Thursday, April 30, 2009

House Committee Gives Go Ahead on Mortgage Reform

Posted on the Housing Wire by Kelly Curran:

The House Financial Services Committee approved legislation today that may potentially bring sweeping changes to the way the mortgage industry conducts business.

HR1728 or the Mortgage Reform and Anti-Predatory Lending Act, aims to curb forms of lending that have been a major factor in the highest home foreclosure rate in the nation in 25 years, the committee said in a statement.

“The bill would ensure that mortgage lenders make loans that benefit the consumer and prohibit them from steering borrowers into higher cost loans,” the Committee says. “It would establish a simple standard for all home loans: institutions must ensure that borrowers can repay the loans they are sold.”

The sponsor, Brad Miller (D-NC), and the committee called it a tougher version of the bill approved by the House in 2007 but never passed by the Senate. Among the current bill’s loaded provisions approved by the Committee is a risk retention provision, holding creditors responsible, to some extent, for the loans they originate.

In testimony Thursday before the committee, the Mortgage Bankers Association (MBA) chairman David Kittle said a risk retention provision could make it impossible for many lenders to compete, among other faults.

But as the legislation stands, creditors would be required to retain an economic interest in a material portion — at least 5% — of the credit risk of each loan that the creditor transfers, sells, or conveys to a third party. Federal banking agencies would, however, have the authority to make exceptions to the bill’s risk retention provisions, including form and amount.

HR1728 would also ban yield spread premiums and other “abusive compensation structures” that create conflicts of interest, protect tenants who rent homes that go into foreclosure and encourage the market to revert back to originating fixed-rate, fully documented loans.

The House of Representatives is expected to consider HR 1728 as soon as next week.

Wednesday, April 29, 2009

Yet Another Program to Enrich Banks at Taxpayer and Borrower Expense

Posted on Naked Capitalism:

The latest bit of looting fobbed off as a win for homeowners is a program to shovel money to second mortgage lenders:
The Obama administration unveiled a new program to help borrowers with second mortgages stay out of foreclosure, offering cash to servicers, investors and borrowers who modify loan terms.

Guess what? Plenty of seconds are under water and have NO economic value. But they play like pigs in foreclosure and renegotiations. So this program will validate values above market value for these homes and unnecessarily enrich second mortgage holders, who otherwise would have to eat their losses.

Elizabeth Warren wrote about it last November:
"Hostage value" in secured lending refers to the ability of a secured lender to extract a payment in excess of the value of the collateral from a borrower by threatening to reposses the collateral. The classic example was the old practice of taking a security interest in all of a family's household goods, which might add up to a resale value of $2000, then demanding that every penny (plus interest) of a $10,000 loan be repaid before the security interest would be released. This version of the practice involving household goods is now banned by the FTC. In bankruptcy law, undersecured claims would be bifurcated into its secured ($2000) and unsecured ($8000) portions.

Rescue programs limit their payouts to 100% of the value of the property, which makes sense both to protect the fund and not to reward the mortgage lenders by paying them more than they could get for the house if the family gave it back to the lender. But the mortgage lenders want more. If they don't get it, they won't release the mortgage--even though the lenders won't get anything close to 100% of the value of the home if they are forced to foreclose. They hold the home hostage: Pay the amount the mortgage company wants or move out of the house. Some families will find the money to pay, and others will lose their home.

The mortgage lenders are counting on the leverage of their hostage taking to do better than 100% payment. So long as they hang on. rescue efforts are irrelevant and renegotiation won't work.

The bankruptcy amendments that passed the House this week would break the hostage value of the home. The amendment would give families a chance to negotiate deals that would take them out of ruinous mortgages and let them get into something that is affordable--with or without a rescue plan. The mortgage industry oppses the bill, saying it will decide "voluntarily" when they will or will not turn a homeowner loose--which is another way of saying they want to hang on to the hostage value.

The new Treasury program is being spun as a benefit to first mortgage holders, but I am skeptical. As Warren made clear, the remedy is cramdowns, writing the value of the property down to current market value and treating any surplus mortgage amount as unsecured debt. This is standard process in corporate bankruptcies, and no one has a problem with it there, but it is treated as a heinous idea for residential property. More from Bloomberg:
The program is primarily aimed at borrowers who are “underwater,” owing more on their mortgages than their homes are worth.

No other legislative changes are required for the administration’s revised housing plans to take effect, the officials said.

The new measures may ease mortgage investors’ concerns that the biggest banks and servicers would be tempted to rework too many loans under the program in order to bolster their home- equity portfolios, Laurie Goodman, an analyst at Amherst Securities Group LP in New York, said in a telephone interview.

“Certainly, it appears that the Treasury has listened to first-lien investors,” Goodman said. Today’s announcement “goes a very long way toward addressing their objections,” she said.

The second-lien program should be up and running in about a month, the officials said. They estimated that about 75 percent of all U.S. mortgages are managed by servicers that already have agreed to participate in the government’s modification programs. Servicers are administrators in the relationship between lenders and borrowers.

The mortgage initiative offers subsidies to servicers and lenders, including bond investors, to help lower borrowers’ housing payments to 31 percent of their income. Because modifications are voluntary, the Treasury is offering incentive fees to encourage participation in the program.

The $12,000 in possible incentive fees has several components. Many of the fees are paid over time, as an incentive for borrowers and servicers to strike deals that will last.

When modifying first mortgages, servicers can receive $1,000 up front, and $1,000 per year for three years. If the mortgage being modified is eligible and not yet delinquent, they can also receive $500, for a maximum possible total of $4,500.

This is just more bells and whistles and expense pursuing the wrong course of action. Mortgage cramdown would take care of much of this, and the threat of this as an option would cut down investor and servicer unresponsiveness (although I have been told that in BK, the lowest tranches take the hit first, while in a mod, the writeoff is distributed across the tranches, so this bit of tranche warfare has been ignored. And since the servicers often have parents that hold top tranche paper, this all appears unlikely to work, or more accurately, to guarantee activity designed to establish that it won't work).

It was three plus years into the Depression until Gordian knots like this got cut. However, with Obama having put his name on programs to help the banksters, I wouldn't hold my breath that we will see course changes even when Plan A is revealed to be failing.

Tuesday, April 28, 2009

Doing the Homework

Posted on Portfolio.com by Ryan Avent:

A lot of recent financial innovation has been defended on grounds that it improved the flow of credit or made credit easier to obtain. But increasingly it seems that it did this by allowing everyone to stop doing their homework. Magical de-risking processes made the need to do homework before investing unnecessary. Magical hedging formulas did the same thing, and saved lenders the trouble of caring when a borrower got in trouble. The financial system became like a fancy new car -- full of top-of-the-line safety features, traction control, ABS, and so on. And like drivers who seem so effortlessly in control and completely safe that they forget how deadly two tons of steel traveling at 80 miles per hour can be, market participants were lulled into forgetting how dangerous finance can be.

Posted on Rortybomb:

The homework [he] are talking about about is the soft-skills part of mortgage applications, the part of the mortgage application that isn’t just a function of your FICO score and a few quantifiable variables. The soft-skills part has almost entirely been replaced by quantification over the past decade. Part of the move in this direction is the (rightly at a certain point) fear that those soft-skills were cover for racism. Part of the move is that the costs of deploying soft-skills when handling loans at large firms is too high once banks get too big. And of course, another suggestion is that the quantification process, FICO and the like, had gotten so good that they could save the costs on this homework part.

