Empty Nests

With a third child on the way, Gary and Tracey Butcher decided that they needed a new house for their growing family.

So in 2003, the couple sold their three-bedroom in Roeland Park and took out a ticking time bomb: an adjustable-rate mortgage.

The Butchers borrowed $158,400 from NovaStar, a Kansas City company that specializes in making home loans to people with shaky credit. At the time, companies like NovaStar were making a killing selling those kinds of loans — so-called affordability loans that allowed people with little savings, spotty work histories and low credit scores to borrow money. Subprime loans were a $600 billion industry in 2006, up from $120 billion in 2001.

Kansas City had emerged as a nerve center of this industry.

In 2002, nearly half of H&R Block’s income came from its subprime mortgage business, Option One. NovaStar traded for $70 a share in March 2004. Now, as foreclosures empty homes across the country, these two Kansas City companies, which once were among the top 20 subprime lenders in the United States, face the consequences of their promiscuous lending.

Simply put, companies such as NovaStar and Option One gave too much money to too many borrowers who lacked the means or sophistication to meet their obligations. Rising home prices kept the charade going for a while — borrowers could refinance their sucker loans before the higher interest rates kicked in. Then the market cooled, and homeowners began to default. The United States recorded 320,000 home foreclosures in the last three months of 2006.

As defaults and delinquencies mounted, Wall Street ran for the hills. One subprime high-flier, the Irvine, California-based New Century, went into bankruptcy after its stock price fell by 90 percent. H&R Block put a for-sale sign on Option One last November and sold the subsidiary at a discount in April.

NovaStar lost $1 billion in market value in the downturn, which NovaStar CEO Scott Hartman delicately termed “a difficult phase.”

A tumbling stock price isn’t the company’s only concern, however. Last month, NovaStar paid millions to resolve the claims of borrowers in Washington state; the month before, a nonprofit in Washington, D.C., filed a federal lawsuit accusing the company of discriminating against minorities and disabled people.

NovaStar has managed to remain solvent in the face of adversity. Some subprime borrowers haven’t been so lucky.

Walter Cook mounts a video camera on a miniature tripod and waits for 3 p.m. so he can start the auction.

The afternoon sun bakes the north steps of the Jackson County Courthouse in downtown Kansas City. Cook leans against the building’s limestone façade, paperwork under his arm. He is wearing a striped Oxford shirt and black slacks. He is alone except for the handful of county employees taking smoke breaks.

Cook works for Millsap & Singer, a St. Louis law firm that represents banks and mortgage lenders. The Sony Handycam at his feet is poised to document the sale of about a dozen houses whose owners defaulted on their home loans.

Cook auctions a lot of property. On this afternoon, he has already visited the courthouses in Independence and in Cass, Platte and Clay counties. “I just drive all day long,” he says.

The first house for sale is located at 75th Street and Main. Cook gives the legal description of the property in a patter more city clerk than barnyard auctioneer.

“Opening bid is $120,069.46. Do I hear any other bids?”

Pause.

“No other bids. Property’s going once, twice, three times. Property is sold.”

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A bank submitted the winning bid in advance. Sometimes live buyers show up. But what Cook does is mostly a formality. It takes him about a minute to sell each piece of property.

The house at 75th and Main had been owned by Adrian and Venetia Delgado. County records indicate that the couple refinanced the house in 2005 with Ameriquest, a subprime lender based in Southern California.

The Delgados borrowed $105,000 on an adjustable-rate mortgage. The interest rate on the Delgados’ loan was scheduled to increase in January. The deed on file with the county indicates that the Delgados were looking at a rate hike from 9.65 percent to as much as 11.65 percent, depending on market fluctuations. (The Delgados, who still reside in the house on Main, declined to comment.)

Home loans didn’t used to be so exotic. In the not-so-old days, people who wanted to buy houses went to their local banks with a 20 percent down payment in hand.

But over the past decade, as investors searched for new ways to make money, mortgages became available in new flavors. Borrowers could get loans with 40- or 50-year terms and no down payments. Sometimes, they didn’t even have to prove how much money they made.

