Subprime Mortgages Return to the Market with a New Name
Subprime mortgages, home loans to borrowers with sketchy credit who contributed little or no equity, were blamed for the biggest financial disaster in a century. After the epic housing crash, they disappeared because of strong new regulation and zero demand from investors who were badly burned. Barely a decade later, they are coming back with a new name—nonprime—and, so far, some new standards.
California-based Carrington Mortgage Services, a mid-sized lender, just announced an expansion into the space, offering loans to borrowers, “with less-than-perfect credit.” Carrington will originate and service the loans, but they will also securitize them for sale to investors. “We believe there is actually a market today in the secondary market for people who want to buy non-prime loans that have been properly underwritten,” said Rick Sharga, EVP of Carrington Mortgage Holdings. “We’re not going back to the bad old days of ninja lending, when people with no jobs, no income, and no assets were getting loans.”
Sharga said Carrington will manually underwrite each loan, assessing the individual risks. But it will allow its borrowers to have FICO credit scores as low as 500. The current average for agency-backed mortgages is in the mid 700’s. Borrowers can take out loans up to $1.5 million on single-family homes, townhomes, and condominiums. They can also do cash-out refinances, where borrowers tap extra equity in their homes, up to $500,000. Recent credit events, like a foreclosure, bankruptcy or a history of late payments are acceptable. Not all loans, however, will be the same for all borrowers. If a borrower is higher risk, a higher down payment will be required, and the interest rate will likely be higher. “What we’re talking about is underwriting that goes back to common sense sort of practices. If you have risk, you offset risk somewhere else,” added Sharga, while touting, “We probably are going to have the widest range of products for people with challenging credit in the marketplace.”
Carrington is not alone in the space. Angel Oak began offering and securitizing non-prime mortgages two years ago and has done 7 non-prime securitizations so far. It recently finalized its biggest securitization yet—$329 million, comprising 905 mortgages with an average amount of about $363,000. Just over 80% of the loans are non-prime. Investors in Angel Oak’s non-prime securitizations are, “a who’s who of Wall Street,” according to company representatives, citing hedge funds and insurance companies. Angel Oak’s securitizations now total $1.3 billion in mortgage debt. Angel Oak, along with Caliber Home Loans, have been the main players in the space, securitizing relatively few loans. That is clearly about to change in a big way, as demand is rising. “We believe that more competition is positive for the marketplace because there is strong enough demand for the product to support multiple originators,” said Lauren Hedvat, Managing Director, Capital Markets at Angel Oak. “Additionally, the more competitors there are, the wider the footprint becomes, which should open the door for more potential borrowers.”
Big banks are also getting in the game, both investing in the securities and funding the lenders, according to Sharga. “It’s large financial institutions. A lot of people with private capital sitting on the sidelines, who are very interested in this market and believe that as long as the risks are managed well, and companies like ours are particularly good at managing credit risk, that it’s a good investment opportunity,” he said. As the economy improves, and rents continue to rise, more Americans are trying to become homeowners, but the scars of the great recession still stand in the way. One-fifth of consumers today still have very low credit scores, often disqualifying them from obtaining a mortgage in today’s tight lending market.
Last summer, Fannie Mae announced it would relax its lending standards for prime loans, allowing borrowers with higher debt and lower credit scores to obtain loans without additional risk overlays, such as large down payments and a year’s worth of cash reserves. Fannie Mae raised its debt-to-income (DTI) limit from 45% to 50%. DTI is the amount of total debt a borrower can have compared to his or her income. As a result, demand from buyers with higher debt exceeded all expectations. The share of high DTI loans jumped from 6% in January of 2017 to nearly 20% by the end of February, according to a study by the Urban Institute.
The outsized demand from borrowers with more debt as well as demand for non-prime mortgages in the private sector show just how many borrowers today would like to become homeowners but are frozen out of the mortgage market. Millennials, the largest home buying cohort today, have much higher levels of student debt than previous generations. Members of older generations who went through foreclosures during the housing crisis or other hits to their credit are still struggling with lower FICO scores. In addition, credit tightened up dramatically. In fact, between 2009 and 2015, tighter credit accounted for just over 6 million “missing” loans, according to research by Laurie Goodman at the Urban Institute. These are mortgages that would have been granted under more normal historical underwriting standards. The rebirth of the non-prime market is focused on these missing mortgages. The hope is that the industry will also focus on better standards of underwriting and not take risk to the levels it once did, levels that resulted in disaster.