How can we tell if the third part is true? One interesting test, using a regression discontinuity method, is to see how the behavior of defaults looked around the securitization checkoff line. A FICO score of 620 was the cutoff for most loans - if your loan was 619, you couldn’t be resold to an investment bank in a CDO. At 621 you could. This number was picked arbitrarily by the GSEs in the 1990s, and kept by the hedge funds and investment bankers in the 2000s who were trading the stuff. Since it is arbitrary, a FICO score at 621 is just marginally better than 619. There is no magical jump there in terms of how FICO is measured at that point.

So check out these two charts from the paper Did Securitization Lead to Lax Screening? Evidence From Subprime Loans (Benjamin J. Keys, Tanmoy Mukherjee, Amit Seru, Vikrant Vig), reproduced in their powerpoint presentation:

The only difference between the 619 and the 621, besides a marginal increase in credit quality, is that the 619 had more soft skills used in it and it was very likely that the loan would not be resold but instead would stay on the originating bank’s balance sheet. So in the first chart we should expect 621 to have a slightly lower delinquency rate than the 619. If your FICO is 621, you are 2 points more credit trustworthy than 619. Instead we see a much higher rate. It is even more dramatic with the 615-619 versus the 620-624; the 620-624 should have a lower rate of delinquency, since they have a higher FICO score and are less of a credit risk. Instead we see the exact opposite.

The powerpoint is very interesting, and worth a few minutes of your time. This should cast some doubts on how much large banks can provide social utility by replacing the soft skills, the comparable advantage of small and mid-sized banks, with number-crunching computers, Ivy-Leaguers and giant bonuses.

Quick Update: There are some concerns, in the comments and at Business Insider, that one can game one’s FICO scores. Three quick points. The bank lending can’t alter the FICO score - they just type in your SSN and it shows up.

Two, picture you are a borrower without any qualms who wants to game the loan procedure, and the broker says “We need you to state your income and occupation, but we won’t verify it. Also you need to make $100,000 a year to get this loan. What do you make?” You would respond “What a coincidence! I’m a football player/astronaut, and my salary is $101,000 a year.” Gamed!

If your FICO is 619, it isn’t really easy to do some quick things to make it 621, provided you don’t rob a liquor store to pay off your credit card balance. There’s a time lag, and as anyone who wants to improve their FICO can tell you, the movements can feel arbitrary in the short run. Now if you do pay off your credit cards and make consistent payments on your bills for 6 months, and your FICO goes up, you haven’t gamed the system - you are actually more credit reliable (according to the algorithm).

This Infosys paper on subprime and credit risk measurement has a good illustration (emphasis by Tracy Alloway in FT Alphaville):

In 2006, a large Wall Street firm solf a $1.2bn sub-prime loan portfolio in which the borrowers had an average FICO score of 631, within the upper range of subprime borrowers. Around the same time another portfolio was sold by another large mortgage company with borrowers scoring an average of 600, putting them in the depths of sub-prime. The investors were told that based on the credit cut off scores, the portfolio sold by [the] Wall Street firm was less risky. But 18 months into both pools lives, 15% of the borrowers defaulted in the first case while only 4% in the second case. The reason given was poor documentation for the former case — which obviously was not taken into consideration during the process of creating tranches. Clearly cut off scores are not sufficient. They rate an individual’s risk over time but do not necessarily provide the best assessment of credit risk of the loan, still that of a portfolio.

US Treasury Announcement on Home Affordable Program 2nd Lien Tweak

WASHINGTON – The Obama Administration today announced details of new efforts to help bring relief to responsible homeowners under the Making Home Affordable Program, including an effort to achieve greater affordability for homeowners by lowering payments on their second mortgages as well as a set of measures to help underwater borrowers stay in their homes.

"With these latest program details, we're offering even more opportunities for borrowers to make their homes more affordable under the Administration's housing plan," said Treasury Secretary Tim Geithner. "Ensuring that responsible homeowners can afford to stay in their homes is critical to stabilizing the housing market, which is in turn critical to stabilizing our financial system overall. Every step we take forward is done with that imperative in mind."

"Today's announcements will make it easier for borrowers to modify or refinance their loans under FHA's Hope for Homeowners program," said HUD Secretary Shaun Donovan. "We encourage Congress to enact the necessary legislative changes to make the Hope for Homeowners program an integral part of the Making Home Affordable Program."

The Second Lien Program announced today will work in tandem with first lien modifications offered under the Home Affordable Modification Program to deliver a comprehensive affordability solution for struggling borrowers. Second mortgages can create significant challenges in helping borrowers avoid foreclosure, even when a first lien is modified. Up to 50 percent of at-risk mortgages have second liens, and many properties in foreclosure have more than one lien. Under the Second Lien Program, when a Home Affordable Modification is initiated on a first lien, servicers participating in the Second Lien Program will automatically reduce payments on the associated second lien according to a pre-set protocol. Alternatively, servicers will have the option to extinguish the second lien in return for a lump sum payment under a pre-set formula determined by Treasury, allowing servicers to target principal extinguishment to the borrowers where extinguishment is most appropriate.

Separately, the Administration has also announced steps to incorporate the Federal Housing Administration's (FHA) Hope for Homeowners into Making Home Affordable. Hope for Homeowners requires the holder of the mortgage to accept a payoff below the current market value of the home, allowing the borrower to refinance into a new FHA-guaranteed loan. Refinancing into a new loan below the home's market value takes a borrower from a position of being underwater to having equity in their home. By increasing a homeowner's equity in the home, Hope for Homeowners can produce a better outcome for borrowers who qualify.

Under the changes announced today and, when evaluating borrowers for a Home Affordable Modification, servicers will be required to determine eligibility for a Hope for Homeowners refinancing. Where Hope for Homeowners proves to be viable, the servicer must offer this option to the borrower. To ensure proper alignment of incentives, servicers and lenders will receive pay-for-success payments for Hope for Homeowners refinancings similar to those offered for Home Affordable Modifications. These additional supports are designed to work in tandem and take effect with the improved and expanded program under consideration by Congress. The Administration supports legislation to strengthen Hope for Homeowners so that it can function effectively as an integral part of the Making Home Affordable Program.

Making Home Affordable, a comprehensive plan to stabilize the U.S. housing market, was first announced by the Administration on February 18. The three part program includes aggressive measures to support low mortgage rates by strengthening confidence in Fannie Mae and Freddie Mac; a Home Affordable Refinance Program, which will provide new access to refinancing for up to 4 to 5 million homeowners; and a Home Affordable Modification Program, which will reduce monthly payments on existing first lien mortgages for up to 3 to 4 million at-risk homeowners. Two weeks later, the Administration published detailed guidelines for the Home Affordable Modification Program and authorized servicers to begin modifications under the plan immediately. Twelve servicers, including the five largest, have now signed contracts and begun modifications under the program. Between loans covered by these servicers and loans owned or securitized by Fannie Mae or Freddie Mac, more than75 percent of all loans in the country are now covered by the Making Home Affordable Program.

Continuing to bolster its outreach around the program, the Administration also announced today a new effort to engage directly with homeowners via MakingHomeAffordable.gov. Starting today, homeowners will have the ability to submit individual questions through the website to the Administration's housing team. Members of the Treasury and HUD staffs will periodically select commonly asked questions and post responses on MakingHomeAffordable.gov. To submit a question, homeowners can visit www.MakingHomeAffordable.gov/feedback.html. Selected questions from homeowners across the country and responses from the Administration will be available at www.MakingHomeAffordable.gov/asked-and-answered.html.

For additional details on the program announced today, please see the Program Update Fact Sheet.

REPORTS

Second-Mortgage Holders Are Target of Obama Administration Plan

Posted on Bloomberg by Rebecca Christie:

The Obama administration will offer a new program today to help borrowers with second mortgages stay out of foreclosure, along with revisions to other government loan-modification programs, administration officials said.

