Wednesday, April 30, 2008

FDIC's Home Ownership Preservation Loan Proposal

(From the horse's mouth...) The FDIC is proposing that Congress authorize the Treasury Department to make loans to borrowers with unaffordable mortgages to pay down up to 20 percent of their principal. The repayment and financing costs for these Home Ownership Preservation (HOP) loans would be borne by mortgage investors and borrowers. This approach is scaleable, administratively simple, and will avoid unnecessary foreclosures to help stabilize mortgage and housing prices.

This proposal is designed to result in no cost to the government:

  • Borrowers must repay their restructured mortgage and the HOP loan.
  • To enter the program, mortgage investors pay Treasury's financing costs and agree to concessions on the underlying mortgage to achieve an affordable payment.
  • Treasury would have a super-priority interest -- superior to mortgage investors' interest -- to guarantee repayment. If the borrower defaulted, refinanced or sold the property, Treasury would have a priority recovery for the amount of its loan from any proceeds.
  • The government has no continued obligation and the loans are repaid in full.

Mortgage Restructuring:

  • Eligible, unaffordable mortgages would be paid down by up to 20 percent and restructured into fully-amortized, fixed rate loans for the balance of the original loan term at the lower balance. New interest rate capped at Freddie Mac 30-year fixed rate.
  • Restructured mortgages cannot exceed a debt-to-income ratio for all housing-related expenses greater than 35 percent of the borrower's verified current gross income ('front-end DTI'). Prepayment penalties, deferred interest, or negative amortization are barred.
  • Mortgage investors would pay the first five years of interest due to Treasury on the HOP loans when they enter the program. After 5 years, borrowers would begin repaying the HOP loan at fixed Treasury rates.
  • Servicers would agree to periodic special audits by a federal banking agency.


  • Mortgage investors would apply to Treasury for funds and would be responsible for complying with the terms for the HOP loans, restructuring mortgages, and subordinating their interest to Treasury.
  • Administratively simple. Eligibility is determined by origination documentation and restructuring is based on verified current income and restructured mortgage payments.


  • A Treasury public debt offering of $50 billion would be sufficient to fund modifications of approximately 1 million loans that were "unsustainable at origination." Principal and interest costs are fully repaid.

Eligible Mortgages:

Applies only to mortgages for owner-occupied residences that are:

  1. Unaffordable – defined by front-end DTIs exceeding 40 percent at origination.
  2. Below the FHA conforming loan limit.
  3. Originated between January 1, 2003 and June 30, 2007.

Home Ownership Preservation Loans: Questions and Answers

Home Ownership Preservation Loans: Examples

Related Link: Financial Times, April 29, 2008 – Op Ed: How the State can Stabilise Housing Market

FDIC Proposes $50 Billion Mortgage Pay Down Program; Questions Abound

(Housing Wire) The Federal Deposit Insurance Corp. on Wednesday proposed the latest in a string of recent attempts by lawmakers and policyheads to stem growing mortgage losses, suggesting that the Treasury fund $50 billion to help borrowers pay down a portion of principal on outstanding mortgages deemed “unaffordable” by the government.

“Government efforts should focus on helping the market reach equilibrium without overshooting,” wrote Sheila Bair in an op-ed published Wedensday in the Financial Times. “This can be done only through widespread restructuring of unaffordable mortgages into affordable ones.”

The program would see certain borrowers’ mortgages restructured by paying down up to 20 percent of principal via a so-called “Home Ownership Preservation loan” backed by the Treasury; borrowers would then refinance into a fixed-rate traditional mortgage, and pay only on that 80 percent of modified principal for the first five years after restructuring.

Investors, in turn, would agree to take a 20 percent haircut on their existing position — sort of. Under the FDIC proposal, investors would receive funds from the Treasury’s HOP loan and agree to pay interest at the Treasury’s rate for the first five years of the loan (making the loan free to consumers). After five years, borrower would then pay on the full 100 percent owed, with the 20 percent HOP loan amortized at below-market, Treasury-specific rates.

If the borrower defaults, sells or refinances, the HOP debt is in the super-senior position, putting the Treasury in the pole position for any recovery.

“The housing crisis is a national problem,” Bair said. “Painful as it is, we must be prepared to apply government efforts now.”

The program would only be available to borrowers whose loans are defined as “unaffordable” — that is, borrowers whose debt-to-income was above 40 percent at the fully-indexed rate when the loan was originated, borrowers whose mortgage fits within current FHA lending limits, and who took out their loan between 2003 and mid-2007.

The FDIC said in press materials that it expects that one million borrowers would qualify for the program.

Industry response tepid
There appear to be a number of concerns about the FDIC’s proposal, according to senior executives that spoke with HW on strict condition of anonymity — not to mention some apparent confusion as to implementation and contingencies.

“We’re talking about underwater borrowers, which means most of these people either have a second lien or they’ve got MI [mortgage insurance],” said one source, an exec at a large servicing operation. “Why would a second lien holder voluntarily agree to be completely and immediately wiped out in a transaction, when they could get more by collecting even one more payment from a borrower that will ultimately default?”

“And what does this mean for a mortgage insurer? That the Federal government is taking up their loss position?”

A review of the proposal materials provided by the FDIC did not answer that question directly, saying only that under the proposal, “the underlying loan is modified within the mortgage pool and does not worsen the position of subordinate lien holders.” Which, we suppose, is another way of saying that you can’t do worse than zero. As our sources have suggested, however, it’s when you reach zero that matters, too.

An attorney that spoke with HW raised different concerns, suggesting that the program could expose the Federal government to various levies and fees that various local municipalities are now charging lien-holders on mortgages.

Most sources had a tough time believing that the program would be costless to the government, a stance the FDIC reiterated numerous times in materials detailing the HOP plan.

“What happens if an investor goes belly up in year two of five? What happens if payments are missapplied?” another source said. “Is the Treasury going to repossess its secured interest because whomever refinanced the loan went out of business or filed bankruptcy? Or are they going to eat the losses? Or are they going to recap that lost interest onto what the borrower owes?”

It’s certainly not out the realm to consider such scenarios, given the number of lenders/noteholders/investors that have run aground in the past 12 months alone.

An ABS analyst that spoke with HW focused on the distribution of proceeds from the HOP loan, saying that it’s unclear which investors would support such a deal and which would not — support would likely depend on the relative status of a given transaction, we were told, and where current and expected losses stacked up against structural keys, like overcollateralization triggers.

“All investors and all deals are not created equal,” said the analyst.

A week in the life of mortgage "reform"

Here's a mortgage crisis chronology for this week, as reported by the New York Times and Washington Post. Can you guess what these articles have in common?

On Sunday, Michelle Singletary's The Color of Money column discussed Treasury Secretary's Henry Paulson's recommendation to create a Mortgage Origination Commission that would promulgate standards for mortgage loan officers and would rate and report state efforts to license and regulate mortgage brokers. In her view, a new Commission isn't needed. Instead, she argues that what we need to do is send some of these people to jail. Rather than have a commission talk about their fraudulent acts, she suggests that we need to criminally prosecute loan officers who have engaged in fraudulent lending activities.

On Monday, the New York Times reported that the mortgage industry has stepped up its attack on proposed Federal Reserve regulations that are designed to regulate certain mortgage lending practices. These regulations would require lenders to disclose all fees (including broker's yield spread premiums), would require lenders to show that customers can actually afford the mortgage, would ban certain types of advertising, and would regulate other practices viewed as abusive. The mortgage community argues (of course) that tighter regulations will increase the cost of credit and ultimately will harm creditworthy borrowers. The Times reports that the industry's aggressive attack on the regulations and their flood of comments have been successful in convincing the Fed to narrow the proposed regulations.

Yesterday (Tuesday). An editorial in the Times criticized the government for waiting too long to respond to the foreclosure crisis and sharply criticizes the pro-mortgage industry aspects of the bill the House recently passed. It specifically notes that the bill relies too heavily on the voluntary participation of lenders, and stresses that lenders can choose whether to reduce the mortgage loan balances or whether to continue with a pending foreclosure. The editorial urges Congress, especially the Democratic leadership, to push forward with legislation that would let borrowers modify their mortgages in bankruptcy.