Skillz Rides the Exploding Popularity of Mobile eSports Tournaments
For many years, Andrew Paradise, the CEO of mobile game developer Skillz, felt like an outsider in eSports—a new revenue source in the video game industry, built around enormous multiplayer competitions. Skillz, his mobile eSports platform, was small in comparison and deemed fringe by his peers. They were focused on PC games with dazzling, hardware-intensive visuals, not phones. But things are different now. At the annual Game Developers Conference (GDC) held each March in San Francisco, on the day dedicated to eSports, one of the first panels focused on mobile game competitions. More than 200 developers visited the Skillz Inc. booth. “Mobile eSports was the hottest thing at GDC,” Paradise says. “The industry is shifting very quickly.”
Esports contests have gone from peripheral affairs to massive spectacles, with investment from billion-dollar game publishers, broadcast TV networks, and venture capitalists pouring into teams adept at PC games. Mobile games such as Angry Birds and Candy Crush attract more players—2.2 billion worldwide, according to researcher Newzoo—but generally not the kind who’ll train for tournaments. Now that phone hardware is good enough to run more complex games, even hard-core players are shifting their attention to phones. Six-year-old Skillz, the mobile eSports leader, says it hosts more than 1 million tournaments a day and has doubled its monthly revenue, to $16 million, in the last nine months, putting it on pace to blow past $200 million in the next year.
Skillz is a central hub that can turn any game into a contest among friends or strangers, either by pitting players against one another or by ranking their scores. The company works with more than 8,000 developers to tweak their games for its 15 million players, who enter tournaments of as few as two people or as many as 10,000 and win prizes based on their results. (Average entry fee: about $2.) Skillz says it matches players based on ability. Cash prizes are paid via check or PayPal, and occasionally a new car or paid vacation is up for grabs. There are also free contests without cash-value prizes. Newzoo predicts mobile games will account for a majority of game industry revenue, roughly $65 billion, by 2020. Paradise says he expects the $900 million eSports business to do the same. “Software follows hardware,” he says, “and mobile is the dominant hardware.” The average Skillz gamer spends about an hour a day on the platform.
Unlike in traditional eSports, most Skillz players are women, Paradise says, including 7 of last year’s 10 biggest winners, who each collected more than $200,000. The No. 1 player in 2017, who goes by the handle “yutourmaline,” won just shy of $421,000; that would rank her among the top 25 in the better-financed PC eSports. Skillz’ players include a diverse group of obsessives, many of whom drip candle wax onto their phones and scrape it off before each match, hoping the remaining residue will improve their grip on the screen. One member of last year’s top 10, Harvard sophomore Jennifer Tu, estimates that she spends about 10 hours a week on Skillz as a study break or on the shuttle between classes. Her go-to game is Solitaire Cube. “You have to be crazy good to make it big on a popular PC game,” says Tu, who also plays League of Legends. “Skillz is more low-key.”
The son of two tech entrepreneurs, Paradise started coding when he was 6 years old. The following year he built his first video game from scratch in Pascal, an early programming language. He kept playing and thinking about games through the end of his 20s, when he sold mobile checkout startup AisleBuyer LLC to Intuit Inc. for $100 million. He started Skillz soon after with fellow AisleBuyer alum Casey Chafkin, now Skillz’ chief operating officer.
Big-name competitors are moving in on Skillz’ turf. In the past month, Fortnite and PlayerUnknown’s Battlegrounds, two of the world’s top-grossing computer games, released mobile versions. (As of April 11, they’re the two top free apps in the iOS App Store.) Shortly after, Finnish game developer Supercell Oy, last year’s highest-earning mobile publisher, announced the formation of a 36-team league that will compete using its super-popular game Clash Royale. Some of the biggest eSports teams signed on for the Clash Royale League, including NRG Esports, co-owned by Skillz investor Andy Miller, who’s also part owner of the NBA’s Sacramento Kings. “I’m really bullish on mobile gaming,” says Miller, an entrepreneur who sold Quattro Wireless to Apple. “The tech is there, and everyone has a phone.”
Microsoft Corp. and Amazon.com Inc. are experimenting with similar services. Microsoft recently bought PlayFab Inc., which helps developers make and publish games, and Amazon just launched GameOn, a direct Skillz competitor. Paradise says that’s validation. “Amazon doesn’t enter industries where they don’t see massive market opportunities,” he says. “And they won’t be the last.”
The Good News Is . . .
- New applications for U.S. unemployment benefits fell last week, pointing to sustained labor market strength. Initial claims for state unemployment benefits dropped 9,000 to a seasonally adjusted 233,000 for the week ended April 7, the Labor Department said. Data for the prior week was unrevised. Economists polled by Reuters had forecast claims falling to 230,000 in the latest week. Claims tend to be volatile around this time of year because of different timings of the Easter and school spring breaks, which can throw off the model that the government uses to smooth the data for seasonal fluctuations.