Wall Street loved these newfangled loans. Big firms such as Lehman Brothers and Bear Stearns began buying the mortgages and bundling them into bonds. Investors bought the securities because they paid a nice coupon, supported by the higher interest rates that subprime borrowers had to pay for credit.

To satisfy the demand, the industry loosened its standards. Lending became a high-volume game. In a recent Washington Post story about how the industry got so out of control, one appraiser who worked for New Century recounted how salesmen would bang her desk with baseball bats when she rejected a loan application.

“Bottom line is, these mortgage companies and banks have been much more willing to give mortgages to just about anybody, and that’s where the problems start,” says George Thomas, a Prairie Village lawyer who specializes in bankruptcy work.

When a mortgage goes bad, it’s not just the borrower who suffers. Foreclosures drag down the property values of surrounding homes. Nearby schools suffer collateral damage, too. “Anytime there’s a home foreclosure, that means there’s no tax money coming in. And anytime there’s no tax money coming, the district in essence loses money,” says John Baccala, a spokesman for the Hickman Mills School District.

Cities and school districts in Kansas and Missouri are feeling the pain. In both states, subprime adjustable-rate mortgages are being foreclosed at a higher rate than the national average, according to a report by NeighborWorks America, a community-development nonprofit.

Of course, brutal lending agreements alone did not send thousands of Kansas and Missouri homes into foreclosure. Scheming borrowers have a played a part, too. Instances of mortgage fraud, when borrowers and brokers lie on lending applications, have exploded in recent years. Earlier this year, sitting Kansas City, Missouri, Councilwoman Saundra McFadden-Weaver was indicted after borrowing $400,000 for a house that she never intended to occupy. When the bank foreclosed, the house sold for only $255,000. Former Jackson County Executive Katheryn Shields and her husband also face federal mortgage-fraud charges.

But the bulk of foreclosures are owed to ignorance or naiveté. Kevin Glendening, a deputy state banking commissioner in Kansas, says many borrowers fail to comprehend what they’re doing on the way to fulfilling the American dream. “People, I think, sometimes get caught up in the moment in getting the transaction,” he says.

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The consequences can be devastating.

Gary Butcher is sitting at a table in his narrow kitchen. He’s sifting through old papers, an activity that prompts two of his four children to begin doodling. Crayon marks on the wall tell of past occasions when the budding artists didn’t wait for scratch paper.

Butcher is watching the kids, who range in age from 2 to 8, while his wife is sleeping. She’s a respiratory therapist at Overland Park Regional Medical Center. Gary Dee, the oldest of the four children, explains his mother’s job like this: “She works with babies that can sit in the palm of your hand.”

Gary Dee settles in for a late-afternoon viewing of The Prince of Egypt on DVD. The living room is a riot of newspapers, plastic cups, dolls and pieces of train set. The untidy house reflects the challenge two parents face in working two jobs (Gary delivers newspapers) and raising four children. The two boys are old enough to attend elementary school, but Robert, age 7, is autistic. Today, he is refusing to wear anything more than his eyeglasses and a pair of white briefs.

Robert hadn’t been diagnosed at the time the Butchers sold their home in Roeland Park and bought a four-bedroom house in western Shawnee. Tracey was pregnant with Elizabeth, now 4. The couple thought that it be nice to have something bigger.

Gary, who says he wasn’t even that crazy about the new place, wishes they had stayed in Roeland Park. “We were so stupid,” he says. “We had three bedrooms. That would have been fine. Even with four kids, we would have been fine.”

A mortgage broker found them the loan with NovaStar. The note quoted an interest rate for the first two years of 7.99 percent and monthly payments of $1,161.

The numbers looked manageable. But when they signed an adjustable-rate mortgage, the Butchers put themselves at the mercy of an interest rate that could nearly double over the life of the loan.

Gary says he felt pressure from the broker and NovaStar to sign the papers and finish the deal. He says they reassured him that they could refinance the loan before the interest rate changed.

“We never should have gotten the loan,” he says. “But everyone was pushing us.”

Their move to Shawnee didn’t go smoothly. The Butchers ran up charges on their credit cards to replace a $200 high chair and other items the movers broke. Crunched for money, they took out a second mortgage, borrowing $18,000 from another lender.