Today. An article in the Times reports that fewer than 1,800 homeowners have been helped by the Federal Housing Administration program that was designed to provide relief to homeowners who have fallen behind on their mortgage payments. Though FHA officials contend that more than 150,000 people have benefited from the program, the program has largely helped homeowners who are current on their mortgage payments (and who anticipated that they might have problems in the future), not the folks who were in default and at risk of losing their homes in foreclosure. Surprisingly, housing officials seemed surprised by the number of homeowners who sought to benefit from the program. It's surprising that they were surprised by the homeowner interest in the program, since over a million people have fallen behind on their mortgage payments.

Why so few homeowners are benefiting from the FHA program is anyone's guess. Perhaps it's the design of the program, which provides relief only to borrowers who have made 10 timely payments in the 12 months before they went into default. Maybe it's because the program hasn't been well publicized. Or, perhaps officials at the Department of Housing and Urban Development, which oversees the FHA, have been a tad distracted of late by the scandals involving the former-HUD chief (who resigned recently but is still being investigated for questionable business practices). One thing we don't have to guess is that this program is going to do little to help most struggling homeowners this year, unless the program is radically revamped.

So what do these news reports have in common? First, the mortgage industry seems unwilling to voluntarily reform itself. Second, any attempt to regulate the industry will be met with the claim that doing so will do no good and will only exacerbate the credit crisis. Third, no one in the government seems to want to take truly bold steps to do anything meaningful anytime soon, and everyone seems happy to engage in long discussions (in committees or on commissions) about the housing crisis. Fourth, the Fed and members of Congress appear unwilling to alienate the powerful financial services industry.

Of course, the week's not over yet. Things can only go up.

Predatory borrowing, and recidivism

(Housing Wire) We’re probably not going to make a lot of friends on the consumer side with this, but more than a few analysts have asked us here at HW when we’re going to take up the issue of “predatory borrowing,” since the cards have pretty much been dealt on predatory servicing and predatory lending.

How about now?

An earlier story Tuesday on HW covered an upcoming Senate Judiciary subcommittee hearing on foreclosures and bankruptcy, and cited a story in the New York Times. It was penned by Gretchen Morgenson, and we chose to ignore the more — ahem, how shall we put it — misguided portions of her story. We wanted to focus on the news itself.

But those misguided portions that we ignored? They drove Calculated Risk’s Tanta off of a ledge, in a way that only Gretchen seems to have a way of doing as of late. The result is well worth anyone’s time to read, especially if you are in the camp that says all servicers are out to screw borrowers utterly and completely — what you learn just might conflict with your world view.

Tanta went ahead and researched the entire Atchley case history, or at least as much of it was publicly available — the case is the center of the U.S. Trustee’s case against Countrywide — and what she finds is another case of a classic borrower filing bankruptcy to stave off foreclosure and then struggling to make a mortgage payments post-petition, not to mention a lender who managed to screw up on filing Proofs of Claim with the court.

Not exactly the sordid tale of Countrywide and its attorneys quashing a blameless borrower, is it?

Yet somehow, we have a feeling that on May 6, Robin Atchley will be there in front of a nodding Senator from New York named Chuck Schumer — and, oh, did we mention that Diane Feinstein is on the Judiciary subcommittee too? — telling the whole world how wronged she was by that evil, bad and uncaring lender named Countrywide and their nefarious lawyering types.

Bush Homeowner Rescue Program Falls Short of Low Expectations

(NY Times) Fewer than 2,000 homeowners at risk of foreclosure have been helped by a Federal Housing Administration program that President Bush promised would help homeowners who had fallen behind on their mortgage payments, federal housing statistics show.

F.H.A. officials have asserted in recent weeks that more than 150,000 people have benefited from the program, which was intended to help troubled homeowners refinance into stable, government-issued loans. But the vast majority of participants have been homeowners who have made their mortgage payments on time, not the borrowers in crisis who were the targets of the president’s plan, the statistics show.

Housing officials, who initially expected that 60,000 or more delinquent borrowers would benefit, say they greatly overestimated the demand from troubled homeowners.

But they say the program, known as F.H.A. Secure, has helped people who were anticipating difficulties in paying their mortgages. Such homeowners were able to refinance before they fell behind, officials say.

“They came to us before they got into trouble,” said Stephen C. O’Halloran, a spokesman for the Department of Housing and Urban Development, which oversees the F.H.A. “We’d rather have them come to us before they fell behind on their loans.”

But some lawmakers and industry analysts say that the statistics prove that the program, which was announced by Mr. Bush in August, has failed to help the most vulnerable homeowners and, consequently, has failed to ease the foreclosure crisis significantly.

Democratic lawmakers estimate that at least 1.5 million people have fallen behind on their mortgage payments. Yet from October 2007 through the end of March, only 1,729 delinquent mortgages were refinanced by F.H.A., housing statistics show. Officials project that 4,000 such mortgages will be refinanced by the end of September.

More than 400,000 mortgages will be refinanced through F.H.A. Secure this year, officials say. Of those, only about 4,000 will be held by homeowners who have fallen behind on their payments, the statistics show.

“F.H.A. Secure, while a good idea, is not addressing the magnitude of the problem,” Senator Christopher J. Dodd, the Connecticut Democrat who is the chairman of the Banking Committee, said at a hearing this month. He is calling for legislation that would help many more troubled borrowers.

Scott Stern of Lenders One, an alliance of mortgage bankers based in St. Louis, called the program’s record with the neediest homeowners “a tragedy.”

“F.H.A. is helping borrowers who aren’t currently in trouble and that is fine,” Mr. Stern said. “But there is a specific subset of borrowers right now who are in trouble. The program needs to be helping people who need the help immediately.”

Housing officials say they have worked hard to reach such borrowers. In August, the program was tailored toward low-income homeowners who were falling behind because of interest rate increases on their adjustable-rate mortgages. The officials say that interest rate cuts by the Federal Reserve reduced the number of such people.

Homeowners who were not delinquent on their loans, however, were hearing about the F.H.A.’s refinancing programs for the first time as HUD expanded its outreach. The phones at F.H.A. started ringing as consumers and lenders tried to get more information about the new program.

“I think a lot of people thought we were the Federal Highway Administration,” Brian Montgomery, the F.H.A. commissioner, told lawmakers this month.

Until recently, Mr. Montgomery said, “we were almost an afterthought for many borrowers.”

The publicity surrounding the program led to a surge of refinance business for F.H.A., mostly from homeowners in good standing with their mortgage companies. From October 2007 through the end of March, F.H.A. refinanced 131,881 conventional loans. Only 43,397 conventional loans were refinanced in the period a year earlier, statistics show.

This month, the Bush administration announced that it would broaden the eligibility criteria for F.H.A. Secure to help larger numbers of troubled homeowners.

Under the original program announced in August, homeowners were eligible to refinance only if they were current on their mortgages before their interest rates spiked. Under the new plan, homeowners who fall behind because of extenuating conditions — lost jobs, declining wages, family illnesses — are eligible, regardless of whether their rates have increased or not.

Officials say the change would allow an additional 100,000 people to refinance this year.

“We’re trying to figure out how to serve consumers caught up in economic circumstances,” said Meg Burns, director of F.H.A.’s single family program development.

“Interest rates are no longer spiking,” Ms. Burns said. “People are going into delinquency not as a result of the resets, but because of the local economy.”

Advocates for homeowners say the changes represent some progress, but not enough.

The F.H.A. still requires borrowers hoping to refinance to have made 10 on-time payments in the 12 months before they went into default. That will block many borrowers, said John Taylor, president of the National Community Reinvestment Coalition, which helps people in underserved communities get credit.

Tuesday, April 29, 2008

More Subprime, Alt-A Mortgages May Head `Underwater'

(Bloomberg) -- About half of recent subprime and Alt-A borrowers may soon owe more on their mortgages than their houses are worth or hold minimal equity, putting $800 billion of debt at greater risk of default, according to Barclays Capital.

Subprime loans from 2006 and 2007 that exceed the value of the homes jumped 5 percentage points to 19.8 percent in the fourth quarter, and may reach 26 percent by midyear if prices drop at the same pace, Barclays analysts wrote in a report yesterday. Alt-A loans, a grade better than subprime, would grow to 23 percent from 16.3 percent.

Many of the loans are in areas where prices are falling faster than the U.S. average, so the size of the shift is underappreciated, New York-based analysts Ajay Rajadhyaksha and Derek Chen wrote. The odds that a borrower will default, saddling lenders and bond investors with losses, rises when a homeowner owes more on a property than it can sell for, they wrote.

