiculously-low foreclosure rates: Hudson City Bancorp and ING Direct. (For the whole story, go to No Mortgage Meltdown For These Banks.)

Hudson and ING prove that “everybody” didn’t offer option ARMs or qualify borrowers with stated-income loan applications. Instead, these two lenders — and no doubt others — stuck to their underwriting standards and as a result are not on anyone’s list of troubled banks.

You might think that such lenders would do a lot of FHA lending, thus I was surprised when Hudson’s Chairman, President, and CEO Ronald E. Hermance, Jr. told me that his bank doesn’t do FHA loans.

The reason: Too much back-office work, too expensive to process.

Now this is interesting.

If you’re a lender you have to love the FHA program, especially now. You go out, you get a borrower, complete the origination process and Uncle Sam insures you or whoever buys the loan against default. This is about as good as it gets in terms of assured mortgage income and profits.

And yet here is Hudson, what Jim Cramer says “is now the largest savings and loan in the country” and it doesn’t do FHA mortgages.

In the great lottery of financial life Hudson has done well by being smart and steady. You can’t get a mortgage from Hudson without equity — the typical Hudson mortgage has a loan-to-value ratio of 61.5 percent, thus the lender has a lot of protection in the event of default.

But you don’t need a big downpayment or lots of equity to make a loan secure. You can get the same effect with mortgage insurance, whether that insurance is from the VA, FHA or a private insurance source.

For Hudson the issue is efficiency. Yes, if an FHA-insured loan goes bad you’ll get your money back — but only after a bunch of hassle and time, things which consume employees and back offices.

The Hudson model is based on credit quality (remember when all lenders thought credit quality was important…) and efficiency. It has a tiny staff relative to its 125 branches — an average of about 11 people per branch. The result is a very low cost basis and growing profits.

I suspect this is a case where the exception makes the rule. I don’t see many lenders following in Hudson’s path, despite the fact that Hudson has been remarkably successful.

Why? Because the market for FHA mortgages is huge and growing, it’s a source of easy business for lenders, the loans are guaranteed by the U.S. government and few borrowers have 20 or 30 percent equity.

I don’t expect lenders to look at the Hudson model and dump FHA loans — but I do expect them to look at Hudson with a substantial sense of envy.

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