The interest rate on the original mortgage wasn’t supposed to increase until April 2005. But Gary says the monthly payments to NovaStar began increasing almost immediately. “It was, like, every six months, it went up,” he says. Tracey says she remembers making mortgage payments of around $1,400 at the end of their stay in the Shawnee house.

It’s not clear why the Butchers’ payments went up — a lot of their paperwork went into the trash. However, their bankruptcy petition supports Tracey’s memory of events. One of the documents indicates that the Butchers were paying NovaStar an average of $1,466 a month by early 2005.

Gary says he tried to work with NovaStar when the couple started having trouble paying the mortgage, their doctor bills and their credit cards. First, he says, NovaStar suggested that they sell. But the house had wood rot that needed to be repaired before it could go on the market.

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Eventually, Gary says, a man who worked at NovaStar told him that it would be better for the company if the house went into foreclosure. He remembers the man from NovaStar saying, “We’d make more money.”

In the end, the Butchers couldn’t climb out of their hole. They filed for bankruptcy on April 26, 2005 — the same month the interest rate on the NovaStar loan was going to reset.

The Shawnee house was sold at auction.

NovaStar is more consumer-friendly than some other lenders, says Jana Castanon, a community outreach director at Consumer Credit Counseling Services in Kansas City, a nonprofit that NovaStar and other lenders pay to advise borrowers. NovaStar started a program to prepare people with adjustable-rate mortgages for the rate resets. The company also employs career coaches to help borrowers find jobs and stay on track with their loans. “They are very proactive in trying to get their customers aware of what’s going on,” Castanon says.

Gary Butcher describes a different experience.

“What kills me is, we tried to save the house, but they wouldn’t help us,” he says.

Citing privacy concerns, NovaStar officials would not comment on the Butchers’ situation and declined the Pitch‘s request for an interview with company executives. In a written statement to the paper, a NovaStar spokesman said that the company strives to make good loans its customers can repay. Only a small percentage of its borrowers encounter difficulty making payments, the spokesman wrote. He added: “The last thing the company wants is to foreclose — everyone including the lender loses money when that happens.”

Now the Butchers rent a duplex off Woodland Drive. Gary says he laughs when he sees ads for subdivisions in Shawnee where the homes begin at $290,000. He says the family might be able to afford something in Olathe, but they don’t want to pull Robert out of his elementary school, where he’s making progress. Robert spent most of last summer in hospitals. He was having seizures, and his behavior was out of control. His condition improved with a change in his medication. This spring, Johnson County began paying for counselors who come to the house and give Robert the one-on-one time his parents can’t always supply.

“We weathered it all,” Gary says. “I guess we can weather anything.”

NovaStar Financial was built on the ambitions of two guys in their mid-30s.

Founders Scott Hartman and Lance Anderson met while they were working for Dynex, a real-estate investment trust in Richmond, Virginia. Anderson was president of a mortgage operation that Dynex sold in 1996, prompting the pair to strike out on their own.

Hartman and Anderson set up their company in Westwood. According to The Kansas City Star, they chose metropolitan Kansas City because of its central location and Hartman’s ties to the University of Kansas. (An Iowa native, Hartman earned his MBA in Lawrence.) In press accounts, Hartman has been described as the numbers man, with Anderson, a former military brat, taking a more sales-oriented role.

Making and investing in subprime loans, NovaStar went public in 1997; within five years, the company employed 1,500 people in several states. Eager to be part of the expansion, Missouri officials put together an incentive package to lure NovaStar across the state line. NovaStar accepted the offer and now makes its headquarters in a curving office building on Ward Parkway.

In 2001, NovaStar’s stock took off. The company’s dividend payments appealed to investors. Until recently, NovaStar was organized in a way that made it exempt from corporate income taxes. In exchange for this status, NovaStar was forced to pay at least 95 percent of its taxable income to shareholders. Owning the stock was like having a cash machine.

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Not everyone was sold on NovaStar, however.

On the Friday before Christmas 2002, a story about NovaStar appeared on the stock market Web site TheStreet.com. Senior columnist Herb Greenberg had been talking to short sellers — investors who place bets on stocks to decrease in value. The short sellers were telling Greenberg that NovaStar’s rising stock was inflated.