``Mortgage loans are moving underwater at a very sharp pace, far more than suggested by aggregate home price data,'' they wrote. Home mortgages held by households totaled $10.5 trillion on Dec. 31, according to Federal Reserve data.

The analysts used quarterly home-price data from the Office of Federal Housing Enterprise Oversight, which showed a 0.3 percent dip in prices nationwide in the fourth quarter from a year earlier, and tumbles of more than 14 percent in Modesto, California, and Port St. Lucie, Florida. S&P/Case-Shiller indexes tracking areas around 20 cities have shown more severe declines, including a 9 percent nationwide drop in the same period.

`Better to Sell'

Borrowers on about 26 percent of subprime loans from 2006 and 2007 will have equity of less than 10 percent by midyear, down from 29.4 percent at yearend, according to Barclays, as more borrowers slip underwater. The percentage on Alt-A mortgages should hold steady at about 23.5 percent. The report said 10.8 percent of Alt-A loans were underwater on Sept. 30.

``If they have home equity left, borrowers are hesitant to default, even if in trouble,'' the analysts wrote. ``If the house is worth more than the loan, why default and leave money for the bank? Better to sell the house instead.''

Borrowers with poor or limited credit records or high debt used subprime mortgages to buy properties or tap home equity by refinancing. Lenders made Alt-A home loans to borrowers who want atypical terms such as proof-of-income waivers, delayed principal repayment or investment-property collateral, without having to offer sufficient compensating attributes.

Walking Away

Among two-year-old Alt-A mortgages that are underwater, 33 percent are at least 60 days late, the analysts wrote. That compares with 7 percent delinquency on similar loans in which homeowners have equity of at least 20 percent. For corresponding subprime loans, the delinquency rate is 58 percent for underwater debt and 29 percent where equity exceeds 20 percent.

Borrowers who have never been delinquent on a subprime mortgage are three times more likely to miss a payment if they have less than 20 percent equity in their homes, when compared with similar borrowers with more equity, according to a report last week from Credit Suisse Group. These homeowners then catch up only half as often as their counterparts, the report said.

Home prices in 20 U.S. metropolitan areas fell in February by the most on record, according to a report released today. The S&P/Case-Shiller home-price index dropped 12.7 percent from a year earlier, more than forecast and the most since the figures were first published in 2001. The gauge has fallen every month since January 2007.

Senate Panel to Look at Foreclosure Management Practices

(Housing Wire) If anyone needed proof that default servicing is now headed towards the spotlight, look no further than yesterday’s announcement by the Senate Judiciary Committee that it will hold a session focusing on recent high-profile bankruptcy management missteps. The Judiciary Committee’s Subcommitree on Administrative Oversight and the Courts will hold a hearing titled “Policing Lenders and Protecting Homeowners: Is Misconduct in Bankruptcy Fueling the Foreclosure Crisis?”

The hearing, scheduled for May 6, was called by chairman Charles Schumer (D-NY) — who has said that he wants legislation enacted to protect borrowers from servicer missteps in and after bankrupcty proceedings.

Schumer has invited Countrywide Financial Corp. (CFC: 5.85, +0.34%) Angelo Mozilo to testify, the New York Times reported Tuesday. Also invited were representatives from McCalla, Raymer, Padrick, Cobb, Nichols & Clark in Atlanta, a creditor’s rights law firm and one of the largest such firms in the default servicing industry. Both the law firm and Countrywide have been at the center of a highly-publicized series of case involving the United States Trustee, in which the Trustee has alleged “abuses of the bankruptcy process” by Countrywide and its associated counsel in Georgia, Florida and Ohio.

A similar case, a putative class action suit filed in February by a group of borrowers in Texas, was thrown out by a judge in a federal bankruptcy court in Houston this past March.

While it’s unknown whether Mozilo or McCalla Raymer will be attending the hearing, the New York Times reported that three others will be testifying: Robin Atchley, the borrower at the center of the Countrywide bankruptcy brouhaha in Atlanta, as well as Clifford J. White III, director of the executive office for the United States Trustee, and Katherine M. Porter, an associate professor of law at Iowa University. Porter published a study in 2006 that found half of foreclosures contained “questionable fees.”

The New York Times covers more details:

What the hearing is going to show is what an ongoing, awful enterprise some of these companies ran, not just taking advantage of the terms of the mortgage, but when they control the mortgage how they continue to squeeze and squeeze and squeeze,” Mr. Schumer, Democrat of New York, said.

Monday, April 28, 2008

Bank of America Unveils Mortgage Aid Plan

(Housing Wire) Continuing efforts to fast-track its acquisition of Calabasas, Calif.-based Countrywide Financial Corp. (CFC: 5.83, -0.17%), executives at Bank of America Corp. (BAC: 38.18, -0.31%) unveiled an aggressive mortgage aid plan Monday morning, ahead of scheduled testimony at the Federal Reserve in Los Angeles. The bank also confirmed its plans to mothball the Countrywide brand upon completion of the merger, and said that it will centralize its mortgage operations in Countrywide’s Calabasas-based headquarters.

The plan includes a commitment to workout $40 billion in troubled mortgage loans over the next two years, keeping at least 265,000 borrowers out of foreclosure, as well as a doubling of the bank’s commitment to community development lending, according to a press statement released Monday morning. Monday’s announcement comes on the heels of last week’s announcement that the bank would be pulling back on key lending programs once the merger is complete, in an effort to focus on high-quality mortgage originations.

“We believe the financial strength, security and stability of the combined company will allow us to enable people to buy homes and stay in homes, and to assist many of those affected by the current mortgage troubles,” said the bank’s top global consumer and small business banking exec Liam McGee during testimony.

Monday’s testimony also featured remarks from Rep. Maxine Waters (D-CA), as well as representatives from prominent community groups and public offices, including the office of the California Attorney General. The California Reinvestment Coalition sponsored testimony from witnesses with troubled mortgages who have said that the Calabasas-based lender hasn’t done enough to help them, and scheduled a demonstration outside of the Los Angeles Fed branch for after the hearing as well.

Critics have said that BofA needs to make a strong commitment to working with troubled borrowers and minority communities in the wake of the proposed acquisition, which would ostensibly create the nation’s largest mortgage banking operation.

“We will continue to work with distressed borrowers to match the customer’s repayment ability with the appropriate loss mitigation option, including loan modifications, forbearances, repayment plans, lower rates and principal reductions,” McGee said. “We will not assess new late charges for customers in foreclosure and we will waive certain other associated fees, when permitted.”

McGee said that Bank of America would invest $1.5 trillion in community reinvestment funds over the next ten years, an amount equal to double BofA’s previous community development goal. The bank also said it will invest an additional $2 billion over 10 years in housing-related philanthropy.

“This new goal raises the bar and is certain to enhance quality of life for millions of Americans in need,” McGee said.

Interestingly, Bank of America also touted a commitment to tenants of former owners in a foreclosure — saying that it had instituted a national policy of allowing tenants to remain in a subject property for up to 60 days after the completion of a foreclosure sale. BofA also runs an aggressive cash-for-keys program in which tenants vacating within 30 days post-foreclosure will receive $2,000 to help defray the cost of relocation.

Legal sources told HW that the plan was relatively aggressive, and a good response to increasing policital pressure tied to lease holders caught in a foreclosure.

For more information, visit

Servicers Increase Focus on Modifications; Foreclosures Jump 35 Percent in First Quarter

(Housing Wire) Almost 503,000 prime and subprime homeowners were able to stay in their homes during the first quarter of 2008 because of loan workouts provided by mortgage servicers, according to a report released Monday morning by the HOPE NOW coalition.

Of 502,500 total loan workouts booked in the first quarter of 2008, the group said that approximately 323,000 were repayment plans and 179,500 were loan modifications; loan modifications represented roughly 44 percent of all subprime workouts, double the rate recorded in 2007, but were just 23 percent of prime workouts.

“I guess it’s almost better to be a troubled subprime borrower these days,” said one source, who suggested that political pressure to help subprime borrowers has not extended to prime borrowers. “There’s an easy reference point for someone categorized as subprime, whether right or wrong, which means that more effort and focus has gone into programs to help this group of borrowers,” she said.

The difference in workouts offered to prime and subprime borrowers is likely not due to a plan announced in December by the American Securitization Forum that would fast-track solutions for subprime ARM borrowers who could afford their starter rate, but could not afford the reset rate — resets have since become a minimal problem for borrowers, as rates have dipped significantly, essentially eliminating payment shock as a key problem for every class of borrower.

