Buffett’s sub-prime doin’ just fine

Berkshire Hathaway bought Clayton Homes[1], America’s largest provider and financier of “manufactured homes” (aka prefabs), in 2003. Based on reams of newsprint and political waffle this is probably the worst investment in the world. Except it isn’t, of course! Warren Buffett tells us why, from Berkshire Hathaway’s 2008 annual report[2]:

Clayton’s 198,888 borrowers…have continued to pay normally throughout the housing crash, handing us no unexpected losses… Their median FICO score is 644, compared to a national median of 723, and about 35% are below 620, the segment usually designated “sub-prime.”

Yet at year end, our delinquency rate on loans we have originated was 3.6%, up only modestly from 2.9% in 2006 and 2.9% in 2004… Clayton’s foreclosures during 2008 were 3.0% of originated loans compared to 3.8% in 2006 and 5.3% in 2004.

Why are our borrowers – characteristically people with modest incomes and far-from-great credit scores – performing so well? The answer is elementary, going right back to Lending 101. Our borrowers simply looked at how full-bore mortgage payments would compare with their actual – not hoped-for – income and then decided whether they could live with that commitment. Simply put, they took out a mortgage with the intention of paying it off, whatever the course of home prices.

Just as important is what our borrowers did not do. They did not count on making their loan payments by means of refinancing. They did not sign up for “teaser” rates that upon reset were outsized relative to their income. And they did not assume that they could always sell their home at a profit if their mortgage payments became onerous. Jimmy Stewart would have loved these folks.

[1] For anyone with an interest in Buffett the purchase is a fascinating tale:
http://www.fastcompany.com/magazine/78/claytonhomes.html?page=0%2C0

[2] T’is brilliant as usual:
http://www.berkshirehathaway.com/2008ar/2008ar.pdf
Pages 10-12 for the Clayton Homes info and more mortgage insight.

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