The thing is, our yarn took place in 1994. The S&L in question was Oakland-based Golden West Financial Corp. (GDW
), which has offered its Pick-A-Payment loans since the U.S. government first allowed adjustable-rate mortgages, or ARMs, in 1981.
The naysayers couldn't have been more wrong about $20.6 billion Golden West. It wasn't crippled by defaults during the last housing bust. In fact, it held up better than anyone expected. And Golden West should do the same this time, too.
Adjustable-rate mortgages are once again high on analysts' worry lists. Given the Fed's recent rate hikes, some lenders will be hit by defaults as borrowers find it more difficult to make their payments. Analysts have already issued warnings about Washington Mutual (WM
), Countrywide Financial (CFC
), and FirstFed Financial (FED
), along with Golden West.
But ARMs aren't frightening to Herbert M. Sandler. He and his wife, Marion O. Sandler, have been co-chairman and co-CEO of Golden West since they founded the company in 1963. For 25 years the pair has offered so-called pay-option ARMs, which let borrowers choose from among various low-payment scenarios each month, with the principal and interest recalculated accordingly. These loans are the most sensitive to rising interest rates, because their rates reset every month. While option ARMs are big at WaMu and the others, they're Golden West's No. 1 loan product by far.
But the Sandlers have survived rate hikes before, and their long-term success is unrivaled among mortgage lenders. Over the past 39 years of housing booms and busts, Golden West's earnings have grown at a compound annual rate of 19%, a record matched in U.S. business only by Warren Buffett's Berkshire Hathaway Inc. (BRK
).PERFECTING THE BASICS
The Sandlers' 1994 performance was impressive. In California, where 78% of the company's loans were concentrated, the jobless rate jumped to 9.4%, while home prices fell 4.5%. Moreover, the Fed raised banks' overnight lending rate from 3.25% to 5.5% that year, often in big half-point leaps. Yet Golden West charged off a mere 0.43% of its loans in 1994 -- above average for its conventional-mortgage-oriented peers, but hardly disastrous. The following year charge-offs fell to 0%.
Golden West's secret? It excelled at the basics of mortgage lending: conservative underwriting practices, funding loans with core deposits, and balancing interest paid on deposits with interest earned from loans. Even though the loans were risky, the customers, for the most part, weren't. Herbert Sandler dismisses the hand-wringing now. "We have been through high interest rates, low interest rates, and sideways interest rates, and not very much exciting has happened," he says.
Still, analysts are sounding the alarm. In a recent report, Christopher Whalen of independent research firm Institutional Risk Analytics reiterated his sell rating on Golden West, calling it "the poster child for the U.S. real estate bubble." In an interview, Whalen added: "There is no flexibility in its portfolio."
He has a point. Last year pay-option ARMs made up 99% of Golden West's loan pool. (It also offers home-equity lines of credit.) And 62% of the loans were secured by homes in California, where housing prices could fall in coming years.
But Golden West's risk management is among the best in the industry. Its annual default rate has been lower than that of its peers for years. Golden West maintains a higher-than-average percentage of assets in cash to cover losses. And the Sandlers don't lend to the riskiest borrowers with spotty credit histories.
Golden West's conservative strategy will be put to the test if housing tanks. For now, though, it looks like history is on the Sandlers' side. By Justin Hibbard