That sentiment is borne out in the data, as well. There were 431,171 subprime 2/28 and 3/27 loans scheduled to reset during the first quarter of 2008, according to HOPE NOW’s data; 14,418 were modified, while 203,000 of these loans — that’s 47 percent of scheduled resets — were paid in full via refinancing or a sale. Many of those prepayments might have been defaults in a different rate environment, industry experts that spoke with HW suggested.

A self-inflicted foreclosure surge?
While total workouts increased roughly 6 percent quarter over quarter — and servicers clearly have focused on more permanent loan modification activity — the increase was not nearly enough to keep pace with a 35 percent quarterly jump in foreclosure activity. The industry recorded a ratio of 2.4 workouts per foreclosure during the first quarter, below the 3.1:1 ratio recorded in Q4 and the 2.9:1 ratio recorded in Q3.

Some sources have suggested that an over-reliance on repayment plans earlier in the current cycle is now coming back to bite servicers and, potentially, investors. Borrowers that might have defaulted in Q3 or Q4 are finally seeing what was essentially an inevitable foreclosure take place in early 2008 instead.

“The pressure on many servicers is just enormous,” said one source, an MBS analyst who asked not to be named. “I’m sure the consumer side will latch onto these numbers as proof that servicers aren’t doing enough, when the real question ought to be: what percentage of these foreclosures were actually preventable, and were they prevented?”

“Mortgage servicers continue to focus on doing everything possible to help troubled homeowners avoid foreclosure,” said Faith Schwartz, executive director of HOPE NOW. “While there is still more work to be done, concrete progress is being made, and HOPE NOW members will continue their efforts and work to help as many borrowers as possible.”

For more information, visit

While You Weren’t Looking: FHA-Insured Jumbos on the Move

(Housing Wire) While the financial press — including HW — and others in the industry have been focused on the new market for so-called conforming jumbos at Fannie Mae and Freddie Mac, none other than Ginnie Mae went ahead and published their first “FHA jumbo” pools on April 15. Industry insiders say that the FHA loans have been moving, while activity on higher-limit jumbos at either GSE has yet to register on anyone’s radar screen.

Under the Economic Stimulus Act of 2008, The Federal Housing Administration received a huge shot in the arm when it saw its lending limits boosted, along with those of Fannie Mae and Freddie Mac. All three are temporarily authorized to purchase mortgages up to $729,500 in certain high cost areas — and while activity thus far has been slow, FHA jumbos have clearly been the first to market as borrowers have flocked to the revitalized government-sponsored lending program.

Ginnie published its guidelines and multi-issuer pool types for the higher balance loans on March 6. The first pools under the new lending limits included three jumbo conforming 30-year fixed rate pools with an issue date of April 1 (pool prefix is JM, for jumbo), led by a $10.9 million issue offering a 5.5 percent coupon; according to eMBS, a provider of mortgage data and analytics, the pool’s collateral is 43 percent in California with average original loan (AOL) amount of $436,907.

Other pools include $3.4 million of a 6 percent coupon, 45 percent in New Jersey; and $2.8 million of a 6.5 percent coupon, 30 percent in Washington, DC.

Small activity compared to the dollar volume other issues, to be sure, but also proof that the market for jumbo conforming loans is beginning to finally move forward.

The FHA was — prior to the emergence of private-party subprime — the traditional vehicle for subprime lending and first-time homebuyers, established during the Depression era to help stabilize a faltering housing market. As the current housing crisis has rolled on, Bush administration officials and Congressional leaders alike have looked to revitalize the program.

That revitalization effort has paid dividends, and quickly. Ginnie Mae said last week that MBS issuance increased to nearly $15 billion during March — it’s highest issuance rate since November of 2003. For the first quarter, issuance totaled $39.1 billion, more than doubling year-ago volume.

“Ginnie Mae has seen a steady increase in our issuance since October of last year,” said Theodore B. Foster, senior vice president for MBS at Ginnie Mae. “As the mortgage credit market tightened, and the subprime mortgage market and the private label MBS market collapsed, investors began moving toward the safety and stability of Ginnie Mae MBS, just as borrowers began moving back to the security of government loans — particularly Federal Housing Administration loans.”

Ginnie Mae also securitizes loans from the Veteran’s Administration — one government program that, oddly enough, was left out of the Economic Stimulus bill. Congressional legislators have proposed an amendment that would see VA lending limits raised to match those of Fannie, Freddie and Ginnie.

Real estate lenders fight tough rules

(Naked Capitalism) The New York Times, in "Loan Industry Fighting Rules on Mortgages," tells us that the real estate creditors are fighting tooth and nail to gut new rules that the Fed intends to impose.

The Times, apparently reflecting the sentiment of sources in the Fed, Capitol Hill, and consumer advocates, seems surprised at the vehemence of the effort.

What did they expect?

This is an industry that has been minimally regulated for at least the last dozen years, which given high turnover in many banks, is almost a lifetime. Anyone who remembers life in the bad old days is by definition a dinosaur.

But what amazes me is not the reaction of the industry, which was predictable, or the litany of arguments against new rules. Some of my favorites:
“We have heard from commenters who have expressed concern that in the current market environment, the proposed trigger could cover the market too broadly, and we will carefully consider the issues they raise and other possible approaches to achieve our objective,” Mr. Kroszner said last month at a conference of the National Association of Hispanic Real Estate Professionals.

Please. By definition, there is never a good time to implement new rules, at least according to those who will have to live with them. Either the industry is suffering, so it's not the time to inflict more pain, or it's doing well, and therefore the rules are obviously misguided and unnecessary. The intent IS to cover the market broadly; anything else leaves the barn gate open for the horse to leave again.
The new rules would apply extra protection to any mortgage with an interest rate three percentage points above Treasury rates. Officials said that they would cover all subprime loans, which accounted for about a quarter of all mortgages last year as well as many exotic mortgages known in the industry as “Alt-A” loans.

These loans are made to people with relatively good credit scores but who might provide little documentation of their income or assets, or who make smaller than usual down payments or purchase loans that have unusual terms, like interest-only payments for an initial period.

Many mortgage brokers and bankers complain that the lower threshold would unnecessarily include many borrowers who are not at risk from abusive practices.

Oh, no, those borrowers are merely at risk of becoming deadbeats, which means society as a whole has to eat the risk due to costly rescue operations that involve hidden or explicit taxpayer subsidies. Alt-As are showing high default rates; to maintain that no docs are a good practice that should continue boggles the mind.
One common industry criticism is that at a time of tight credit, tighter rules could make many mortgages more expensive by creating more paperwork and potentially exposing lenders to more lawsuits.

Um, expensive new paperwork? Much of this is a requirement to do the sort of documentation and analysis banks did once upon a time, when it was understood that lending was a risky business. And the protests confirm that the industry want the right to make risky loans (note the lawsuits point is valid, and by design: Sheila Bair believes the current standards are skewed too far in favor of lenders. So greater risk of being sued is a feature, not a bug.

But what is most surprising about the piece is the spin the Times puts on it, It voices surprise at the vehemence of the response (the only thing that is surprising is how shameless and self-serving it is), when what is really stunning is how fast the powers that be are making concessions. Is this a symptom of how we really do have the best government money can buy, or of how deeply anti-regulatory sentiment has been internalized?

From the New York Times:
The mortgage industry, facing the prospect of tougher regulations for its central role in the housing crisis, has begun an intensive campaign to fight back.

As the Federal Reserve completes work on rules to root out abuses by lenders, its plan has run into a buzz saw of criticism from bankers, mortgage brokers and other parts of the housing industry. One common industry criticism is that at a time of tight credit, tighter rules could make many mortgages more expensive by creating more paperwork and potentially exposing lenders to more lawsuits.

To the chagrin of consumer groups that have complained that the proposed rules are not strong enough, the industry’s criticism has already prompted the Fed to consider narrowing the scope of the plan so it applies to fewer loans.

The debate over new mortgage standards comes in response to a severe crisis in the housing and financial markets that many economists trace back to overly loose credit and abusive loans. Those practices, combined with low interest rates, led to inflated market values that have declined rapidly in recent months as investors have begun to lose confidence in the financial instruments tied to those loans.

Four months ago, the Fed proposed the new standards on exotic mortgages and high-cost loans for people with weak credit. The Fed’s proposals came after it was criticized sharply as a captive of the mortgage lending industry that had failed over many years to supervise it adequately.

