Lending Operations

Golden West Kept its Loans in Portfolio.
Golden West Originated High-Quality Loans and Did Not Engage in Subprime Lending.
Golden West’s “Pick-a-Payment” Option ARM Was Structured Differently than other Option ARMs.
Golden West Remained a Small Percentage of the Mortgage Market.
Golden West Had Conservative Underwriting and Appraisal Practices.
Golden West Had Record Low Losses.
Golden West Closely Monitored Its Loan Portfolio.
Golden West Carefully Reviewed all Training Materials.
Golden West Had Regular Contact with Borrowers About their Loans.

Golden West Kept its Loans in Portfolio.

Throughout its 40-year history, Golden West kept its loans in portfolio, meaning that the company kept its loans on its books and retained the risk of loss. The company did not securitize and sell ARMs to Wall Street or other investors as most of the rest of the banking industry did. During the last 25 years of its history, almost all of Golden West’s assets were adjustable rate mortgages (ARMs) on residential properties that were kept in the company’s portfolio.
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Golden West Originated High-Quality Loans and Did Not Engage in Subprime Lending.

Golden West made low-yield, low loan-to-value (LTV) loans to a full spectrum of qualifying borrowers. The company did not originate subprime loans.

Note on Subprime Lending.

The subprime mortgage industry was built around the concept of risk-based pricing, which meant charging different yields for loans based on the borrowers’ perceived credit quality. In practice, this meant that a subprime lender charged the borrower a higher interest rate for a subprime loan than the rate for prime loans (even if the borrower might have qualified for a prime loan). Golden West rejected the concept of risk-based pricing, believing it would invariably be discriminatory. At Golden West, any borrower who qualified for a loan would receive a prime rate, irrespective of the borrower’s financial information or other characteristics.

Virtually all of the subprime lending in the early- and mid- 2000s used a “2/28” loan product. The 2/28 loan refers to a loan that was structured to trigger a significantly higher interest rate and monthly payment after two years. For example, a 2/28 might have a “teaser” rate for two years of 7%, but the rate could jump to 12% or more after two years, creating a significant risk of payment shock to the borrower. Another popular subprime loan was a “3/27”, which had similar features and would recast after three years. Golden West made no 2/28 or 3/27 loans.

Subprime lending was a small proportion of the overall mortgage market until the late 1990s and early 2000s, when its growth was fueled by the combination of technological advances, investor demand for higher yields, and the purchase of subprime operations by major mortgage banks. In order to generate high volumes of loans, subprime lenders looked for ways to shortcut traditional underwriting. A principal tool they used to expedite underwriting decisions (and to justify charging higher rates to borrowers) were FICO credit scores, which have never been fully validated for residential mortgage lending (they were initially adopted for consumer credit). There are many factors that call the veracity of FICO scoring into question: (a) three different agencies can give widely different FICO scores for the same borrower at the same point in time, and lenders can play games with which FICO scores they choose to use; (b) FICO scores can change quickly for reasons unrelated to true credit risk or, alternatively, the scores can move much too slowly to capture actual risk; and (c) FICO scores can be manipulated; companies exist to help borrowers improve their credit scores in ways that do not meaningfully alter the borrowers’ real risk profile. Golden West, unlike most other lenders, continued to do traditional, holistic underwriting (looking at the borrowers’ actual credit history and the appraisal of the property), rather than relying on shortcut methods like FICO credit scores as a sole or primary determinant for underwriting.

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Golden West’s “Pick-a-Payment” Option ARM Was Structured Differently than other Option ARMs.

For 25 years, Golden West’s principal loan product was an ARM that was structured for portfolio lenders to reduce the risk of a material increase in a borrower’s payment that could cause?payment shock?when the loan “recasts.” A recast refers to the point when the payment changes to enable the loan to be paid down (or reamortized) over its remaining life. Read a summary of the history of the Option ARM and the structural features of the Golden West Option ARM. Because of built-in protections in its structure, only a nominal number of Golden West ARMs ever recast in Golden West’s 25-year history with the product that led to a payment increase of more than 7.5% to borrowers. The principal causes of deliquencies, foreclosures and losses have historically been divorce, unemployment, and medical emergencies. In the mortgage crisis, the historically unprecedented decline in housing prices was the principal cause of losses.

In 2003, aggressive mortgage bankers seeking to generate large volumes of Option ARMs for sale changed the structure of the Option ARM in the following significant and risky ways, which increased the risk of an early recast that would cause a material payment shock to borrowers: (1) the triggers that would cause a recast event were shortened, increasing the likelihood that the borrower’s payment would increase significantly in a relatively short period of time, (2) the starting rate used to calculate the borrower’s minimum payment rate was significantly reduced, far below what portfolio lenders had ever done, (3) many loans were made with high loan-to-value ratios of 90-100%, and (4) underwriting standards were reduced, with the principal criteria being whether the loan could be pooled and sold to investors. See a chart showing the differences among the Golden West ARM, the Option ARM Made For Sale, and the Subprime 2/28 loan.

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Golden West Remained a Small Percentage of the Mortgage Market, While Other Mortgage Banking Operations Grew Dramatically.