Greenberg came to a similar conclusion. He looked at NovaStar’s earnings and determined that they were driven in large part by an accounting method. Greenberg concluded that NovaStar was “walking a perilously thin line.”

Greenberg’s skepticism persisted into 2003. In February, he wrote a piece for Real Money describing how NovaStar would have a hard time getting insurance to back its loans. Greenberg also criticized NovaStar because it didn’t appear to have a chief financial officer and for its continued “aggressive accounting.”

Over time, Greenberg tells the Pitch in an e-mail, “skeptics questioned whether the company really earned its dividend — or whether it needed to go to Wall Street to raise cash to pay it.”

The stock went up more than 200 percent in 2003. Greenberg continued to doubt the quality of the company’s earnings. In January 2004, he wrote that NovaStar appeared to lower its standards as the credit scores of its borrowers dropped.

Greenberg’s columns didn’t put much of a damper on investors’ enthusiasm for NovaStar. But a critical Wall Street Journal article, published on April 12, 2004, sent the share price into a tailspin.

The Journal found that NovaStar had paid fines for operating without licenses in two states. A regulator in one of the states, Nevada, said he found that most of the branches listed on NovaStar’s Web site didn’t exist.

The stock went down 30 percent on the day of the report.

Class-action lawyers raced to file complaints against the company on behalf of shareholders who had seen their portfolios suffer. One Connecticut team of lawyers accused NovaStar of creating an “illusion.”

NovaStar hired Lanny Davis, Bill Clinton’s former lawyer, to manage the crisis. In an interview with The Kansas City Star, Davis dismissed the shareholder suits as “boilerplate complaints.” NovaStar officials blamed the problems described in the Journal article on a faulty Web site and a rogue branch manager.

Lawyered-up investors weren’t the company’s only problem, though.

In 2002, the PMI Group, an insurance company, stopped insuring NovaStar mortgages. A year later, NovaStar sued PMI for payment on loans that had defaulted. In a counterclaim, PMI said NovaStar “misrepresented … material facts” about their borrowers — such as income levels.

Regulators were also watching NovaStar closely. In September 2004, the inspector general for Housing and Urban Development found that NovaStar’s branch system didn’t comply with HUD rules. (NovaStar rejected the audit’s conclusions. The branch system shut down last year.)

Finally, NovaStar came under attack by borrowers.

In 2005, a group of homeowners in Washington state accused NovaStar of violating truth-in-lending laws. The suit alleged that NovaStar had charged what amounted to a hidden fee by paying brokers who persuaded borrowers to take out loans with higher interest rates. A judge allowed the case to proceed as a class action.

But as it celebrated its 10th anniversary, NovaStar projected an image of success. In February 2006, the company predicted that its shares would continue to produce a $5.60 dividend.

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The good times wouldn’t last.

The Easter Bunny’s message began: “Folks, like you, I have been body-slammed by this.”

The message appeared on a Web site called Investor Village on February 27, 2007. A few days earlier, shares of NovaStar had fallen almost 43 percent. The company had announced a loss of $14.4 million and didn’t foresee a return to profitability anytime soon. Like other subprime lenders, NovaStar was reckoning with mounting defaults on its loans.

The stock price bottomed out in early March at $3.25, and the company’s near collapse caused its loyal investors to lose faith. The Easter Bunny was the nom de plume of a NovaStar believer who also blogged under the name Bob O’Brien. When times were good, O’Brien had gone after NovaStar doubters with a fury. (On one message board, he posted the names and addresses of the family of a prominent short seller.)

O’Brien was such a tireless defender that The Wall Street Journal wrote a story about his efforts. O’Brien gave an interview, but he refused to divulge his real name. The New York Post later identified him as a salesman on the West Coast named Philip Saunders.

NovaStar’s plunge caused Saunders, once an adherent, to swear off stocks. “This casino has just lost its allure,” he wrote on the Investor Village message board devoted to NovaStar. (Contacted by the Pitch, Saunders says he no longer comments on NovaStar.) On the same site, an investor who went by the name Sealman29 described the pain of liquidating 21,000 shares of NovaStar. “Mom and Dad were right,” Sealman wrote. “The stock market is pure gambling.”