The goal is to make it easier for homeowners to seek help with second liens such as home-equity loans, said the officials, who declined to be identified before the announcement. The new program will provide cash to mortgage servicers, investors and borrowers who modify the terms of a loan and show success with the new payment schedule.

The administration has offered a series of initiatives in efforts to stem the collapse in home values and the rise in foreclosures. Mortgage delinquencies increased to a seasonally adjusted 7.88 percent of all loans in the fourth quarter, the highest in records going back to 1972, the Mortgage Bankers Association in Washington said March 2. Loans in foreclosure rose to 3.3 percent, up from 2.04 percent a year earlier.

The proposals to be announced today by the Treasury and the Housing and Urban Development Department will have eligibility standards similar to the Obama administration’s existing mortgage-modification program.

Fannie Mae and Freddie Mac, the government-backed mortgage finance companies, will administer the new initiative. Funds will come from $75 billion already set aside by the administration for housing. That includes $50 billion from Treasury’s Troubled Asset Relief Program, supplemented by $25 billion from Fannie Mae and Freddie Mac.

Second Liens Adjusted

Under the new plan, second liens will be adjusted automatically when a homeowner’s primary mortgage is altered through the federal program, the administration officials said in a telephone interview. The program also will include procedures under which second loans can be modified independently.

The program should be up and running in about a month, the officials said. They estimated that about 75 percent of all U.S. mortgages are managed by servicers that already have agreed to participate in the government’s modification programs. Servicers manage the relationship between lenders and borrowers.

Obama’s overall plan to reduce foreclosures by modifying mortgages targets as many as 4 million homeowners. As many as half of the participants in the mortgage-modification program may be eligible for the second-lien assistance, the administration officials said.

The mortgage initiative offers subsidies to servicers and lenders, including bond investors, to help lower borrowers’ housing payments to 31 percent of their income.

$2,500 to Servicers

The administration’s latest plan also aims to beef up the government’s Hope for Homeowners mortgage-aid program. That initiative, enacted during the previous administration, so far has helped only a handful of borrowers refinance their mortgages into government-backed Federal Housing Administration loans.

To improve results of Hope for Homeowners, the Obama administration plans to add an upfront incentive payment of $2,500 to loan servicers, the officials said.

The administration also intends to urge Congress to pass other changes to Hope for Homeowners to make it easier to use and more accessible, the administration officials said. The program is primarily aimed at borrowers who are “underwater,” owing more on their mortgages than their home is worth.

No other legislative changes are required for the administration’s revised housing plans to take effect, the officials said.

Bankruptcy Judges

The administration separately backs giving bankruptcy judges the ability to change mortgage terms, as provided under legislation passed by the House and now awaiting action in the Senate. The administration hasn’t taken a stand on so-called safe harbor provisions that would shield mortgage servicers from bondholder lawsuits.

The servicer protection is needed if the U.S. wants as many homeowners helped under Obama’s loan-modification plan as intended, a Bank of America Corp. executive said.

“If the government wants to go down a path of being all- inclusive of who would be eligible, then I think that’s required,” Barbara Desoer, head of mortgage, home equity and insurance at the Charlotte, North Carolina-based bank, said in an April 23 interview.

Monday, April 27, 2009

Q1 2009: Homeownership Rate at 2000 Levels

Posted on Calculated Risk:

The homeownership rate is back to the level of Q2 2000. So much for the homeownership gains of the last 8+ years. Gone.

This morning the Census Bureau reported the homeownership and vacancy rates for Q1 2009. Here are a few graphs ...

Homeownership Rate Click on graph for larger image in new window.

The homeownership rate decreased to 67.3% and is now back to the levels of Q2 2000.

Note: graph starts at 60% to better show the change.

The homeownership rate increased because of demographics and changes in mortgage lending. The increase due to demographics (older population) will probably stick, so I expect the rate to decline to the 66% to 67% range - and not all the way back to 64% to 65%.

The homeowner vacancy rate was 2.7% in Q1 2009.

Homeowner Vacancy RateA normal rate for recent years appears to be about 1.7%. There is some noise in the series, quarter to quarter, so perhaps the vacancy rate has stabilized in the 2.7% to 2.9% range.

This leaves the homeowner vacancy rate about 1.0% above normal, and with approximately 75 million homeowner occupied homes; this gives about 750 thousand excess vacant homes.

The rental vacancy rate was steady at 10.1% in Q1 2009.

Rental Vacancy RateIt's hard to define a "normal" rental vacancy rate based on the historical series, but we can probably expect the rate to trend back towards 8%. According to the Census Bureau there are close to 40 million rental units in the U.S. If the rental vacancy rate declined from 10.1% to 8%, there would be 2.1% X 40 million units or about 820,000 units absorbed.

This would suggest there are about 820 thousand excess rental units in the U.S.

There are also approximately 100 thousand excess new homes above the normal inventory level (for home builders) - plus some uncounted condos.

If we add this up, 820 thousand excess rental units, 750 thousand excess vacant homes, and 100 thousand excess new home inventory, this gives about 1.7 million excess housing units in the U.S. that need to be absorbed over the next few years. (Note: this data is noisy, so it's hard to compare numbers quarter to quarter, but this is probably a reasonable approximation).

These excess units will keep pressure on housing starts and prices for some time.

Saturday, April 25, 2009

No recovery seen for housing until late 2010

Posted on the OC Register:

Nobody has a bigger stack of housing data than the First American real estate information empire from Santa Ana. We figured we’d ask Sam Khater, an economist at First American’s CoreLogic unit, what’s up …

Us: What’s your sense of the health of our local housing markets?

Sam: The biggest factor is home-price depreciation. And until home prices begin to stabilize, the overall market will not stabilize. The great thing about home prices is that it conveys a lot of information about the health of the market. Tells us about the demand-supply dynamics. Until you see depreciation recede, the market will not recover. Given the fact that home prices exhibit memory and momentum, it will take time.

Us: How do we compare to the national market?

Sam: We group together the “sand states” — California, Nevada, Arizona and Florida — that are roughly in the same category with steep price depreciation. They all have a severe oversupply of housing. And, for parts of California and Florida — financing is restricted. There is no jumbo mortgage market.

California’s been in this downturn the longest; it’s been intense; but that’s one positive. Given the very low mortgage rates, affordability is much higher. Granted there’s affordability, but is the homebuyer really going to buy when you see rapid depreciation? And will lenders be reluctant to lend? Unfortunately, affordability is only a part of this. The housing downturn’s gone on in California for some time. The overall economic downturn’s been happening for just a year and a half, and that’s got a way to go.

The rest of the country is experiencing price declines. And they’re slowly catching up to the sand states. Like Rhode Island, that’s knocking on the door in terms of home-price depreciation.

Us: Will it take California-sized price losses to restart the national housing market? We seem to be enjoying a sales bump recently …

Sam: No, The bubble wasn’t as bad elsewhere as California. What you’re seeing in California is an uptick in distressed sales. All things being equal, the distressed sales will eventually wear off and sales will slow again.

I view the housing boom starting in 1997 when sales a prices began to move above historical trends. We have to remember what a normal year us. We’re not that far below, in terms of sales. You’ve got to view some of these housing numbers through a long-term series.

Us: What about all those homes with negative equity with borrowers owing more than their home’s worth? How to fix that?

Sam: We estimated at year’s end there were 8.3 million borrowers upside down. If you assume that the government gave them a modification — just for conversation’s sake, $100,000 per loan — that’s $830 billion. When we talk a lot about trillions, that’s not that much money. That’d solve the negative equity problem in the short run. But that’s like a Band-Aid on the Titanic; longer-run structural issues need lots of work, too.

Even if you solve negative equity, prices are falling so fast that a lot of people would be upside down again in six months. And if you’re upside down, you are vulnerable. And the biggest risk right now is job loss.