Proposals are pending in Congress on mortgage standards, but it is not clear whether they will be adopted this year. The Fed has its own authority under housing and lending laws to adopt mortgage standards.

The plan presented by the Fed was proposed by its chairman, Ben S. Bernanke, and Randall S. Kroszner, a former White House economist in the Bush administration who is now a Fed governor and leads the Fed’s consumer and community affairs committee.

The plan would not cover existing mortgages but would apply only to new ones. It would force mortgage companies to show that customers can realistically afford their mortgages. It would require lenders to disclose the hidden fees often rolled into interest payments. And it would prohibit certain types of advertising considered misleading.

The Fed is expected to issue final rules this summer.

Earlier this month, as the comment period was about to close, the Fed was deluged with more than 5,000 comments, mostly from lenders who said the proposals could affect loans that have not presented problems. Some bankers and brokers also said the rules would discourage them from lending to some creditworthy borrowers.

The plan was criticized in separate filings by three of the industry’s most influential trade groups — the American Bankers Association, the Mortgage Bankers Association and the Independent Community Bankers of America. More modest concerns about some of the provisions were also raised by the National Association of Home Builders and the National Association of Realtors.

Regulators have been meeting about the proposals with bankers, brokers and consumer groups in recent weeks and are continuing to do so.

Some of the groups seeking changes maintain that the proposals threaten to make borrowing for a home far more expensive and would unfairly deny mortgage brokers the right to earn certain fees.

Small community banks, which have played no significant role in the housing crisis, have urged the Fed to limit the scope of the proposed rules so that they do not discourage them from issuing loans. Lending groups have also raised concern that they would lead to frivolous and expensive litigation.

“We support many of the provisions in the proposed rule, but we do have concerns about the increased regulatory burden, liability and reputational risks that lenders might face,” said Kieran P. Quinn, chairman of Column Financial, Credit Suisse’s mortgage lending subsidiary in Atlanta, and the chairman of the Mortgage Bankers Association.

On at least one major aspect of the proposed restrictions — how broadly they should apply — the industry appears to be making headway. In a recent speech, Mr. Kroszner suggested that in response to criticism that the plan was including too many kinds of loans the Fed was considering whether to narrow the plan.

“We have heard from commenters who have expressed concern that in the current market environment, the proposed trigger could cover the market too broadly, and we will carefully consider the issues they raise and other possible approaches to achieve our objective,” Mr. Kroszner said last month at a conference of the National Association of Hispanic Real Estate Professionals.

Before this year, the Fed had applied an extra set of protection from abusive lending practices to a subset of subprime borrowers under the Home Ownership Equity Protection Act of 1994. The Fed has applied the law to fewer than 1 percent of all mortgages — those with interest rates at least eight percentage points above prevailing rates on Treasury securities.

Some economists and housing experts say the Fed’s lax oversight helped enable lending companies to reap enormous profits by providing millions of unsuitable and abusive loans to homeowners who often did not fully understand the terms or appreciate their risk.

As of January, the most recent month of available data, about a quarter of all subprime adjustable mortgages were delinquent, twice the level of the same period last year. Lenders began foreclosure proceedings on about 190,000 of these mortgages in the last three months of 2007.

The new rules would apply extra protection to any mortgage with an interest rate three percentage points above Treasury rates. Officials said that they would cover all subprime loans, which accounted for about a quarter of all mortgages last year as well as many exotic mortgages known in the industry as “Alt-A” loans.

These loans are made to people with relatively good credit scores but who might provide little documentation of their income or assets, or who make smaller than usual down payments or purchase loans that have unusual terms, like interest-only payments for an initial period.

Many mortgage brokers and bankers complain that the lower threshold would unnecessarily include many borrowers who are not at risk from abusive practices.

“There are a lot of community banks that have shied away from these loans because nobody wants to be a higher-priced lender,” said Karen Thomas, a lobbyist for the Independent Community Bankers. “With the trigger being set so low, it is encroaching on traditional, common sense mortgages. Our fear is it will result in less credit availability, which is not what we need in an already tight credit market.”

But consumer groups say that the proposed rules are already weak and that efforts to further weaken them would render them all but useless.

“The Fed has accurately diagnosed that this is a brain tumor and responded by prescribing an aspirin,” said Kathleen E. Keest, a former state regulator who is now a senior policy counsel at the Center for Responsible Lending, a group supporting home ownership. “In the industry, there is a fair amount of denial. They just don’t get it. There is a calamity within the industry, and they don’t have a new script yet, so they rely on the old script, which is that regulation will raise costs.”

But, she went on, “What we now see is that the unintended consequences of deregulation are worse. Their line is that regulation will cut back access to credit. That’s been their line ever since the small loan laws were adopted in the early 1900s.”

At the same time, letters urging the Fed to further tighten the rules were sent by Sheila C. Bair, the Republican head of the Federal Deposit Insurance Corporation, as well as senior members of the House Financial Services Committee.

In her letter, Ms. Bair, whose agency regulates many banks, urged the Fed to apply the proposed restrictions to loans that are three percentage points or higher than equivalent Treasuries. To prevent lenders from evading the limit by creatively structuring the loan and fees, she also suggested that the Fed impose the tighter restrictions if the loan fees exceeded a dollar amount.

While the Fed plan would require disclosures that could make it harder for lenders to include hidden sales fees that are usually paid to the mortgage broker, Ms. Bair suggested that the plan go further and ban some practices.

The plan, for instance, would require subprime lenders to explicitly describe fees that are now hidden. But Ms. Bair has proposed the elimination of such fees, saying such a ban would “eliminate compensation based on increasing the cost of credit and make the amount of the compensation more transparent to consumers.”

Ms. Bair also proposed making it easier for borrowers to sue lenders without having to show that they were engaged in a pattern of abusive practices, which is a requirement under the proposed Fed rules. She said that forcing borrowers to show a pattern of abuse “clearly favors lenders by limiting the number of individual consumer lawsuits and the ability of regulators to pursue individual violations.”

Ms. Bair also recommended that the Fed eliminate a so-called safe harbor provision in the proposal that protects lenders who fail to verify the income or assets of a borrower in some circumstances.

Did Hedge Funds Help Stabilize the Mortgage Market?

(Felix Salmon) Brad DeLong approvingly quotes a correspondent:

The fact that there was an ABX index and thus an easy way for people to bet that the mortage-backed securities market would crash probably cut short the bubble--the true hedge funds were stabilizing speculators; the destabilizing speculators were (i) the funds that were long CDOs and (ii) the banks and other issuers who retained the CDOs because their portfolio managers believed their marketeers. A world without derivatives but with mortgage-backed securities would probably be a world in which we have a bigger problem than we have now.

I've heard this argument made before, by Sebastian Mallaby; I didn't buy it then, and I don't buy it now.

It's easy to be awed by the sums of money made by John Paulson and the Goldman Sachs mortgage desk. But compared to the amount of money tied up in RMBS, the profits made by shorting mortgage-backed securities have been tiny. For Paulson to have played a significant role in stopping the mortgage-backed credit bubble from continuing to exapand, he would have had to have been orders of magnitude larger than he was.

But more to the point, the ABX index is an index of CDS spreads referencing subprime RMBS. The chain of arbitrage which would lead from shorting the ABX to RMBS prices falling is long and convoluted: first any drop in the ABX would have to be arbitraged by buying the ABX whilst selling buying protection on the underlying CDS contracts. Then any widening in those underlying CDS contracts would have to be arbitraged by selling protection on the RMBS while at the same time shorting the underlying bonds. (Good luck trying to do that. And of course this isn't a risk-free arbitrage, since CDS and bonds have been behaving in idiosyncratic and dissimilar manners of late.) Then any drop in the price of the specific RMBS which underlie the CDS which underlie the ABX would have to be arbitraged by buying up those bonds while selling the broad mass of other RMBS, creating generalized downward pressure on the secondary-market prices of subprime RMBS. Then a drop in secondary-market RMBS prices would have to be arbitraged by investors buying up secondary-market securities rather than the primary-market securities being offered to them by the investment banks structuring the RMBS deals, and this would have to be a common enough occurrence that the yields on primary-market RMBS deals would rise as a consequence. Finally - as if all that wasn't improbable enough - the higher yields on these RMBS deals would have to somehow feed through into fewer of those deals being done, and less demand from investment banks for securitizable mortgages.

