Madam Chairwoman and members of the Committee, I appreciate the opportunity to appear before you today to discuss the subprime mortgage crisis and America’s veterans.

The Subprime Crisis

“Subprime” is a generic term used to describe mortgage loans with interest rates higher than prime rates. The subprime loans that are causing the current crisis usually have several layers of risk associated with them. These layers of risk are generated by a combination of one or more factors, such as lack of income verification, lack of asset verification, lack of underwriting at a fully indexed rate, low borrower credit scores, large margins, low teaser rates, interest only payments, borrower option payments, and secondary liens. (Note: Industry often labels loans with some of these characteristics as Alt-A rather than subprime if borrowers have high credit scores.) VA guaranteed loans, on the other hand, have none of these characteristics and have carried an average borrower FICO credit rating of around 680, as compared to the subprime average of below 620.

In 2000, loans characterized as subprime represented a low percentage of all mortgage originations, and were made mostly to borrowers with low credit scores and small loan balances. By comparison, in 2006, subprime originations represented more than 20 percent of all mortgage originations, and borrowers, despite having slightly higher credit scores, carried much higher loan balances and much higher loan-to-value ratios.

Credit losses mounted from the record-setting losses of the subprime loans made in 2000. Secondary market investors recognized this risk and priced the potential of losing money on future investments to the point where originators of subprime mortgage loans could no longer afford to sell them. This lack of liquidity in the secondary market has had a tremendous impact on the ability and desire of lenders to originate subprime loans. It is the primary reason few institutions are willing to make them.

The VA Guaranteed Home Loan Program

It is important to understand that the VA-guaranteed home loan program is not a part of the subprime mortgage market. VA-guaranteed home loans are not subprime products. Additionally, the average borrower using the VA-guaranteed home loan program does not have what would be considered a subprime credit score. To date, VA has not been affected by the current subprime turmoil as dramatically as lenders that have all or even some percentage of their portfolios concentrated in subprime loans.

The laws governing our program provide that VA-guaranteed home loans must be made in accordance with VA’s credit underwriting standards, which are promulgated in VA regulations. Lenders underwriting VA loans must ensure that the contemplated terms of repayment bear a proper relation to the veteran’s present and anticipated income and expenses, and that the veteran is a satisfactory credit risk. VA’s credit standards employ the use of debt-to-income ratios and residual income guidelines in determining the adequacy of the veteran’s income. When evaluating borrower creditworthiness, however, VA’s standards require lenders to evaluate all of the borrower’s available credit data. In marginal cases, VA seeks to give veterans the benefit of the doubt with regard to credit and instructs lenders to examine compensating factors like the veteran’s cash reserves, level of consumer debt, etc., when making an underwriting decision.

The VA program has fared well in recent years with regard to foreclosure rates. According to data from the Mortgage Bankers Association, between the third quarter of 2005 and the third quarter of 2007, VA’s serious default rate declined, while all other mortgage types, including prime loans, rose.

That said, VA does operate in the broader mortgage marketplace and will be collaterally affected by the subprime turmoil currently affecting that market. This collateral effect will generally be the result of declining house prices.

Impact of Subprime Turmoil on VA Home Loan Borrowers

With additional foreclosed homes on the market and a glut of new construction available and weak demand, the inventory of unsold homes has risen. Concurrently, credit has tightened as investors, fearing the quality of subprime loans, withdraw funds from the mortgage market, causing even some well qualified buyers to experience difficulties in obtaining new mortgages. With supply now exceeding demand, prices have naturally declined.

In the current marketplace, there are fewer borrowers able or choosing to purchase homes and, therefore, fewer opportunities to sell homes. VA expects that its robust supplemental servicing program, which offers hope to many veterans with delinquent VA-guaranteed home loans, will be hampered by this situation. Most notably, the deflation in house prices eliminates certain foreclosure-avoidance tools that were previously available to us. The net result will be more foreclosures.

