Remember IndyMac? Before Lehman Brothers declared bankruptcy, before Washington Mutual folded, before CitiBank and Wells Fargo fought a legal duel for hobbled Wachovia, IndyMac's failure on July 11 of this year was considered catastrophic and, by a few stray prophets at least, a harbinger of things to come. Yvonne Taylor, finance manager for Penguin Windows, in Mukilteo, Wash., remembers it particularly well because she had two deals waiting for approval at IndyMac when the closure was announced. That forced her to scramble to find financing from other sources.
The financing situation in July seems comparatively peaceful when measured against the events of September when, one after another, banks and investment houses wobbled and went down. But, for home improvement companies, of greater concern even than the loss of these lending institutions has been the larger issue of home equity erosion.
In June, the Federal Reserve reported that Americans' home equity had dropped to its lowest level since 1945. In the last quarter of 2007, equity levels fell to 47.9%, compared with 50.5% a year earlier. Secured lending usually relies on real estate as loan collateral, and secured loans are the only viable method of granting financing on a large scale. For the home improvement company, secured financing offers multiple advantages, including larger loans, tax deductions on interest, and the possibility of arranging smaller loan payments spread over a greater time frame.
As house values began to fall, equity fell too, far faster in some places than in others. That's made secured lending in all forms - home equity loans, second or third mortgages, home equity lines of credit, mortgage refinancing - more difficult to arrange.
At the beginning of this year, Key Bank announced that it was ending its secured lending program for home improvement. Six weeks later, G.E. Money began phasing out its secured lending program. (G.E. Money continues to be a supplier of unsecured lending to home improvement companies.) Their withdrawal left many companies straining to find financing for customers. Larry Judson, founder and president of K-Designers, the country's largest siding contractor, headquartered in Gold River, Calif., estimates that it took his company three months to line up creditors sufficient to replace Key Bank.
As it turned out, Key Bank's exit was just the beginning of what would become a year like no other. In the spring, home equity lines of credit - the credit that banks extend to homeowners based on the equity value of their homes - began to freeze, or to be curtailed, in certain markets. Charles Gindele, owner of Dial One Window Replacement Specialists, in Irvine, Calif., remembers when vice president Jackie Poehlman came into his office to tell him that she'd received a letter from her bank informing her that her own equity line of credit had been frozen. "She was a little spooked," he recalls.
Not too long after that, production manager Lauren Gindele called to tell the company owner that on that one day six different customers had contacted her to postpone window or door installations because their equity credit lines had been frozen.
There had been prior rumblings. And 2006, Gindele says, is "when it began to hit. [The onset wasn't] dramatic, like a stock market crash or oil up by $50 a barrel." Rather, articles in the media about the housing bubble began to appear; articles that inevitably concluded asking the question: When will the bubble burst?
Then it did. From August of 2007 to August of 2008, the median home value in Orange County, Calif., dropped $555 per day, falling from $642,500 to $440,000. Foreclosures multiplied. Area retailers began to go out of business. And companies like Dial One Window Replacement Specialists - where 40% to 50% of business was paid for by home equity lines of credit - had to fast reduce overhead and find new ways to help customers buy windows.
In Orange County, as it has elsewhere, that has meant a move from secured to unsecured lending, with its stricter loan criteria, smaller loan amounts, and higher interest rates.
The change, Gindele says, "doesn't make it more difficult to sell windows, it reduces the universe of interested people. If ours is a $9,500 job and [the homeowner] has $7,000 to spend, we don't have to sell them on the $9,500 but on the $2,500 gap." Finding ways to bridge that gap - or finding customers who don't want or need financing - is the challenge that many home improvement companies now face.
Juggling Credit Apps
Home equity fell hardest and fastest in states like California and Florida where home prices in the early years of the decade exploded upward. In Texas, Rob Levin, president of Statewide Remodeling, a sunroom and window company, says that the loss of Key Bank and G.E. Money's secured lending program and the fact that the state has among the lowest FICA (Federal Insurance Contributions Act) scores in the U.S. hasn't actually hurt his business. "We were fortunate," he says. "Down here, we didn't do much with Key Bank."
What kept things on an even level, Levin says, is that home appreciation in Texas accelerated at a rate only slightly in excess of the rate of inflation, i.e., 2% or 3% a year. As national lenders walked away, Statewide Remodeling turned to local banks and to unsecured financing.
But for this company, and many others like it that were used to selling higher-ticket items - sunrooms at $25,000 to $35,000 - the problem with unsecured lending is that loan amounts rarely cover the total cost of the purchase. And with more demand for unsecured credit, lending standards, as determined by the applicant's debt-to-income ratio and FICA scores, have tightened. "Today, 720 is the new 620," notes Levin, referring to FICA.
He began to see tighter standards for determining creditworthiness as early as last May. "The banks were turning down a lot more," he says. In the days of secured lending and solid or rising home equity, Levin says, people "bought home improvement jobs to consolidate their debt. But you can't do that anymore."
The reason you can't is that mortgages were typically repackaged and sold as securities, replenishing the capital for further lending. And right now, says Bruce Christensen, vice president and general manager, Home ImprovementIndustry, GE Money, "no one wants to buy them."
Mortgage refinancing - debt consolidation - was one means of selling sunrooms, often using add-back programs that added the value of the improvement to the total equity of the home that could be borrowed against.
Second mortgages were another. In 2007, about three quarters of the loans arranged by Solarshield, a sunroom and window company in Altoona, Pa., were second mortgages, supplied by a combination of local and national banks. This year, says sales and finance manager Matt Taylor, the banks started taking a harder look at equity and the company turned to unsecured lending.
The problem? "You're really limited with what you do with a sunroom at $15,000 or $20,000," Taylor says. Credit turndowns, which were typically around 15% at the company, jumped to about 25% as lending got tighter, leaving Taylor to juggle credit applications. Still, "you have to find a way to make the project affordable to each customer, no matter what the situation is," he says.