I'm quite sure that's not what happened in reality. Yes, the people who shorted the ABX made a lot of money, but they made money because the RMBS market imploded for reasons utterly unrelated to - and not even precipitated by - the fact that a few hedge funds and prop desks were shorting the ABX. In other words, a world without derivatives but with mortgage-backed securities would probably be a world in which the RMBS market would still lie in tatters, and the only real difference is that John Paulson would be a great deal less wealthy than he is now.

Saturday, April 26, 2008

Barriers to Reducing Needless Foreclosures

(Jack Guttentag in the Washington Post) Needless foreclosures are happening all around us.

Note that I am using a coldblooded business definition of "needless foreclosure," not a bleeding-heart one. Under my definition, if it costs the holder of the loan more to foreclose on a mortgage than to make it viable, it is a needless foreclosure. I am not counting the human toll exacted by foreclosures, which can be very high.

For example, it can cost the investor who held the mortgage about $40,000 to foreclose on a home. It might have cost only $25,000 to make the mortgage affordable to the borrower through a reduction in the interest rate. Modifying the loan contract in this way would have kept the person in his home and saved the investor money.

Mortgage contracts are modified, at some cost to the investor, to prevent the larger cost of a foreclosure. Loan modifications include adding the unpaid interest to the loan balance, called "interest capitalization," and calculating a new payment. To make the payment more affordable, the term may be lengthened or the interest rate reduced. In cases where the property is worth less than the loan balance, the balance may be reduced.

The problem is that there are major impediments to loan modifications, including:

· Borrower denial. Developing a new loan contract that a distressed borrower can live with requires the full participation of the borrower. But many borrowers in trouble don't contact their servicers and may not respond when contacted.

· Moral hazard. Investors are concerned that if modifications are offered too easily or too early, some borrowers will pretend to need one even though they really don't. This is a major reason investors restrict the discretion of servicers to modify contracts.

· Restrictions on servicers. Third-party servicing in which the firm servicing the loan does not own it is more often the rule than the exception. In the case of loans that have been packaged and sold to investors, it is always the case.

Investors restrict the discretion of servicers to modify loan contracts because their interests are different. Investors want modification only if the alternative is a more costly liquidation or foreclosure. They want to avoid early modifications that would prove unnecessary, and they want to avoid encouraging borrowers to default who might not otherwise. Servicers, in contrast, want to protect their servicing fees, which they receive only from loans in good standing. Their general preference, therefore, is for early intervention.

A common contractual restriction on servicers is that modifications are permitted only for loans in default or for which default is imminent or reasonably foreseeable. Another is that any modification must be in the best interest of the investor. These create potential legal liability for the servicer. To be safe, some servicers limit modifications to loans already in default, which means 90 days delinquent or more.

· Scarcity of staff. Most interactions between mortgage borrowers and servicers are handled by computers and relatively unskilled employees. Borrowers in serious trouble are referred to a smaller number of more skilled and specialized employees. With the onset of the mortgage crisis, servicers were caught short of this critical but costly resource. While they now claim to have expanded their staffs to handle the workflow, a financial disincentive to staff adequately remains.

· Mortgage insurance. On mortgages carrying mortgage insurance that go to foreclosure, investors are protected up to the maximum coverage of the policy, which is usually enough to cover all or most of the loss. This discourages modifications. Why do a modification for $15,000 if the $40,000 cost to foreclose is going to be paid by the mortgage insurer? Even if the insurance coverage falls short of the foreclosure cost, the shortfall has to exceed the modification cost before modification becomes more attractive financially.

· Second mortgages. Many of the borrowers in trouble have two mortgages with different lenders, which complicates matters. The servicer looking to modify the first mortgage must make sure that the borrower can afford both mortgages and that the second mortgage lender does not upset the apple cart by foreclosing. My mail from borrowers in trouble suggests that some servicers are prepared to work with second-mortgage lenders, and some are not.

· Lack of public disclosure. Nothing in connection with modifications is publicly disclosed except what servicers wish to disclose, which invariably is whatever presents them in a favorable light. There is no way for the public to know who is doing a good job and who isn't.

Because of these impediments, modifications are making only a modest dent in the foreclosure problem. Other remedies will be discussed in a future article.

Jack Guttentag is professor of finance emeritus at the Wharton School of the University of Pennsylvania. He can be contacted through his Web site,

Thursday, April 24, 2008

House Panel Approves Two Housing Bills; FHA Reform on the Floor

(Housing Wire) A House panel Wednesday approved two foreclosure-specific housing proposals, including one that would see $15 billion in federally-funded loans and grants given to local governments to purchase and rehab foreclosed properties, as part of a broader package of housing reform measures being pushed by House Democrats.

The House Financial Services Committee voted 38-26 in favor of H.R. 5818, the Neighborhood Stabilization Act of 2008, which would established a loan and grant program administered by the Department of Housing and Urban Development that would fund the purchase of foreclosed properties by local governments.

Funds would be distributed to areas with the highest foreclosure levels, and would be used to turn foreclosed properties into housing for low-income families.

The bill does not have the strong support of House Republicans, including Rep. Spencer Bachus (R-AL), who has said he thinks the bill incentives foreclosures and rewards lenders, investors and speculators in possession of the vacant and foreclosed property. Committee Chairman Barney Frank (D-MA), who strongly pushed for the bill’s passage, has said that he believes the bill contains protections that will prevent its abuse.

Earlier Wednesday, the House panel also passed H.R. 5579, the Emergency Loan Modification Act, without a vote. The proposed bill would seek to shield mortgage servicers from legal liability arising out of bulk loan modifications that may violate existing Pooling and Servicing Agreements, and is strongly opposed by many industry groups.

Congressmen Michael N. Castle (R-DE) and Paul E. Kanjorski (D-PA) originally introduced the bill in mid-March.

“I think it’s in the best interests of at-risk homeowners and investors to work out payment terms that give a homeowner financial stability and the investor some return for their investment,” said Castle. “Without this legislation, I am concerned that lawsuits could bring modifications to a halt.”

FHA reform work begins
The House Financial Services Committee begins work today on FHA reform via the H.R. 5830, FHA Housing Stabilization and Homeowner Retention Act. The bill would allow the Federal Housing Administration to back as much as $300 billion in refinanced loans for homeowners who are facing foreclosure, a move that its supporters say would help troubled borrowers stave off foreclosure.

Early debate from House panel members on Thursday morning focused on counseling requirements, with local lawmakers suggesting that more Federal funds would need to be appropriated for troubled borrower counseling — some House representatives even argued that new Federal funds were needed to fund consumer attorneys who would defend homeowners against foreclosure and eviction actions.

“These people are at the mercy of the lender and servicers in this case,” said Rep. Melvin Watt (D-NC). “They don’t have the legal background that the lenders have needed to defend themselves.”

Watt said consumer counseling doesn’t help borrowers completely, and that he wanted funds appropriated from the Neighborhood Reinvestment Corp. to fund the defense of foreclosure and eviction actions.

Frank voiced supported the proposed amendment as well, in a heated exchange between Housing Republicans and Democrats that set off what is expected to be over a weeks’ worth of discussions covering FHA reform.

“Some legal work is necessary,” Frank said. “The emphasis here is on legal work, not advocacy work.”

Death to the servicers!

(Naked Capitalism) As the housing/mortgage crisis has progressed, homeowner advocates and legislator have to get mortgage servicers to offer more loan modifications to struggling borrowers. Even though this housing recession has a far higher proportion of borrowers seriously underwater than past downturns, the logic of loss mitigation is still valid. It's still better for the bank to keep the homeowner in place, even at a reduced payment, than foreclose (although in some communities where home valued have plummeted, the banks seem content for the moment not to take action against defaulting debtors).

Some observers have taken the view that it's impractical for banks to negotiate on a case-by-case basis (gee, that's how they used to make loans and do workouts before they decided to go for efficiency at the expense of quality). And that may be a valid objection: serivcers are factories. Even by some affordable housing experts report that they are unable to do one-offs.

Another impediment is that securitized transactions often limit the ability of the servicer to do loan modifications (although no one seems to have good estimates on how often that is operative).

Last year's Treasury sponsored Hope Now Alliance was a cosmetic rescue program to address those issue, offering a "one-size-fits-few" template that was anticipated to offer servicers a legally defensible ground for making mods. However, few have happened.

