An opportunity for banks.

"Most subprime buyers have a positive experience with homeownership," asserts Eric Rosengren, president and chief executive officer of the Federal Reserve Bank of Boston. He told a regional Chamber of Commerce meeting in Portland, Maine, in October that Boston Fed researchers "looked

Rosengren notes that default rates on recently originated subprime mortgages are higher than on earlier loans. Yet he believes community banks can profitably step in now and refinance many existing subprime borrowers into home loans with lower rates. Analysis of publicly available information from registries of deeds in New England states was the basis of the Boston Fed's conclusions.

Subprime loans typically have short life spans, says Rosengren, and need to be refinanced. Two-thirds of subprime originations between 1999 and 2004 had prepaid within two years, he explains. Close to 90 percent prepaid within three years.

Rapid home-price growth helped keep subprime delinquencies low during that period, Rosengren believes. Real estate values went up more than 5 percent annually in Massachusetts from 1998 until late 2005.

Consequently, foreclosures were below 0.1 percent of homes from mid-2000 until mid-2005. Yet two years later, foreclosure rates had risen above 0.4 percent. "In a strong housing market with rising home prices," says Rosengren, "a borrower who faced the prospect of an increase in an adjustable-rate mortgage [ARM] could probably refinance the loan, frequently with a withdrawal of some of the appreciated equity."

Subprime loans no longer are available from the mortgage brokers who had been originating them. Recently "many mortgage lenders found themselves with sharply limited access to funds to finance new subprime loans or refinance existing ones," Rosengren explains. "The inability to refinance has been a key component of the recent rise in foreclosures."

High FICO[R] scores

Yet Rosengren says many subprime borrowers could qualify for a new loan now. Almost two out of three subprime borrowers in Middlesex County, Massachusetts, "had FICO scores greater than 620, and 18 percent had scores over 700," according to the Fed study. Rosengren adds, "Many subprime borrowers have held their house long enough for it to appreciate, so they may now have sufficient equity in their house to facilitate refinancing into a prime product."

Refinancing also would provide "a significant reduction in their interest rate," he says. Boston Fed's research pegs average two-year teaser rates at 8.35 percent in 2006 for subprime borrowers in Middlesex County.

Because refinancing would let many subprime borrowers stay in their homes, Rosengren champions "responsible subprime lending" now. He adds, "I believe there is an opportunity for commercial and savings banks to help provide liquidity in this market. Most commercial and savings banks were not involved in originating subprime mortgages and are well-capitalized, and may have profitable opportunities to explore in this market."

Yet, lending institutions and individual loan officers would need to focus on that business niche. That's not currently necessary for Bonnie Thompson, a mortgage loan officer with Banner Bank, Moses Lake, Washington. Banner Bank is a $4.3 billion commercial bank based in Walla Walla, Washington, with offices in three states.

Thompson says her local real estate market has slowed, but still is basically healthy. Sale homes representing four months of inventory are on the market, compared with a national average of 10.5 months, according to the National Association of Realtors[R] (NAR), Chicago. Although she's doing a few ARM refinancings, Thompson's originations remain mostly for purchase loans or home construction.

Not on the menu

"I've never done option ARMs," says Thompson. "They aren't on the rate sheet." Yet she notes that Federal Housing Administration (FHA) borrowers can have FICO scores below 600, and that some Fannie Mae programs require just 600 scores. All loans at Banner Bank go through automated underwriting and also are seen by human underwriters, Thompson notes.

She wasn't worried about competition when some local mortgage brokerages were moving into the subprime arena. Today a few of those high-flying brokerages are gone.

Thompson's business saw just a moderate increase during those boom years, but is continuing to be steady now. "I try to be responsible and do what's right," says Thompson. "I have to be able to sleep at night." She counsels borrowers who are considering hybrid ARMs to make sure they can handle higher loan payments in the future.

So far, large numbers of subprime borrowers aren't seeking out Banner Bank to refinance their loans. For that to change, it's important for regulators such as Rosengren to encourage lenders to pursue those homeowners. Even lower rates won't help borrowers if banks become too risk-averse to extend credit to a wide range of consumers.

Howard Schneider is a freelance writer based in Ojai. California. He can be reached at howard@mmnl.net.