Us: Any glimmer of hope in the numbers?

Sam: Oversupply is declining — unsold inventory and months of supply. Supply is still high, it’s just starting to come down. You want supply and demand in equilibrium and demand will not increase any time soon.

Us: Bottom this year?

Sam: I think, absolutely, there first chance for any kind of housing recovery is late 2010. We’ll see some bumps from the stimulus and the economy will look somewhat better than it really is .But we won’t see any housing bottom — and I’m talking prices — until late 2010. To me, the price is the most important thing.

Friday, April 24, 2009

More Servicers Approved for Treasury Funds

Posted on the Housing Wire by Kelly Curran:

Four more institutions joined the list of servicers set to receive Troubled Asset Relief Program (TARP) funds through the U.S. Treasury Department.

Bank of America, Countrywide Home Loans Servicing, Home Loan Services and Wilshire Credit became the eighth, ninth, tenth and eleventh firm to be pre-approved for TARP funds, under the Making Home Affordable loan modification system.

Simi Valley, Calif.-based Bank of America, will be allowed to draw up to $798.9m of government funds. Countrywide Home Loans has been promised a maximum of $1.86bn. Home Loan Services and Wilshire Credit can draw up to $319m and $366m, respectively.

The other seven servicers on tap to receive funds include Chase Home Finance (which was allotted the largest share thus far — up to $3.55bn), Wells Fargo Bank ($2.87bn), CitiMortgage ($2.07bn), GMAC Mortgage ($633m), Saxon Mortgage Services ($407m), Select Portfolio Servicing ($376m) and Ocwen Financial ($659m).

It’s unclear at this time how much of those allotted funds the institutions have actually received. The rate at which they’re stepping up to the deposit window — if at all — is unknown.

The Treasury bases investment figures on the size of each company’s servicing portfolios, however the government lender may adjust the actual dollar amount based on servicer usage. So far, program funds allocate a total of $13.92bn to the 11 servicers, just a fraction of the Treasury’s $75bn program to prevent foreclosures and help borrowers refinance into new loans.

The government plans to pay servicers a $1,000 one-time fee for modifying a mortgage down to a 38% payment-to-income ratio for five years. Modified loans must survive a 90-day trial in order to be eligible for the incentive payment. Government funds will also match the cost of further interest-rate reductions or other modifications to bring payments down to 31% of a borrower’s income. If borrowers perform in their newly-modified mortgages, servicers would be eligible to receive $1,000 per annum for three years under the government incentive program.

A Treasury spokesperson told HW that servicers are being added to the program on a rolling basis — suggesting this list is just the beginning, and other servicers are likely in the pipeline.

Thursday, April 23, 2009

Mortgage Bondholders Form Battle Lines Over Obama Housing Plan

Posted on Bloomberg by Jody Shenn:

The head of Greenwich Financial Services LLC warned bond investors in Washington last month that government efforts to reverse the housing slump are doing more harm than good by undermining debt contracts.

More than 30 money managers with stakes in the $6.7 trillion mortgage bond market that underpins the real-estate industry heard Bill Frey’s March 25 talk, according to a list of the attendees. Since then, a group of investors with home-loan bonds totaling more than $100 billion have hired Patton Boggs LLP, Washington’s biggest lobbying law firm, said Micah Green, a partner and former head of the Bond Market Association.

Bondholders are preparing for a fight over legislation approved last month by the House of Representatives that would shield companies that collect homeowners’ payments from lawsuits over modified mortgages, even if new terms harm investors. The government’s actions may increase borrowing costs because creditors would demand higher returns to compensate for the risk that once-sacrosanct investment terms can be changed, they say.

“Certainly some greater amount of loans should be restructured, but it is a fallacy to think that policymakers can selectively abrogate contracts without affecting future investor behavior,” said Frey, chief executive officer of Greenwich Financial, a mortgage-bond broker and investor in Connecticut. “We are actively exploring strategies with major investors to protect their rights,” he added in an e-mail.

Four Coalitions

Amherst Securities Group, an Austin, Texas-based firm that specializes in mortgage bonds, said it’s been asked to join four similar coalitions forming to fight the legislation or lobby against the details of President Barack Obama’s plan to cut borrowers’ payments.

Frey, 51, made his presentation at a bond investor conference with David Grais, a lawyer at Grais & Ellsworth LLP in New York, and Laurie Goodman, an analyst at Austin, Texas- based Amherst Securities and UBS AG’S former fixed income research chief. Attendees included representatives of Royal Bank of Canada’s Voyageur Asset Management Inc. and Thrivent Financial for Lutherans.

By “allocating losses to some place that’s not expecting it,” including state pension plans, college endowments and life insurers, those investors will demand more return to hold mortgage debt without government backing, if they buy at all, said Amherst Securities CEO Sean Dobson, whose firm trades home- loan bonds and advises clients about the securities. “Capital’s going to cost a lot more for a long time.”

Bonds Plummet

Prices of many mortgage bonds have plummeted in the past two years as delinquency rates on the underlying loans soared. Mounting losses from securities tied to subprime home-loans caused credit markets to seize up in August 2007, triggering a slowdown in the U.S. economy that spread around the world.

In the market for bonds backed by fixed-rate Alt-A loans, a category viewed as less risky than subprime mortgages, the safest securities typically traded at about 52 cents on the dollar last week, down from about 100 cents in mid-2007, according to a Barclays Capital report.

Fixing the mortgage market and stabilizing housing prices would help Obama end the worst U.S. recession since 1982.

The U.S. mortgage-finance system depends on bond investors. About 64 percent of the value of America’s home loans is bundled into bonds, a market that is 10 percent bigger than the sum of Treasuries outstanding. Mortgages account for 80 percent of consumer debt, and housing costs represent about 22 percent of the economy, Federal Reserve and Hoover Institution data show.

Jennifer Psaki, a White House spokeswoman, declined to comment on bondholder complaints about the government’s efforts.

Congressional Panel

An administration official who helped craft Obama’s plan said it only allows loan modifications that are permitted by the terms of the bonds the mortgages back and that are in debt holders’ best interests. The official spoke on the condition of anonymity because he isn’t authorized to discuss the issue publicly.

A congressionally appointed panel overseeing the U.S.’s $700 billion finance-industry bailout said in a March 6 report that government action is needed to encourage loan modifications because soaring foreclosures “injure both the investor and the homeowner.”

Mortgage delinquencies increased to a seasonally adjusted 7.88 percent of all loans in the fourth quarter, the highest in records going back to 1972, the Mortgage Bankers Association in Washington said March 2. Loans in foreclosure rose to 3.30 percent, also a record and up from 2.04 percent a year earlier.

Obama’s Plan

Obama’s $75 billion plan to reduce foreclosures by modifying mortgages targets as many as 4 million homeowners. Foreclosed properties helped drive down home prices in 20 U.S. cities by an average of 19 percent in January from a year earlier, the fastest decline on record, according to an S&P/Case-Shiller index.

The program, announced Feb. 18, is part of Obama’s efforts to shore up companies from General Motors Corp. to Citigroup Inc. and financial markets amid the first global recession since World War II. U.S. gross domestic product shrank 6.3 percent in the fourth quarter. Last month, the World Bank predicted the global economy would contract 1.7 percent this year.

The mortgage initiative offers subsidies to lenders, including bond investors, to help lower borrowers’ housing payments to 31 percent of their income. What troubles bondholders are the incentives for loan servicers, the industry middlemen who decide which loans will be reworked.

Servicer Fees

Servicers can get $1,000 for each modified loan under the plan, an additional $500 for every loan changed before borrowers fall more than two months behind and $1,000 annually for as many as three years of on-time payments.