Now legislators are considering another approach: require servicers to attempt loss mitigation before foreclosing. From Credit Slips:
n my prior post on mortgage servicing, I talked about the potential of mortgage servicers to be harmful barriers between homeowners and investors, both of whom may want to negotiate a loan modification. Recognizing such a problem raises the question of a solution. U.S. Representative Maxine Waters recently introduced legislation that would profoundly alter the duties of mortgage servicers. The bill, HR 5679, The Foreclosure Prevention and Sound Mortgage Servicing Act of 2008, would prohibit the initiation of a foreclosure if the mortagee or servicer has failed to engage in "reasonable loss mitigation activities." The bill lays out exactly what counts as loss mitigation and offers up non-binding guidance on standards of affordability for loss mitigation. Servicers would have to report data on their loss mitigation activities, disaggregated by the type of mitigation activity (separately accounting for things like modifications, deeds in lieu of foreclosure, or repayment plans).

The bill also takes aim at the communication problems between servicers and homeowners. The bill requires services to provide a toll-free number that provides borrowers with direct access to a person with the information and authority to fully resolve issues related to loss mitigation and specifies that such a person must be physically located in the United States. Servicers are also required to forward borrower's information to HUD-certified housing counselors whenever a borrower is 60 days or more overdue.

In the hearing last week on the bill (which you can watch as an archived webcast), Chairwoman Waters kept returning to a fundamental point--mortgage servicing is an unregulated industry. The witness testimony was essentially unanimous that mortgage servicing has a tremendous impact on American families and on the resolution of the current crisis. Of course, the debate was over whether this regulation was the right approach. The bill hasn't gotten much publicity yet, but I encourage readers who are interested in the foreclosure crisis to take a look and post their feedback.

Mind you, I skimmed the text only quickly, but several thing stood out. This bill is clearly thought out, and is tough. Not only do the servicers have reporting obligations as discussed, but there are explicit requirements regarding communication with the borrower. For instance:
`(2) INCOME USED IN DETERMINING AFFORDABILITY- In making a determination of affordability for purposes of this subsection, a mortgagee or servicer shall use the income information furnished by the borrower at the time of loan origination, except that the borrower or mortgagor may elect to provide the mortgagee or servicer with current information and, if so provided, such current income information shall be used for purposes of determining affordability. The mortgagee or servicer shall advise the borrower or mortgagor of any right under this paragraph to provide current income information. If current income information is used, all sources of income shall be verified by tax returns, payroll receipts, bank records, or other third-party verification; the best and most appropriate documentation shall be used....

`(4) WRITTEN NOTIFICATION OF AFFORDABILITY CALCULATION- The mortgagee or servicer shall notify the borrower or mortgagor in writing of the results of the determination of affordability under this subsection and the income on which the determination was based. Such written notice shall be provided by mail not later than 7 business days after such action is taken or as part of the written notice required under subsection (c)(1), whichever is earlier.

The bill also permits servicers to recover "reasonable fees" (although they are subject to review) and applies to any "federally related mortgage loan that is secured by a lien on the principal residence of the borrower or mortgagor" that defaults after the bill is enacted.

My initial reaction is schadenfreude: the industry has brought this sort upon themselves. If it can't figure out a way to do mods despite the mounting pressure to do so (and in cases where a mod might be possible, lose/lose to borrower and investor for failure to do so), it will be imposed on them, and as this bill delineates, in a way that offers them little wriggle room. My second is that it won't be passed; there appears to be no Senate version of this bill. My third is that that's a shame, the credible threat of the passage of a measure like this would light a fire under servicers (although that might only be to mobilize lobbying against it).

But to the more serious question: is this bill a good idea? Given the track record so far, it may be that servicers need something this confining to force them to act, and to give them cover with their investors to do so. Mods, however, typically favor certain tranches over others, so this might produce some sharp repricings.

Moreover, even if the team at the servicer has the best of intentions, it has to start with the mit plan from the income records at the time of the loan. With no docs, low docs, and generally lousy standards, that information is generally terrible. And while the debtor can provide current information, it isn't clear they will be forthcoming. Servicers aren't particularly well liked or trusted in borrower land.

But as much as I have little sympathy for companies that made a lot of money during the gravy days of the housing bubble and now plead poverty as an excuse for inaction, this bill would an industry under stress to the wall. It will have to incur the costs of notification and reporting for all defaulting borrowers, but will be able to collect fees only out of continuing cash flow from the borrower or a foreclosure sale. Most of these activities (setting up a call center, creating methods, forms, and supporting systems for borrower communication and regulatory reporting) have high fixed and low variable costs. It will be hard to determine the right fee levels up front (and you can't readily go back if you got it wrong). And its quite possible the fees will look disproportionate, even if they are costed properly.

Plus there's a big cash flow problem: the costs are incurred up front, the fees recovered over time. And servicers are already having big time cash flow problems. I have been told that servicers, which in most cases are part of large banks, are hemorrhaging cash. Notes from a conversation with informed parties:
The servicer has guaranteed to pay whatever interest is promised to the investors for at least 90 days after default. Some agreements also require them to pay principal during that period. Even after the 90 days, the servicer has to continue to pay real estate taxes and insurance. The servicer can use any late payment or other penalties from the borrower to offset these costs.

The idea was that if you were good at collecting and efficient at serciving, the overcollateralization would give you enough of a cushion. But they assumed 5% loss rates, not 20%.

And the cash flow drain is worse in prime or mixed pools than in subprime pools. The defaults relative to assumptions are far worse there.

As we noted, the banks will probably dodge this bullet. But a measure like this is an indicator of how sentiment about regulation is changing, Expect to see more tough-minded proposals, some of which will stick.

Wednesday, April 23, 2008

The Future of Mortgage Servicing

(Housing Slips) In my prior post on mortgage servicing, I talked about the potential of mortgage servicers to be harmful barriers between homeowners and investors, both of whom may want to negotiate a loan modification. Recognizing such a problem raises the question of a solution. U.S. Representative Maxine Waters recently introduced legislation that would profoundly alter the duties of mortgage servicers. The bill, HR 5679, The Foreclosure Prevention and Sound Mortgage Servicing Act of 2008, would prohibit the initiation of a foreclosure if the mortagee or servicer has failed to engage in "reasonable loss mitigation activities." The bill lays out exactly what counts as loss mitigation and offers up non-binding guidance on standards of affordability for loss mitigation. Servicers would have to report data on their loss mitigation activities, disaggregated by the type of mitigation activity (separately accounting for things like modifications, deeds in lieu of foreclosure, or repayment plans).

The bill also takes aim at the communication problems between servicers and homeowners. The bill requires services to provide a toll-free number that provides borrowers with direct access to a person with the information and authority to fully resolve issues related to loss mitigation and specifies that such a person must be physically located in the United States. Servicers are also required to forward borrower's information to HUD-certified housing counselors whenever a borrower is 60 days or more overdue.

In the hearing last week on the bill (which you can watch as an archived webcast), Chairwoman Waters kept returning to a fundamental point--mortgage servicing is an unregulated industry. The witness testimony was essentially unanimous that mortgage servicing has a tremendous impact on American families and on the resolution of the current crisis. Of course, the debate was over whether this regulation was the right approach. The bill hasn't gotten much publicity yet, but I encourage readers who are interested in the foreclosure crisis to take a look and post their feedback.

Subprime Mortgage Litigation Continues to Explode

(Housing Wire) The number of subprime mortgage-related cases exploded in the first quarter of 2008, increasing 85 percent from the fourth quarter of 2007. A staggering 170 cases were filed during the quarter, enough to approach the 181 subprime-driven filings recorded over the final six months of 2007, according to a study released Wednesday by Navigant Consulting, Inc (NCI: 20.00, +5.49%).

“Like the credit crunch itself, the litigation is unrelenting,” said Jeff Nielsen, Managing Director of Navigant Consulting. “In this most recent quarter, we are looking at approximately two filings per day, including weekends. What we saw in 2007 was a mild breaking wave compared to the tsunami we are witnessing now.”

Over a 15-month span ending in March, the number of subprime-related cases filed totaled 448, up from 278 previously reported at year-end 2007.

“The cases are piling up at a rather prodigious rate and, at this point, appear to be going nowhere fast,” said Nielsen. “Like the S&L cases, this is a process that will likely take years to play out.”

The first quarter cases were comprised of borrower class actions (46 percent), securities cases (26 percent), and commercial contract disputes (10 percent), among other case types. Class actions accounted for 76 percent of the 170 cases filed in the first quarter; however, there were also some atypical plaintiffs entering the subprime litigation scene, such as municipalities like Baltimore and Cleveland.

