“The Best defense is a good offense,” is the old saying, that is exactly the approach Warren Buffett continues to take in defending Berkshire Hathaway’s mobile-home manufacturer Clayton Homes from those who say it preys on low-income home buyers.
It was less than a year ago that the company first came under attack, when with the force of a volcano, a Seattle Times and the Center for Public Integrity investigative report titled “The Mobile Home Trap” accused Clayton Homes of relying on “predatory sales practices, exorbitant fees, and interest rates…trapping many buyers in loans they can’t afford and in homes that are almost impossible to sell or refinance…”
Buffett’s immediately addressed the accusations head on at the 2015 Berkshire Hathaway annual meeting, when he said, “I make no apologies whatsoever about Clayton’s lending terms.”
Now, in his 2015 annual letter to shareholders, Buffett has a devoted one and a half pages to defending Clayton Homes from its detractors.
In a vigorous defense, Buffett wrote:
“Our retail outlets, employing simple language and large type, consistently inform home buyers of alternative sources for financing – most of it coming from local banks – and always secure acknowledgments from customers that this information has been received and read.”
In an unusual move, Buffett went so far as to include the actual form on page 119 of the 2015 annual report.
In the Same Boat as the Home Buyer
In defending Berkshire’s practices as a home seller and mortgage lender, Buffett points to Berkshire’s holding on to the mortgages it originates rather than selling them off in the broader market. Buffett notes that this adds risk to Berkshire, and that by holding on to the mortgages it is in the same boat as the home buyer. If a home buyer defaults on their mortgage it leaves Berkshire not only with a bad loan, but it also has to eat the costs associated with repossessing a used mobile home.
“At Clayton, our risk retention was, and is, 100%. When we originate a mortgage we keep it (leaving aside the few that qualify for a government guarantee). When we make mistakes in granting credit, we therefore pay a price – a hefty price that dwarfs any profit we realized upon the original sale of the home. Last year we had to foreclose on 8,444 manufactured-housing mortgages at a cost to us of $157 million. The average loan we made in 2015 was only $59,942, small potatoes for traditional mortgage lenders, but a daunting commitment for our many lower-income borrowers. Our buyer acquires a decent home – take a look at the home we will have on display at our annual meeting – requiring monthly principal-and-interest payments that average $522.
Some borrowers, of course, will lose their jobs, and there will be divorces and deaths. Others will get overextended on credit cards and mishandle their finances. We will lose money then, and our borrower will lose his down payment (though his mortgage payments during his time of occupancy may have been well under rental rates for comparable quarters). Nevertheless, despite the low FICO scores and income of our borrowers, their payment behavior during the Great Recession was far better than that prevailing in many mortgage pools populated by people earning multiples of our typical borrower’s income.”
Congress Weighs In
The Seattle Times report did not fall on deaf ears in the halls of Congress. In January, Representatives Maxine Waters, Michael Capuano, Emanuel Cleaver and Keith Ellison wrote a letter to the Justice Department and the Consumer Financial Protection Bureau calling for a probe of the company’s lending practices.
So far, there has been no action by the Justice Department or the Consumer Financial Protection Bureau, and in his annual letter Buffett forcefully touts what he feels is Berkshire’s outstanding record in regards to adhering to the regulations that govern mortgage lending.
“Let me talk about one subject of which I am particularly proud, that having to do with regulation. The Great Recession caused mortgage originators, servicers and packagers to come under intense scrutiny and to be assessed many billions of dollars in fines and penalties.
The scrutiny has certainly extended to Clayton, whose mortgage practices have been continuously reviewed and examined in respect to such items as originations, servicing, collections, advertising, compliance, and internal controls. At the federal level, we answer to the Federal Trade Commission, the Department of Housing and Urban Development and the Consumer Financial Protection Bureau. Dozens of states regulate us as well. During the past two years, indeed, various federal and state authorities (from 25 states) examined and reviewed Clayton and its mortgages on 65 occasions. The result? Our total fines during this period were $38,200 and our refunds to customers $704,678. Furthermore, though we had to foreclose on 2.64% of our manufactured-home mortgages last year, 95.4% of our borrowers were current on their payments at yearend, as they moved toward owning a debt-free home.”
While all has been quiet recently in regards to Clayton Homes, the fact that Buffett has devoted so much space in his annual letter to defending the company may mean that more tremors are coming, and issues related to Clayton Homes could erupt again in the future.
© 2016 David Mazor
Disclosure: David Mazor is a freelance writer focusing on Berkshire Hathaway. The author is long in Berkshire Hathaway, and this article is not a recommendation on whether to buy or sell the stock. The information contained in this article should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results.