At least six servicers have signed up to participate, including New York-based JPMorgan Chase & Co. and Wells Fargo & Co. in San Francisco. Government payments to those companies may total $9.9 billion, according Treasury data released April 15.

Guidelines on the Treasury’s Web site tell servicers they can rework a loan only after they verify through financial models that new terms for the homeowner would be better for investors than an immediate foreclosure.

Bondholders still fret that some homeowners who don’t need help will be allowed to rework loans and that calculations to measure the impact will be skewed against bondholders, said Sean Kirk, a trader at New York-based Seaport Group LLC.

Part of the concern is that the four largest servicers, including Charlotte, North Carolina-based Bank of America Corp. and JPMorgan, own almost $450 billion in home-equity loans, many tied to the same properties as the mortgages they service, Amherst’s Goodman said.

‘Financial Incentive’

“They have a large financial incentive through the program to modify, and they’ll also benefit from putting more losses onto the first-lien holders because of their large second-lien positions,” said John Huber, who oversees about $30 billion in Minneapolis as chief investment officer of fixed income at Royal Bank of Canada’s Voyageur unit.

“What’s probably most troubling from a bigger picture perspective is what this means for the sanctity of contract law that has historically differentiated the U.S. as the gold standard of markets,” he added.

Responding to complaints that American International Group Inc. was excessive in awarding bonuses and paying off banks after accepting $182.5 billion in bailout funds, National Economic Council Director Lawrence Summers said March 15 on ABC’s “This Week” that “we are a nation of law, where there are contracts” and “the government cannot just abrogate contracts.”

‘Respect the Laws’

“If we don’t respect the laws on which people reasonably relied, the potential chaos, disruption, lack of credit and resulting unemployment will be that much greater,” he said.

The legislation opposed by bondholders passed in the House 234-191 on March 6. The measure, which also would allow bankruptcy judges to lower mortgage amounts through so-called cram-downs, is now before the Senate.

“I don’t think it’s Congress’s intent to damage the sanctity of contract law and the U.S. capital markets, but there is a risk of that happening,” said Michael Swendsen, a senior money manager in Minneapolis at Thrivent Financial, which oversees $61 billion of assets.

Resistance to loan modifications by Greenwich Financial’s Frey has prompted protesters from the Neighborhood Assistance Corp. of America consumer group to gather outside his Greenwich, Connecticut home, and has spawned a legal tussle with Bank of America.

Legal Tussle

In October, the bank reached a settlement with state attorneys general investigating whether Countrywide Financial Corp. tricked homebuyers into mortgages they couldn’t afford before Bank of America acquired the company last year. The deal, which more than 30 states have signed, will save homeowners $8.4 billion, the bank said.

Greenwich Financial sued Bank of America, alleging that much of the cost will be borne by bondholders. Frey’s firm is seeking class action status for the suit.

Barbara Desoer, Bank of America’s mortgage chief, said in an interview that her company isn’t modifying loans without bondholders’ permission, either in existing bond terms or in newly negotiated agreements.

The bank isn’t “going to do anything to put a contract at risk,” Desoer said. “But, at the same time, we’re thrilled that there’s a standard, and we have a head start because of the AG settlement.”

TCW Group Inc., a Los Angeles-based money manager that oversees more than $100 billion, is lobbying the Treasury for changes to the government’s plan.

Servicer Duties

Obama’s program encourages servicers to “abrogate their duty,” said Chief Investment Officer Jeffrey Gundlach, who oversees $52 billion of mortgage securities, on a conference call with clients March 18. “Servicers’ No. 1 duty is to us, the investor.”

While billed as beneficial to mortgage investors, Obama’s plan will mostly be ineffective in cutting losses because it focuses on lowering payments rather than reducing homeowner debt, said John Geanakoplos, an economics professor at Yale University in New Haven, Connecticut. Many borrowers with “negative equity” will choose to default anyway, he said.

“It’s a lot better situation when contracts are broken in a way that makes everybody better off,” said Geanakoplos, who is also a partner at Michael Vranos’ Ellington Management Group LLC, a hedge-fund firm in Old Greenwich, Connecticut. Geanakoplos has advocated breaking contracts by putting the power to modify loan terms into the hands of independent arbiters.

Program Retool

Scott Simon, Pacific Investment Management Co.’s mortgage bond chief, said retooling the Federal Housing Administration’s Hope for Homeowners program would be best for all parties.

Bond investors sustain losses equal to the amount needed to reduce a loan to 87 percent of a home’s current value under that strategy. In return, the remaining debt is refinanced with government-insured loans, preventing further investor losses. The congressionally approved program was designed to help 400,000 borrowers when it started in October; 51 of the loans have closed, said Lemar Wooley, an FHA spokesman.

“It was a great idea, but there was horse-trading to get the bill passed, creating subtle little things that made it unusable,” said Simon, whose Newport Beach, California-based firm manages the world’s biggest bond fund.

‘Elephant in the Room’

The FHA program “addresses the elephant in the room,” he added, referring to how many borrowers have “negative equity.” Almost one in six U.S. homeowners with mortgages owed more than their homes’ worth after the market lost $3.3 trillion in value last year, according to a Feb. 3 Zillow.com report.

Don Brownstein, CEO of Structured Portfolio Management LLC, said another Obama administration mortgage program announced Feb. 18 also represents the government acting “extra-legally.”

Under that plan, as many as 5 million additional Fannie Mae and Freddie Mac mortgagees with less than 20 percent in equity will be able to refinance without buying or paying for mortgage insurance. The two government-sponsored companies’ charters typically require insurance for loans with debt-to-value ratios of more than 80 percent.

The new program was created without congressional approval. Federal Housing Finance Agency Director James Lockhart, who oversees the two companies, said it didn’t require legislation because the refinancing is akin to permitted loan modifications, even though some bondholders incur losses if their securities’ underlying loans are paid off faster than expected.

Mistreating “customers, the ones who ultimately lend to the homeowners, is not good a business practice,” said Brownstein, whose hedge-fund firm is based in Stamford, Connecticut.

Commentary by Joe Weisenthal on the Business Insider:

Now it would be easy to dismiss their arguments, as just being bondholders not wanting to take a haircut. And surely they don't. But it's also true that Obama's mortgage modification and cramdown plans aren't even good for homeowners.

They're basically a lose-lose.

Bondholders see their contracts ripped up, and are forced to take a haircut, while homeowners are basically stuck with the equivalent of a new teaser rate -- low payments for five years, balloon payments after that. The hope, of course, is that the housing bubble will be fully reflated by then, and that the economy will have returned to "normal" so that the new payments aren't much of a problem.

What's more, the loan mod game has brought back all the old predatory lenders out of the woodwork, wearing new clothing and bearing gifts of lower payments.

At best, when it's homeowners vs. banks or homeowners vs. mortgage bondholders, you're looking at a zero-sum game. You prop up the banks, but then you try to give the homeowners a break on their payments and all of the sudden the financial system gets nervous again.

Wednesday, April 22, 2009

Desecuritization: Value There for the Taking

Posted on Yahoo Finance by Jack Guttentag:

The government is betting that, by lending large amounts to private investors to purchase securities, markets will revive and security values will rise. This is a costly and risky venture; I hope it works, but I fear it won't. This article proposes another approach to the same objectives -- an approach that would cost the government nothing. I call it desecuritization. All it requires is the appropriate enabling legislation.

Desecuritization means reversing the securitization process. Securitization converts large numbers of individual loans into security issues. Descuritization converts the securities back into individual loans. The objective of both is the same: to enhance value. The first works during normal periods, the second can work during a crisis period such as the one we are in now.