Skeptics, meanwhile, felt validated. Herb Greenberg called NovaStar a “high-wire act.” Excitable cable TV host Jim Cramer wrote on TheStreet.com: “Now we have another horror story about the industry and I keep thinking, ‘Wait a second, NovaStar routinely lowered standards and did whatever was necessary to keep the balls in the air.'”

The company put on a brave face. “We’ve been through down cycles before,” Lance Anderson told Star reporter Dan Margolies in a sit-down interview in March.

A month later, NovaStar announced that it was exploring “strategic alternatives,” which included selling the company.

NovaStar’s stock price has made up a portion of what it lost in the subprime lending crack-up.

In recent weeks, the company’s worst days have not been on Wall Street but in courtrooms.

A federal lawsuit filed in Washington, D.C., in May accused NovaStar Mortgage of discriminating against African-Americans, Native Americans and the disabled. The National Community Reinvestment Coalition alleges that NovaStar violated the Fair Housing Act by refusing to offer mortgages on rowhouses in downtown Baltimore, homes on Indian reservations and homes that may be used as adult-care facilities.

NovaStar says the coalition’s charges are baseless. In court papers, the company said its actions were based on legitimate business reasons: It avoided Baltimore rowhouses because they had abnormally high instances of mortgage fraud; writing loans on Indian reservations was “like lending in a foreign nation”; and it stayed away from adult-care facilities because of its policy of not making loans to purchase commercial-use property.

On June 21, NovaStar agreed to pay $5.1 million to resolve the class-action suit in Washington state. Approximately 1,600 borrowers will receive a settlement. “By winning this lawsuit, we hit them where it hurts — in the pocket,” said one of the borrowers, Larry Brown, at a press conference.

In a statement, NovaStar said it settled the case to avoid paying further legal costs. The company said the broker fees (“yield spread premiums,” in industry parlance) were appropriately disclosed and standard practice. On June 29, the lawyers who represented the Washington borrowers filed a similar suit against NovaStar in San Francisco.

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Meanwhile, the subprime-lending default machine continues to grind. Four days after the settlement was announced, NovaStar turned over residences in Grandview and on the east side of Kansas City, Missouri, to its auction house.
The newspapers are late.

It’s 2:30 a.m. Gary Butcher has parked his Honda Odyssey at the warehouse near Nieman and Shawnee Mission Parkway where he picks up 600 editions of The Kansas City Star every morning. “It never fails,” he says. “I get here early, and they’re not here.”

Butcher is wearing a T-shirt and denim shorts. Sitting in his van, he tries to tune in a St. Joseph radio station that plays old-time radio shows — his favorite is Challenge of the Yukon. Other drivers kill the wait with cigarettes and gossip.

Butcher has been delivering papers for six years. He used to work at FedEx but quit when his hours changed. Most of his subscribers live around old Shawnee. He took on a second route when he began seeing more of his original subscribers in the obituaries. (Earlier this year, Butcher contacted an apartment manager after noticing that one of his elderly subscribers hadn’t picked up the previous day’s paper. Police found the 86-year-old man, who lived alone, lying on his bedroom floor. The Star wrote a story about Butcher’s alertness. The old man, who was suffering from pneumonia, died a week later.)

Today is Monday, an easy day. The paper is small, and Butcher doesn’t have the children with him. On nights when Tracey works the 6 p.m. to 6 a.m. shift, he loads the kids into car seats for a ride along the delivery route. “They usually just sleep,” he says.

Butcher can finish his route in about three hours. He wraps the papers in rubber bands as he drives and flings them out both front windows. He keeps an eye out for nocturnal creatures and police officers who like to ticket rolling stops.

Before the bankruptcy, Butcher took classes at Johnson County Community College. He planned to become a teacher. That’s all on hold now. When Greta, the youngest, starts school, Butcher would like to find a different job. The circulation masters at the Star, he says, “haven’t given any raises in I don’t know how long.”

Cruising down a dark and quiet Johnson Drive, Butcher says he’s had an easier time than his wife when it comes to dealing with the loss of their home.

“My wife, she wants a house,” Butcher says. “I don’t really care — less work for me. It’s kind of a blessing in disguise.”

At least this way, there’s no grass to mow.