A lender's recipe for downfall

Mortgage leader's drive to grow led to bankruptcy

Sun Special Report

January 05, 2008|By Laura Smitherman | Laura Smitherman,Sun reporter

The home loan program was dubbed South Street.

It turned the idea of credit risk on its head. Consumers just exiting bankruptcy could get a mortgage with few questions. They could have some of the lowest possible credit scores. And they didn't have to submit any pay stubs or tax returns.

Subprime mortgage lender Fieldstone Investment Corp. of Columbia created the loan program during the real-estate gold rush in 2004 as competitors flooded the market.

Such risk-taking would be Fieldstone's undoing.

The company, once ranked among the top 20 subprime lenders in the nation, sank into bankruptcy late last year after loan defaults soared and some borrowers couldn't make even their first few mortgage payments.

In court filings last week, Fieldstone reported $121 million in liabilities, including claims from employees in Maryland and elsewhere, but less than $15 million in assets.

Wall Street titan Morgan Stanley is now its largest creditor and has filed a separate lawsuit.

Lenient loan guidelines became emblematic of what went wrong at Fieldstone - and how far the subprime industry went to snag borrowers and boost volume.

As interest rates rose and competition intensified, Fieldstone pushed to make more loans to offset diminishing returns. And as Wall Street clamored to buy mortgage securities, the company changed the way it did business to capitalize on that gold rush.

Securities and Exchange Commission filings, bankruptcy court records, lawsuits and interviews with former employees detailed Fieldstone's recent downfall.

The company grappled with internal turmoil as well. General counsel Cynthia L. Harkness warned Fieldstone board members in January 2007 about increased production targets that were driving the company to consider more aggressive loan programs. She also questioned whether marketing plans could run afoul of consumer protection laws, according to a whistleblower complaint filed with federal regulators in March.

Harkness alleges she was harassed and fired for questioning the conduct of Fieldstone founder and Chief Executive Officer Michael J. Sonnenfeld.

The company denied allegations by Harkness in regulatory proceedings. Her complaint was dismissed but it is now under appeal.

Sonnenfeld did not return telephone calls seeking comment. Several other executives and board members either couldn't be reached or declined to comment for this article. A lawyer for the company declined to comment on its business practices.

Fieldstone blames upheaval in the credit markets for its shutdown in bankruptcy filings.

Fieldstone's fall was a surprise to some. Industry analysts regarded the company as more conservative than some of its freewheeling competitors, and the company regularly emphasized what it characterized as rigorous quality control mechanisms. In presentations to Wall Street investors in recent years, executives described the company as the "hardest place to deliver a bad loan."

Even the South Street program had a safety valve: Borrowers needed a hefty down payment. If they defaulted, Fieldstone would be more likely to recover its money in a foreclosure.

But as easy credit flowed and subprime loans grew to account for one-fifth of the market, Fieldstone got caught in the industry's race to the bottom despite signs of trouble, according to former employees. And when the industry collapsed, Fieldstone went with it.

"They were trying to keep up with competitors," said Betty Williams, a former assistant vice president of credit administration at Fieldstone. "Everyone wanted to get into the mortgage industry, just like everyone wanted to get into the computer industry five years earlier. Fieldstone started a lot of new programs to keep up."

Housing bubble

Fieldstone went public in 2005 after 10 years in business and in the midst of a housing bubble that resembled the dot-com craze of the late 1990s. Home sales reached an all-time peak that year and housing prices posted the largest-ever gain, when adjusted for inflation.

After losing money for several years while investing in more workers and facilities to establish a nationwide footprint, Fieldstone saw its profit double in 2002 and 2003. It doubled again in the next two years to about $100 million.

Executives had crafted a new business plan under which they no longer sold all the mortgages they originated but kept a portfolio of subprime loans and financed them by issuing mortgage-backed securities secured by the loans. They sold the first batch of securities for $488 million in October 2003. In a year, the company had sold more than $4 billion of the securities.

Sonnenfeld rang the opening bell at the Nasdaq stock market the month after the stock's debut. The digital sign overlooking New York's Times Square displayed the Fieldstone logo.

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