Securitization enhanced value during normal periods because a single type of loan could be converted into a variety of securities with different characteristics fashioned to meet the diverse needs of investors. For example, a pool of 30-year fixed-rate mortgages could be transformed into a security issue subdivided into sub-issues that vary in their duration (how long before the investor gets his money back), their exposure to risk of default as indicated by credit quality ratings, and their sensitivity to changes in market interest rates.

Appealing to Many

Where investor demand for 30-year fixed-rate mortgages was limited, the diverse securities fashioned from a pool of such mortgages could appeal to a wide range of investors. With securitization, the whole was worth more than the sum of its parts.

The breakdown of financial markets during the financial crisis, associated with high default rates on loans in pools supporting securities, has reversed the equation. The total value of any mortgage security issue on which the AAA-rated pieces have been downgraded is now much smaller than the sum of the values of the individual loans, assuming those loans could somehow be disentangled from the security.

For example, assume 20 percent of a portfolio of 1,000 mortgage loans defaults and each default costs 50 percent of the balance. Because the 200 loans that default do not affect the value of the 800 that don't, the decline in the total value of the portfolio is only 10 percent. But if the loans are in a security issue, every piece of that security may be contaminated by the defaults. The overall decline in value could be 30 percent or even 60 percent; we have no way of knowing because markets have largely shut down.

Rating the Securities

In an interesting paper called The Law of Unintended Consequences, John Mauldin attributes this excessive value decline to the decision by the credit rating agencies to rate asset-backed securities in the same way they have always rated bonds. I agree with him that the rating system needs fixing, but I doubt that any rating system can wholly avoid value contamination within a security when default rates are very high.

In any case, the challenge right now is to find a way to unlock the hidden value in mortgage pools supporting contaminated securities. Perhaps the new federally supported asset purchase program will do it, but desecuritization would be surer and cheaper.

All that is needed to make desecuritization work is a way for investors to acquire control of 100 percent of a security issue. The investor who owns it all can dispose of the security and own the individual loans. To make this possible, we need a law that grants any investor who owns X percent of a security issue the right to buy the remaining 1 minus X at a price equal to Y percent of the average price the investor paid for the X percent already owned.

Profiting From the Program

Investors will attempt to profit from such a program in one of two ways. The basic strategy will be to acquire 100 percent of a security and realize the difference between the value of the loans and the price paid for the security. An alternative strategy is to acquire an amount of an issue equal to 1 minus X + $1, which is just enough to prevent any other investor from executing the basic strategy, forcing them to come to you.

The values for X and Y that will best facilitate the process depend on the characteristics of the security issue. Hence, a first step toward desecuritization is to develop a census of issues, showing the balance of each sub-issue, its initial and current rating, and the current owners. This information will not only help in formulating the enabling legislation but will also provide critical information needed by investors looking to buy up 100 percent of one or more issues.

The enabling law would override the maze of private contracts involved in a securitization, and it is not a step to be taken lightly.

In this regard, it is similar to the cram-down legislation that is being considered by Congress. An important difference is that cram-down is a zero-sum game, meaning that the gains to borrowers are exactly offset by losses to investors. Desecuritization is a positive-sum game because the gains for successful investors will be substantially larger than any losses suffered by other investors.

Thursday, April 16, 2009

U.S. Foreclosure Mitigation: Too Little, Too Late? (Part 1)

Posted on the Shadow Bankers by John Kiff:

As U.S. home foreclosure rates rise to levels not seen since the Great Depression, government policy has consistently been too little, too late, and frankly, off target. In this series of posts, I’m going to do a fairly deep dive into the “end game” of the current mortgage crisis. (The “opening” and “middle games” have been well documented elsewhere - e.g., “Money for Nothing“.) In this first post, I’ll give a very broad-brush overview of the three government foreclosure mitigation programs that have been introduced since 2007. Then, I’ll talk about some of the reasons why they have failed (or are likely to fail).

FHASecure (introduced in 2007) and Hope for Homeowners (H4H, 2008) were designed to encourage lenders to write loans off in return for 90 to 97 percent of appraised home values. However, only about 4,000 loans were refinanced under FHASecure before it was closed down at the end of 2008, and less than 1,000 homeowners have applied for H4H short refinancings. These two programs failed largely because they left implementation to under resourced servicers, and placed almost all the writedown burden on the lenders and investors.

The more recent Home Affordable Modification Program (HAMP, 2009) rectifies these shortcomings by offering various incentive payments to servicers and lenders (investors in the case of securitized loans). The point of the program is to encourage servicers to avert foreclosures by offering loan modifications that reduce monthly payments to more affordable levels. However, unlike FHASecure and H4H, HAMP is not designed to encourage principal writedowns, a problem I’ll discuss later. (HAMP’s incentive payments will apply to H4H refinancings, but in most cases servicers will opt for temporary payment reductions rather than H4H’s principal writedowns.)

It seems fairly obvious that, to be effective, loan modifications should reduce monthly payments. But according to the most recent OCC and OTS Mortgage Metrics Report, some servicers still don’t get it, although they are starting to:

chart-12

Not surprisingly, the OCC/OTC report confirms the lower redefault rates on modifications that reduce payments:

chart-2

In fact, a recent paper by Quercia, Ding and Ratcliffe goes even further, and finds “an even lower likelihood of redefault when the payment reduction is accompanied by a principal reduction.” Given this evidence, it is somewhat surprising that HAMP wasn’t designed to encourage principal writedowns on “underwater” loans (where the home’s value has depreciated below the outstanding mortgage balance, including junior liens).

You might wonder why government intervention is needed to incentivize mortgage servicers to offer payment-reducing modifications in the first place. One reason is that some of the agreements that set out what the servicer can and cannot do (i.e., the “pooling and servicing agreements” or PSAs) limit the number of modifications (although most do not). Also, most PSAs give little explicit guidance as to what kinds of modifications are acceptable or not, so foreclosure often becomes the “better safe than sorry” option. (For much more detail on the economics of servicing, see “foreclosure mitigation efforts“.)

Another problem is the cost of dealing with junior liens. About 25 percent of subprime mortgages currently outstanding had a junior (”piggyback”) lien at origination, and about 40 percent do when home equity lines of credit are considered, according to the Congressional Budget Office. In principle, significant loan modifications can demote the first lien to a junior lien. However, this puts the previously senior lien holder in parity with the original junior lien holder, unless the original junior lien holder agrees to re-subordinate (drop his lien even further down). Hence, first lien holders generally require junior lien holders to agree to re-subordinate their claim before agreeing to modifications. However, in some cases, junior lien holders may try to abuse their position and hold up modifications. Furthermore, unless both the senior and junior mortgages are serviced by the same company, it may be difficult to track and negotiate with the junior lien holder.

Furthermore, about 80 percent of all nonprime loans, which comprise the vast majority of distressed mortgages, have been securitized and tranched into mortgage-backed securities. Modifications that benefit some tranches often compromise others, and sometimes leads to “tranche warfare.” For example, temporary payment reductions tend to spread their impact across all of the tranches, but principal writedowns can wipe out the junior tranches. Hence, for example, the (mostly) hedge funds that hold junior tranches have been threatening litigation, especially if the writedown process is mechanical or “streamlined” (rather than case by case).

Finally, modifications that reduce monthly payments may just be uneconomical from the servicer/lender perspective. According to the American Securitization Forum, “in evaluating whether a proposed loan modification will maximize recoveries to the investors, the servicer should compare the anticipated recovery under the loan modification to the anticipated recovery through foreclosure on a net present value basis.” In some cases, the homeowner just can’t afford even the most drastically cut monthly payments due to insufficient income and/or other debts and obligations. Also, in areas of extreme home price depreciation, foreclosure may be NPV-maximizing (versus principal writedowns on underwater loans and/or bringing debt-to-income ratios down to reasonable levels).