VA-Guaranteed Home Loan Protections

For veterans who obtained a VA-guaranteed home loan, VA can offer supplemental servicing assistance during times of financial hardship and default.

VA-guaranteed home loans are subject to certain regulatory requirements that allow us to help veterans retain ownership of their homes. The following briefly describes VA’s supplemental servicing assistance to veterans in default on their VA-guaranteed home loans and the impact thereof.

VA Supplemental Servicing and Loss Mitigation

When VA receives notice that a veteran borrower has become seriously delinquent on his/her home loan, we take an active role in working to avoid foreclosure. VA’s efforts include pursuing various options to cure the default, thereby allowing the veteran to retain ownership of his/her home. VA can intercede with the loan holder on the veteran’s behalf. In the event the borrower can no longer maintain mortgage payments, VA encourages other alternatives to foreclosure to help mitigate the negative impact on the borrower.

In FY 2007, due in part to VA’s loan servicing intervention efforts, foreclosure was avoided for more than 57 percent of the VA loans in serious default. Additionally, VA was able to intervene in 8,453 instances that resulted in successful loan reinstatement. As a result, VA avoided claim payments estimated at more than $181 million.

However, VA’s supplemental servicing efforts will be significantly hampered by the effects of the depressed state of the subprime market and tight credit.

Specifically, house price deflation in certain areas will limit the options available to veterans hoping to avoid foreclosure.

During the most recent housing boom, house prices were such that a sale often netted the borrower an amount which would satisfy any outstanding mortgage debt. But in the current environment, house prices are deflated and many borrowers find themselves unable to sell at a price which would net an amount to satisfy the outstanding mortgage debt in time to avoid foreclosure. Secondly, as house prices and values decrease, so does a borrower’s home equity. In many areas, borrowers now have less equity or no equity against which to borrow. In many areas home equity values have declined so substantially that this option is altogether eliminated.

VA Assistance for Veterans with Subprime Loans

For a veteran (or servicemember) who may have obtained a subprime loan, VA can offer general advice and guidance through our nine Regional Loan Centers. However, unlike the case of a veteran with a VA-guaranteed home loan, VA has no legal authority or standing to intervene on the subprime borrower’s behalf.

Because VA only maintains home loan data on veterans who have taken advantage of the VA loan benefit, we are not aware of how many veterans may have mortgages that would be categorized as subprime. The Home Mortgage Disclosure Act does not require ‘veteran status’ to be collected as part of the loan applicant’s data.

Regrettably, there are veterans who have subprime mortgages and who will be adversely affected by the subprime crisis. VA is prepared to offer as much assistance as possible to help veterans in this situation. Our VA Regional Loan Centers have Loan Service Representatives who can offer advice to all veterans who are experiencing home loan repayment difficulties, not just those veterans with VA-guaranteed loans.

VA is authorized to guarantee refinancing loans to veterans. However, if a veteran wishes to use his/her home loan benefit to refinance a subprime loan, the resulting loan-to-value ratio could not exceed 90 percent and the total dollar guaranty is limited to $36,000. This means that a veteran with no equity would be able to obtain a refinance loan for only 90 percent of the home’s appraised value, and the maximum loan he/she could effectively obtain is $144,000.

VA Program Revisions with Safeguards

We are proud of the success of the VA home loan guaranty program in helping veterans obtain and retain homes. While the program has been expanded and modified over the years, it retains sound underwriting criteria.

Conclusion

VA expects that our program loan volume will increase. The lack of availability of mortgage credit, especially subprime products, in the conventional market will encourage veterans to obtain VA guaranteed loans. However, VA also expects that the supply glut in the marketplace and the resultant house price decreases will have a collateral effect on VA borrowers in default and that the number of foreclosures in our program will increase. VA stands ready to aid veterans in any way possible.

Madam Chairwoman, this concludes my testimony. I look forward to answering any questions you or the Committee members may have.