The report found that in 42 percent of the filed 448 cases, at least one Fortune Global 500 company was named as a defendant. Ten percent of the cases named at least one non-U.S. Global 500 company as a defendant, with U.K. firms accounting for approximately half of the non-U.S. total.

Geographically, approximately half of the first quarter cases are still being filed in California and New York courts.

For more information, visit

Subprime Mortgage Losses: Not Destined to Pitch World into Abyss, After All

( Here’s a question for the subprime mortgage geeks in the house: which is bigger, the dollar amount of realized losses on 2006-vintage subprime mortgages, or the dollar amount of loans that have been repaid?

Take your time; I’ll get to the answer in a minute. The reason I ask in the first place, though, is that the question is a good first step in getting at a reasonable estimate of how high cumulative losses from the subprime mortgage debacle will ultimately be. That happens to be a number, you’ll agree, an awful lot of people on Wall Street are interested in knowing. Yet estimates are all over the place. For its part, Moody’s says its best guess for eventual 2006-vintage losses is between 14% and 18% of originations. Its “stress case” is more like 21%. Some of the more hysterical numbers I’ve read put the eventual cumulative loss at 80% or more.

It’s hard to not get the impression that people are using all kinds of methods to estimate, some sensible and some not, while others are simply sticking their fingers in the air.

But I believe it is possible at this point to get to a reasonably accurate cumulative loss estimate. How? By looking at the credit performance of the $120 billion of bonds that make up the ABX subprime mortgage indices (in particular, by looking at the bonds that underlie the ABX indices created in 2006, when the lending looniness was at its peak) and extrapolating to the market at large. On the one hand, the bonds were hand-picked to represent the market overall; they should behave the same way the market does. On the other, they constitute a small enough universe that an analyst trying to glean future credit performance can take into account details such as loan-to-value ratios and loan originator.

Bond by bond

So we’ve gone through 2006-vinatge ABX bonds in a fair amount of detail to arrive at an eventual cumulative loss estimate. And (not to give away the ending completely) the number is materially lower than the base cases the agencies have in mind, and much, much lower than the apocalyptic predictions you keep hearing on CNBC.

I’ll get to the details in a second. But first, the answer to my question: which is bigger, realized losses or paydowns on the class of 2006? It’s not even close. Of the $600 billion or so of subprime mortgages originated in 2006 (again, by the lights of what have gone on with ABX bonds), $282 billion have already been repaid, while realized losses have come to just . . . $12 billion.

Surprised? Understandable. That’s not to say, of course, that that $12 billion of realized losses to date isn’t destined to balloon to a much bigger number, and that the ultimate losses on the 2006 vintage won’t be many times higher than the subprime losses of prior years. Of course they will. It does, though, give some perspective on how to most accurately predict what the future will bring.

Anyway, allow me to walk you through how I came up with a loss number I believe will turn out to be reasonably accurate, and not especially scary.

We’ll start at the beginning. First, take the $600 billion in subprime loans originated in 2006 and put them into three imaginary piles: 1) loans that have been paid down, 2) loans that have already resulted in losses, and 3) balances still outstanding.

OK? We already know what the losses are on 1 and 2. They are, respectively, $0 and (as I’ve already mentioned) $12 billion.

So the question as to ultimate losses on the 2006 vintage comes down to what happens to 3, the $306 billion in balances outstanding. And actually, we have a pretty good idea what will happen to a big portion of those loans, as well. Of the $306 billion, $100 billion is delinquent by 60 days or more. As any subprime-mortgage banker will tell you, once a loan gets past 60 days past due it’s pretty much doomed these days. So we’ll assume that fully 93% of those delinquent loans go into foreclosure (a much higher rate than is typical, but hardly uncommon recently) and generate a loss severity of 45% (compared to last year's rate of 35%). Estimated losses from past-due 2006 outstanding balances, therefore: $42 billion.

$206 billion performing

That leaves the $206 billion of outstanding balances that are still performing. Obviously, some of those are destined to default, as well. The question that has the financial markets transfixed is: how many?

To get an answer, I looked at which lenders originated the remaining performing loans, where the properties are located, and other relevant factors, and extrapolated past performance into the future. I came up with an estimate that 26% of remaining loans now current will eventually default, which will in turn lead to (again, assuming a 93% roll rate into repossession and 45% severity) $23 billion in losses. The other, 74% of the remaining outstanding balances will sooner or later pay down. The losses from those loans will of course be zero.

So. Let’s add up all the actual and estimated losses and see how the numbers shake out. Here goes:

Realized 2006-vintage subprime losses to date: $12 billion

Estimated future losses on outstanding balances 60 days or more past due: $42 billion

Estimated losses on outstanding balances still current: $23 billion.

Add those three numbers up, and you get $77 billion in cumulative realized losses on the 2006 vintage. Divide it by originations and you come to a loss rate of . . . .

Actually, before I get to that number, let’s go back and revisit the loss estimates the rating agencies and the bears have in mind. Moody’s base case for 2006 losses, recall, is between 14% and 18%. Its stress case is 21%. Fitch’s stress case is 21%, as well, while S&P’s is 18.8%. The Charlie Gasparino/Bill Ackman/George Soros Axis of Doom, meanwhile, surely has a number in mind that is much, much higher.

$77 billion in expected losses

But, as we’ve seen, if you actually go through the numbers trust by trust, look at what’s happened so far, and make some conservative assumptions about what will happen in the future, you get to estimated total losses of $77 billion. Divide that by the $600 billion in 2006 originations and you get to a total loss rate of just 12.8%. That’s well short of Moody’s base case, and nowhere near the stress cases that the agencies have put out.

You might object to some of my numbers here. Fine, but you can only object to a few of them. You can’t dispute, for example, that nearly half of the subprime class of 2006 has already been paid down, for instance, or that, of the remaining balances, roughly two-thirds are still performing. Those are simply facts.

You might, on the other hand, argue that my 45% severity assumption is too low, or that more than 93% of 60-plus-day delinquent loans will eventually roll into foreclosure. In fact, that’s what Zach did. But even if you assume delinquency roll rates that are even more severe than the elevated numbers I'm using, as he did, you still only come up with an ultimate loss rate of just shy of 16%. As far as that goes, UBS, the only firm on the sell-side that’s analyzed the credit performance of the ABX bond by bond, uses loss estimate embedded in the price of the ABX itself and comes to an estimate of 18%.

It’s notable, I believe, that all these numbers, even the ones based on hyper-severe assumptions, aren’t terribly different from one another. And it’s even more notable that they’re all well short of the agencies’ base cases, let alone their stress cases.

Or let’s turn things around. How bad would things have to get for the Moody’s base case to actually happen? Unbelievably bad—literally. The 16% midpoint of Moody’s base case translates into $96 billion in eventual losses. Twelve billion dollars has already happened. Fine. But, as we’ve seen, $282 billion of the $600 billion in 2006 originations has already been paid down. Those loans won’t default. Of the $306 billion that’s still outstanding, $100 billion is seriously delinquent. We have a good idea of what’s in store for those loans; they’ll likely generate another $42 billion in losses. That still leaves us $42 billion short of the $96 billion needed to get to a 16% loss. By definition, it can only come from the $206 billion in remaining, performing loans. If you assume 50% severity, that means that of the remaining performing loans—the strongest horses in the field so far—fully 41% would have to default.

Stress case losses would be stratospheric

And that’s just to get to the base case. To get to the agencies’ stress cases of a 21% cumulative loss, 71%--yes, that number starts with a “7”--of the remaining performing loans would have to go bad.

I don’t buy it. I don’t buy it, in particular, because at the margin the news from the subprime mortgage credit front seems to be improving. The rate of loans moving from current to 30-days delinquent has slowed over the past few months. And the rates at which delinquent loans are rolling into later-stage buckets seems to have stabilized. It’s as if—can you believe it?—things have finally stopped getting worse. That’s something else you won’t be hearing on CNBC anytime soon.

For months now, investors’ default habit has been to assume the worst regarding subprime mortgage credit. It’s been the profitable habit, too. But this whole time, people seem not to have noticed that a lot of subprime borrowers have paid down their loans completely, and that most others are still current. Guess what? That will keep on happening. And as it does, the subprime mortgage crackup will at last come to an end. In the end, I suspect, the wild-eyed losses being thrown around by the bears will turn out to be way, way off the mark. Don’t take my word for it. Just look what’s happened to the 2006 vintage so far.