Government intervention can play a useful role in providing incentives for foreclosure mitigation, due to the negative feedback loop and vicious circle effects of mass foreclosures (see “foreclosure mitigation efforts“). However, detractors point to the unfairness of bailing out irresponsible homeowners, in addition to the practical problems outlines above. That’s a fair point, but foreclosed properties stay unoccupied for extended periods of time, deteriorating and often inviting vandalism, thereby pushing down home values in the immediate neighborhood. As such, it seems in everyone’s best interest to incentivize foreclosure mitigation. As Fed Chairman Bernanke put it in an appearance on “60 Minutes” in March:

If you have a neighbor, who smokes in bed. And he’s a risk to everybody. If suppose he sets fire to his house, and you might say to yourself, you know, ‘I’m not gonna call the fire department. Let his house burn down. It’s fine with me.’ But then, of course, but what if your house is made of wood? And it’s right next door to his house? What if the whole town is made of wood? Well, I think we’d all agree that the right thing to do is put out that fire first, and then say, ‘What punishment is appropriate? How should we change the fire code? What needs to be done to make sure this doesn’t happen in the future? How can we fire proof our houses?’ That’s where we are now. We have a fire going on.

Nevertheless, while HAMP puts forward some very useful incentives for servicers to offer temporary payment reductions to distressed borrowers, it may only be deferring the impact of the underlying underwater loan (or “negative equity”) problem. In the next post in this series, I’ll delve into some of the more gory details of the program, plus those of the still-active H4H program, to show how these two programs can be merged into something more effective from a longer-term perspective.

Mortgage Cram-Down Stalls in Senate, May Be Revised

Posted on Bloomberg by Dawn Kopecki:

Senate Democrats are scaling back legislation that would let bankruptcy judges alter mortgage terms because lawmakers don’t have enough votes for passage, a spokesman for Senate Majority Whip Richard Durbin said.

The main “sticking point” is whether the measure, which passed the House of Representatives in March, should be limited to certain loans or a specific timeframe, Max Gleischman, a spokesman for Durbin, an Illinois Democrat, said today.

The delay of more than a month in passage of the so-called cram-down legislation holds up a key component of President Barack Obama’s anti-foreclosure initiative announced Feb. 18. That plan seeks to help as many as 9 million Americans modify or refinance their mortgages to more affordable terms.

“Investor buzz surrounding a potential deal on cram-down legislation seems somewhat premature,” Andrew Parmentier, a bank policy analyst for research firm Height Analytics in Washington, said in an investor note today.

The legislation would authorize bankruptcy judges to modify distressed borrowers’ mortgages closer to the lower market value of their homes, even over the objections of creditors. Judges would be able to reduce principal, lower the interest rate, change the maturity, or convert the loan to a fixed rate. The House version of the legislation would apply to all loans originated before the bill takes effect, while bankers and credit unions lobbied to limit it solely to subprime mortgages.

“That’s a non-starter for Democrats,” Gleischman said. “We’re working to find something in between those two points.

“The bill as passed by the House doesn’t have the votes to pass the Senate,” Gleischman said. “There is no agreement.”

Draft Proposal

Negotiations with banks over provisions are still taking place, he said. While a number of potential provisions “have been put to paper,” there is no formal offer, he said.

A draft proposal that Durbin’s staff offered this week would prohibit borrowers from amending their mortgage terms in bankruptcy if they have turned down a loan modification under Obama’s Homeowner Affordability and Stability Plan, according to bankers involved in the discussions who asked not to be named because the proposal was confidential.

Judges also would only be allowed to reduce outstanding principal to market value and interest rates to the conventional rate plus a “reasonable premium for risk,” according to the bankers. Repayment may be extended for 40 years, and borrowers that get principal reductions must share half of any home price appreciation, up to the original amount owed, if the property is sold while they are still in bankruptcy, the bankers said.

Durbin’s plan would be good only until 2014 and would apply only to mortgages under $729,750 that were originated before Jan. 1, 2009, according to an outline of the proposal.

Obama Plan

The Congressional Budget Office said in a Feb. 23 report that the House legislation may encourage more people to file for bankruptcy. More than 1 million households would benefit from the bill and an estimated 350,000 of those would be likely to take advantage of the law in the next 10 years, the CBO said.

Obama’s main loan modification initiative, which targets 3 million to 4 million homeowners, would require lenders to cut interest rates to as little as 2 percent, extend repayment terms as long as 40 years and forbear or forgive outstanding principal as necessary to reduce homeowners’ monthly payment to a maximum ratio of 38 percent of their income for five years.

The Treasury Department would be used to cover half the costs to further reduce their payments to a ratio of 31 percent. The Treasury has set aside $75 billion in taxpayer funds to pay companies to modify loans and subsidize borrower payments.

Under Durbin’s plan, borrowers in foreclosure with incomes less than 80 percent of the median in their area or whose mortgage payments are less than 31 percent of their gross monthly pay would be ineligible for principal reductions.

Could SwapRent stop the foreclosure crisis?

Posted on American Banker's BankThink by Emily Flitter:

In the swarm of ideas for how to stop the financial meltdown, there’s one from a small company in California that seems to have gotten lost in the mix—a tragedy for the country, according to its creator. Though there are obvious barriers to the scheme’s success, it’s worth asking whether Ralph Liu’s SwapRent product, reviewed in a report by the Aite Group this month on new financial products, could really stop home price depreciation.

Liu, who founded Advanced e-Financial Technologies, Inc. to develop the product, says it could not only stabilize the housing market; he claims SwapRent could also halt the slide in the fair value of mortgage-backed securities as well.

Technically, SwapRent is a derivative with a home as the underlying asset. It allows investors to take a stake in the future appreciation of home values without actually purchasing a property. Instead, an investor and a borrower sign an agreement saying that the investor will pay the borrower a fixed monthly sum of cash in exchange for a percentage of the eventual sale price of the house.

This, Liu argues, is the way to solve the foreclosure crisis. Borrowers who are delinquent on their mortgage payments can sign agreements with investors for extra cash each month, while still maintaining ownership of their homes. They also maintain a share in the price growth that many believe is an eventuality in the housing market. Instead of getting 100% of the value of a home upon its sale, however, a borrower who signed a SwapRent agreement would only walk away with 50% (for example).

Liu’s idea may not go over so well with politicians, and Liu himself seems like he needs a lesson in finesse. “The more generous, the more dumb the government acts,” he explained while walking BankThink through the SwapRent concept, “the more people will sign up to participate in this.” He said he thinks the government should use some of its bailout money to start signing SwapRent agreements with borrowers and should then try to recoup the money—with a profit—by selling the agreements to investors in a secondary market.

Each agreement signed would greatly reduce the chances of a foreclosure, since the borrower would have extra cash to pay his or her mortgage, Liu reasoned. The value of structured products backed by the mortgages would increase, too, once the mortgages in a given product were fortified by SwapRent agreements.

In contrast, Liu told BankThink, the Treasury Department’s public-private investment fund concept is riddled with “downstream problems,” and won’t do much to turn the tide of the crisis. He blames “politics” for the lack, thus far, of interest among government officials in his plan, but remains hopeful. “People have to learn, you know,” he said.

And it’s true. SwapRent, especially as it is described on Liu’s company Web site, is hard to follow. But stick with it and it somehow makes sense.

“Everybody knows what it is—it’s a public secret,” Liu said of his efforts to interest state governments and the Obama administration in the plan.

But the description of SwapRent did not ring a bell to an advisor to the federal government on housing policy. “I was intimately plugged into the development process” of the Obama administration’s foreclosure prevention plan, said the advisor, who wished not to be named, “and I don’t recall any idea of this sort being mentioned and certainly it was not discussed.”