- BackRock Inc., one of the nation’s largest hedge fund managers, reported earnings of $6.70 per share, an increase of 28.1% over year-earlier earnings of $5.72 per share. The firm’s earnings topped the consensus estimate of analysts by $0.29. The company reported revenues of $3.6 billion, an increase of 15.9%. Management attributed the results to strong net inflows of capital in its retail segment, both in the U.S. and internationally, as well as improved operating margins.
- Shared working start-up WeWork bought a Chinese competitor, Naked Hub, further expanding its reach into the Asian market. The value of the deal was estimated at $400 million. Naked Hub was established in 2015 by developer Grant Horsfield as part of luxury resort firm Naked Group. The company has 10,000 users across 24 locations. WeWork CEO Adam Neumann said the deal was part of incorporating cities into the working space, as well as buildings. Naked Hub has locations in Shanghai, where it is headquartered, Beijing and Hong Kong. Last year, SoftBank announced a $4.4 billion investment in WeWork, and the company has been driving expansion into Asia, where demand for co-working spaces is expected to grow significantly.
Guide to Asset Allocation Strategies
Establishing an appropriate asset mix of stocks, bonds, cash and real estate in your portfolio is a dynamic process. It plays a key role in determining your portfolio’s overall risk and return. As such, the asset mix should reflect your goals at any point in time. Below are several different strategies for establishing asset allocations, with a look at their basic management approaches. Be sure to consult with your financial advisor to determine the asset allocation strategy that is best for your particular situation.
Base Strategic Asset Allocation – This method establishes and adheres to a “base policy mix”–a proportional combination of assets based on expected rates of return for each asset class. For example, if stocks have historically returned 10% per year and bonds have returned 5% per year, a mix of 50% stocks and 50% bonds would be expected to return 7.5% per year.
Constant-Weighting Asset Allocation – Strategic asset allocation generally implies a buy-and-hold strategy, even as the shift in values of assets causes a drift from the initially established policy mix. For this reason, you may prefer to adopt a constant-weighting approach to asset allocation. With this approach, you continually rebalance your portfolio. For example, if one asset is declining in value, you would purchase more of that asset. And if that asset value is increasing, you would sell it. There are no hard-and-fast rules for timing portfolio rebalancing under strategic or constant-weighting asset allocation. However, a common rule of thumb is that the portfolio should be rebalanced to its original mix when any given asset class moves more than 5% from its original value.
Tactical Asset Allocation – Over the long run, a strategic asset allocation strategy may seem relatively rigid. Therefore, you may find it necessary to occasionally engage in short-term, tactical deviations from the mix to capitalize on unusual or exceptional investment opportunities. This flexibility adds a market-timing component to the portfolio, allowing you to participate in economic conditions more favorable for one asset class than for others. Tactical asset allocation can be described as a moderately active strategy, since the overall strategic asset mix is returned to when desired short-term profits are achieved. This strategy demands some discipline, as you must first be able to recognize when short-term opportunities have run their course and then rebalance the portfolio to the long-term asset position.
Dynamic Asset Allocation – Another active asset allocation strategy is dynamic asset allocation, with which you constantly adjust the mix of assets as markets rise and fall, and as the economy strengthens and weakens. With this strategy you sell assets that are declining and purchase assets that are increasing. This makes dynamic asset allocation the polar opposite of a constant-weighting strategy. For example, if the stock market is showing weakness, you sell stocks in anticipation of further decreases; and if the market is strong, you purchase stocks in anticipation of continued market gains.
Insured Asset Allocation – With an insured asset allocation strategy, you establish a base portfolio value under which the portfolio should not be allowed to drop. As long as the portfolio achieves a return above its base, you exercise active management–relying on analytical research, forecasts, and judgment and experience to decide what securities to buy, hold and sell, with the aim of increasing the portfolio value as much as possible. If, however, the portfolio should ever drop to the base value, you invest in risk-free assets, such as Treasuries (especially T-bills) so that the base value becomes fixed. At such time, you would consult with your advisor on reallocating assets, perhaps even changing your investment strategy entirely. Insured asset allocation may be suitable for risk-averse investors who desire a certain level of active portfolio management but appreciate the security of establishing a guaranteed floor below which the portfolio is not allowed to decline. For example, an investor who wishes to establish a minimum standard of living during retirement might find an insured asset allocation strategy ideally suited to his or her management goals.