What can happen when mortgage lenders become VCs

Buying a home in Silicon Valley is no joke.

It’s difficult for tech workers and it’s even more difficult for those not touched by the modern gold rush. One mortgage originator, Opes Advisors, is incorporating restricted stock units (RSU) and private shares to make it easier for techies to move from incubator to nest egg. But what appears helpful to a population that sees housing prices moving out of reach could actually end up damaging the Bay Area economy if startup valuations take a turn south. 

Opes has developed an automated system for incorporating a number of data points, including RSUs and private shares, into determining key mortgage metrics like interest rates and down payments. A reasonable reaction to this might be to wonder how a mortgage lender values a mostly illiquid asset like a restricted stock unit, and ultimately forms a judgement of the borrower’s ability to repay.

How does this work?

Opes is counting RSUs as income, which in simple terms is a metric for earnings. The key lies in debt to income ratios of prospective borrowers. Because Opes can visualize RSUs as income or stock, it can effectively make a statement about how close a borrower is to being overwhelmed by debt.

“We have investors that allow Opes Advisors to look at RSU’s as both income and / or stock,” said Edgar Urrutia, Marketing Communications Manager for Opes Advisors. “Because of this we can help clients come up with mortgage solutions that are ideally suited to their individual needs.”

Commonly used back-end ratios calculate the portion of income required to pay monthly bills and would be pushed downward if stock was incorporated as income. Notably, restricted stock units are a key component of many startup compensation packages.

“The key metrics for underwriting have always been collateral, credit, and income,” said Robert Box, board member of the California Mortgage Association.

While Opes stresses the complexity and case-by-case nature of mortgage originations, any connection between illiquid private shares/RSUs and mortgage terms deepens the relationship between the historically volatile valuations of private startups and the recovering housing market.

Financial creativity addresses a growing market

By increasing the interdependence of two relatively disparate markets, the Bay Area is making itself more dependent on continued tech prosperity. In the post-2008 housing apocalypse, mortgage lenders are flexing their minds and their checkbooks in an effort to follow the money. In Silicon Valley, that translates to putting more young techies in houses.

Last month, Bloomberg reported that so-called “100 percent mortgages” were trending in California. These mortgages, which require little to no down payment, are being specially built for tech workers who have a substantial portion of their assets tied up in RSUs and don’t have the liquidity for a large down payment.

Indeed, 100 percent mortgages are not a new invention. Before the great recession, such generous terms were quite common. Many traditional mortgage lenders offered them without many drawbacks. Even before that, 100 percent mortgages have been used to put veterans in homes since the G.I. Bill, initiated in 1944. These mortgages are underwritten to different standards and don’t require a down payment. Credit Unions, USDA loans and other government agencies also offer various interpretations of the zero-down concept.

Today, while most government programs still exist, few traditional lenders still offer zero-down mortgages. Those that do have attached stipulations that de-risk the mortgages. For example, Barclays requires that borrowers involve family members in the process, and many banks require home buyers to hold a deposit in a separate account for a few years.

Tech companies have been jumping on the 100 percent mortgage bandwagon, helping banks market directly to tech workers who otherwise might abandon their current jobs for greener pastures and more affordable housing elsewhere.

“Banks are looking to create innovative products for employers to attract and retain key employees,” said Tom Colen, Executive Director of the San Francisco Housing Action Coalition.

A growing number of tech workers incentivized to buy homes can only continue to draw attention to innovative services that support new markets. Box noted that some banks have programs for home buyers that have a significant portion of their assets tied up in public stock, but public shares offer critical liquidity that private shares and RSUs often do not.

Why mortgage lenders need to be cautious

Helping tech companies attract and retain employees is one thing, but by incorporating RSUs into mortgage origination, lenders are effectively playing the part of VCs. It’s incredibly difficult to value private companies, and shareholders are really only worth what they can sell their shares for. Ask Elizabeth Holmes, CEO and founder of Theranos, who saw her net worth plunge from $4.5 billion to almost nothing overnight. It’s one thing for someone like Holmes to lose money, it’s another for tech workers to be granted mortgages that they have no chance of paying back because their equity was overvalued.

We have investors that allow Opes Advisors to look at RSU’s as both income and / or stock. Edgar Urrutia

Opes doesn’t yet have default data on borrowers who used RSUs in the underwriting process, and even if they did the private market isn’t turbulent enough yet to have across the board consequences. The firm may have “deep experience in RSU’s,” particularly in “San Mateo, San Francisco, Palo Alto and other Bay Area locations,” but evaluating private companies is difficult even for venture capitalists who make the task their life goal — shout-out dot-com bubble. 

Markets for trading secondary shares have helped some entrepreneurs convert nebulous equity into income, but it’s always the participating market determining the value of shares. There are enough problems with information disclosure and cognitive bias in this process alone without letting mortgage lenders take a stab at it.

In the simplest terms, the 2008 housing crisis was born partially out of the link between the public stock market and the housing market and partially out of loans being originated to folks who couldn’t pay them back. When banks bet on future income that could disappear in the blink of an eye, they create unnecessary risk in the system that can have major consequences.