A call to the office of Calif. Assemblyman Ted Lieu, D-Torrance, drew a similar blank. “It sounds like a good idea,” a spokesman said, “but I’ve never head of it.”

SwapRent’s creator Liu has received some recognition: He led a panel at Harvard Business School on housing derivatives last year, and he presented the idea to a housing finance conference called “Beyond the Crisis” at the Milken Institute Financial Innovations Lab. He also had some near misses with banks last year—he was trying to sign up IndyMac Bancorp to the idea before the bank went bust last summer, and he claims to have “almost” scored a deal with Citigroup before the crisis hit. But press coverage has been scant since Liu’s idea morphed from that of a quaint, rather hard to grasp hedging tool to a possible fix for the massive foreclosure crisis.

Perhaps Liu should redouble his outreach efforts. With foreclosures continuing to rise and loan modification efforts hardly making a dent in the problem, it isn’t hard to imagine that policymakers might be more open to wacky-sounding solutions than they were even six months ago.

Wednesday, April 15, 2009

Six Servicers Get $9.9B For Loan Modifications

Posted on the Housing Wire by Paul Jackson:

The U.S. Treasury Dept. said Wedensday evening that it had completed arrangements with the first six major mortgage servicers to participate in a much-publicized program announced by the Obama administration to modify three to four million mortgages. The program, part of the Homeowners Affordability and Stability Plan detailed in March, will provide the selected servicers with a combined maximum of $9.9bn to modify troubled mortgages.

The department said the following servicers were the first to become eligible for payments under the Making Home Affordable loan modification program: Chase Home Finance LLC, Wells Fargo Bank NA, CitiMortgage Inc., GMAC Mortgage Inc., Saxon Mortgage Services Inc. and Select Portfolio Servicing.

The payments are part of the administration’s $75 billion program to try to prevent foreclosures and help borrowers refinance into new loans. Other servicers will be added as arrangements are finalized, the Treasury said; and it’s clear that the list of servicers looking to obtain incentive payments is quite long.

For example, West Palm Beach, Fla.-based Ocwen Financial Corp (OFC: 29.50 +9.54%), a subprime servicer not on the initial list of six released by Treasury officials, had said earlier this week it believed it was the first servicer in the country to begin executing loan modifications under the administration’s plan.

Also not on the initial Treasury list was Bank of America Corp. (BAC: 10.44 +3.47%), the nation’s largest servicer after its acquisition of Countrywide Financial last year. A request for comment on BofA’s implementation of the loan modification guidelines set forth in the HASP had not been returned by the time this story was published.

It’s unclear if servicers modifying mortgages to government-specified guidelines ahead of a final agreement with Treasury officials will be able to obtain incentive payments for mortgages they modify during the interim timeframe.

Among the first six to obtain funding from the Treasury, Chase could receive the lion’s share of incentive payments, up to $3.6 billion. Wells Fargo has been allotted $2.87 billion, and CitiMortgage $2.07 billion; GMAC could get $633 million, Saxon $407 million and Select Portfolio $376 million. All figures are based on the size of each company’s respective servicing portfolios, a senior Treasury official told the Wall Street Journal.

Under the plan, the government will pay servicers a $1,000 one-time fee for modifying a mortgage down to a 38% payment-to-income ratio for five years — a plan that analysts, including Amhert Securities analyst Laurie Goodman, say creates an incentive for homeowners to ‘rent’ their home. Modified loans must survive a 90-day trial in order to be eligible for the incentive payment.

Government funds will also match the cost of further interest-rate reductions or other modifications to bring payments down to 31% of a borrower’s income. If borrowers perform in their newly-modified mortgages, servicers would be eligible to receive $1,000 per year for three years under the government incentive program.

Wait, You Mean the Foreclosure Freeze Didn’t Work?

Posted on the Housing Wire by Paul Jackson:

The headline to this column is a question you’ll increasingly see in the press over the next few months as foreclosures begin to filter their way through the default pipeline all over again. But don’t take my word for it — the Wall Street Journal discovered today that foreclosures are back on the upswing, so it must be true.

If you’ll recall, servicers nationwide had implemented a series of foreclosure moratoria that largely ran through the end of March. Many servicers — that would be JP Morgan Chase & Co. (JPM: 31.82 +3.65%), Wells Fargo & Co. (WFC: 18.80 +2.90%), and the like — had implemented a foreclosure and extended eviction halt at the instruction of the GSEs, whose loans they manage; they also had agreed to halt foreclosures for certain borrowers while the details of Obama’s Making Home Affordable program were being implemented and put into place.

The moratoria helped slow actual foreclosure sales the past few months, while the number of foreclosure starts (the start of the default process) have continued to pile up.

Fixed-income researchers at Bank of America Corp. (BAC: 9.84 -2.48%) on Wednesday noted that 90+ day roll rates, which measure the relative number of severely delinquent loans moving to foreclosure sale, have largely been suppressed by the foreclosure freezes. “Although the overall trend and levels for the prime, alt-A and subprime sectors have differed, on average, the [90+ days roll to foreclosure rate] dropped almost 10 percentage points, from around 25% per month to about 15% per month,” the researchers said in a note to clients. They expect to see a spike in foreclosure sales, however, over the next 1 to 3 months “as the moratoriums are lifted and loss-mitigation programs start to filter out ineligible borrowers.”

So we’re seeing a borrower backlog in the default pipeline. Are these borrowers exiting the pipeline via other means, since foreclosure hasn’t been a viable option recently? The data again suggests the answer is a resounding ‘no.’ While cure rates have been increasing in comparative terms over the course of the moratoria duration (essentially Dec. 2008 to Mar. 2009), in real terms cures remain tough to come by. According to data from Clayton Holdings, Inc., for example, the cure rate on 2007 vintage subprime first-lien RMBS in February was 8.16%; for 2007 vintage Alt-A first lien RMBS, the cure rate in February was 4.69%.

What we are seeing, however, is servicers quickly moving to clear bad assets as soon as the GSEs and government pressure points will allow foreclosures to proceed. Analyst Mark Hanson of The Field Check Group circulated data to subscribers last week showing that for California, among the state’s top five servicers, the volume of notices of sale surged more than 170 percent between February and March 2009 alone, from 4,410 NTS filings in February to 11,981 in March. (Notices of sale indicate an imminent foreclosure, usually within a 30 to 60 day timeframe, depending on locale.)

Which means that the financial press, consumer groups, and Capitol Hill are quickly coming to realize something that most of us from the mortgage space have long known to be true: the problem here isn’t entirely the mortgage instrument, and moratoria ultimately can do nothing more for most troubled borrowers than postpone the inevitable. From the Journal, an exercise in finding reality:

“We are getting so many of these cases where people don’t fit the new [Obama] program,” says Michael Thompson, director of Iowa Mediation Service, which works with troubled borrowers. Many borrowers are unemployed or underemployed or have credit problems that go well beyond their mortgage troubles, he says.

Many have been “playing for time” while the moratoriums have been in place, he says. But the delays have only increased the amount of interest and fees they owe, making their loans “nonviable in the long run.”

This should not be considered news to anyone inside the mortgage banking space, or anyone that reads HousingWire. As we’ve written about numerous times in this space, no amount of modification can replace a lost job, or a long-term loss of income. And with 15.6% of the nation’s workforce now either unemployed or underemployed, the problems in the nation’s mortgage markets are as much a broad economic problem as they’re a problem tied to blow-and-go underwriting standards and creative loan products.

“The bottom line is that there is a massive wave of actual foreclosures that will hit beginning in April that can’t be stopped without a national moratorium,” Field Check’s Hanson wrote in a note to clients last week. Here’s to hoping that we’ve already learned our lesson the first time around on this.