Throughout its 40-year history, Golden West never grew beyond 1 – 1.75% of overall U.S. mortgage market. By contrast, mortgage banking operations that generated large volumes of prime and subprime loans for securitization and sale to investors grew dramatically, particularly from the mid-1990s forward. See a chart showing growth of two major mortgage banks that started at less than 1% of U.S. mortgage originations, but grew to 16% and 10%, respectively, in the 2000s; these were the lenders who focused on high volume and high-yielding loans.

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Golden West Had Conservative Underwriting and Appraisal Practices.

As a risk-averse portfolio lender, Golden West’s business strategy required minimizing nonperforming loans in order to keep costs and losses as low as possible. Golden West used traditional, conservative underwriting and appraisal practices to assess the quality of loans. Golden West’s underwriting and appraisal processes were separate from the company’s loan origination process to assure independence and accountability.

a. Manual Underwriting of Each Loan.

The company evaluated the creditworthiness of potential borrowers based primarily on credit history and an evaluation of the potential borrower’s ability to repay the loan. When evaluating a borrower’s ability to pay, Golden West assessed the ability to make fully amortizing monthly payments, even if the borrower had the option to make a lower initial monthly payment. By contrast, many mortgage banking operations only assessed the borrower’s ability to make a minimum, non-amortizing payment. In its underwriting decisions, Golden West also evaluated the characteristics of the property and the loan transaction, including whether the borrower was purchasing or refinancing the property and would occupy the property. Golden West used systems developed internally based on decades of experience evaluating credit risk. Although Golden West used credit scores and technological tools to help with underwriting evaluations, its trained underwriting personnel reviewed each file and analyzed a wide range of relevant factors when making final judgments. Higher-level approvals within the underwriting organization were obtained when circumstances warranted.

b. Internal Appraisal Staff.

Golden West appraised the property that secured loans by assessing its market value and marketability. Golden West maintained an internal staff to conduct and review property appraisals. Any external appraisers used for loans that were originated and retained in portfolio were required to go through a training program with the company, and each external appraisal was reviewed by Golden West’s internal appraisal staff. Golden West did not rely on external automated valuation models (AVMs) in its appraisal process, which is what mortgage banking operations commonly did.

c. Lending on Moderately Priced Properties with Low Loan-to-Value Ratios.

Golden West focused on originating high-quality loans on moderately priced properties because, historically, these properties tended to hold their values better than high-priced properties, particularly in weak housing markets. Golden West did not emphasize lending on higher-priced properties because of concerns about greater price volatility and the larger potential loss if these loans did not perform.

d. Low Loan-to-Value (LTV) Ratios.

The loan-to-value ratio, or LTV, is the loan balance of a first mortgage expressed as a percentage of the appraised value of the property at the time of origination. A combined loan-to-value, or CLTV, refers to the sum of the first and second mortgage loan balances as a percentage of the total appraised value at the time of origination. Golden West focused its lending activity on loans with original LTVs or CLTVs at or below 80%. Golden West’s average LTV at origination was 71%. In the early-to-mid-2000s, many other lenders were regularly making loans equal to the value of the house (100% LTVs).

Golden West Had Record Low Losses.

Throughout its history, Golden West originated ARMS with the lowest delinquencies, foreclosures and losses of any major financial company in the country, including fixed-rate lenders. For example, in its final eight years of operation as an independent company (1998-2005), Golden West’s losses were zero. See a chart that shows Golden West’s low loan losses from 1968-2005.

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Golden West Closely Monitored Its Loan Portfolio.

As a risk-averse portfolio lender, Golden West actively monitored its loan portfolio to detect any credit risk issues early and mitigate risks in the portfolio. For example, Golden West did the following:

a. Conducted periodic loan reviews;
b. Analyzed market trends in lending territories and adjusted loan terms, such as required original LTV or CLTV ratios;
c. Reviewed loans that became nonperforming assets to evaluate if there were detectable signs that the company should incorporate into the training of underwriting and appraisal staff;
d. Identified segments of the portfolio that might have more vulnerability to credit risk, either because of geography, LTV or CLTV ratio, credit score, or a combination of these and other factors; and
e. Worked with customers who may present potential risks and offer them counseling or other programs to try to reduce the potential for future problems

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Golden West Carefully Reviewed all Training Materials.

Every flyer, marketing item or sales or training tape was required to go through a multi-step internal review process by individuals in departments that were independent from the loan sales team, including a loan support team, compliance personnel, and legal counsel. No material could be approved without signatures from all three departments. This process was developed to ensure accuracy, clarity and professionalism of all material. The policy was constantly communicated to the sales field and was part of every new hire orientation and training. Any violation of the policy by field representatives resulted in either a one-time warning or termination. A second violation was automatic termination.

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Golden West Had Regular Contact with Borrowers About their Loans.

When a borrower obtained a loan, Golden West not only provided loan disclosures in compliance with applicable legal requirements, but the company’s practice was also to: (a) contact borrowers multiple times in the first year to make sure the borrower understood the loan and its features, (b) provide regular communications to borrowers about managing the loan in monthly statements, and (c) track the payment behavior of every loan to be able to anticipate potential risks in the portfolio and make early contact with borrowers who appeared to be experiencing problems.

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