Thursday, August 23, 2007

Not All Modifications are Created Equal

by Tanta on 8/23/2007 12:14:00 PM

I want everyone to know that I did not go out of my way to pick on Gretchen Morgenson or the NYT today. I got asked by several different people, one of whom is the blog boss ("Shiloh"), to comment on this article. This involved my wading through long prospectuses at dark-thirty this morning. Sure, Gretchen coulda done that too, but this is business reporting on mortgages, circa mid-2007.

EVERYTHING!! IS NEFARIOUS!!1! AND A CRISIS!!! BUY NEWSPAPERZ!!!1!

Exhibit the first, Ms. Morgenson:

Expanding rapidly as the nation’s largest home mortgage company, Countrywide Home Loans quietly promised investors who bought its loans that it would repurchase some if homeowners got into financial difficulties.

But now that Countrywide itself is struggling, it may not be able to do so, making it even harder for troubled borrowers to reduce their interest rates or make other changes to their loans to avoid foreclosure.

The possibility that Countrywide may have to buy back mortgages that it sold comes on the heels of its announcement last week that the tightening credit markets had forced it to draw on its $11.5 billion line of credit from a consortium of banks, a move that sent the market plummeting.
Pretty exciting stuff.
Countrywide, with its stock depressed, had been seen as a prospect for a takeover. But any obligation the company has to buy back loans may complicate discussions with potential investors or buyers.

The repurchase obligations are discussed in Countrywide’s prospectuses and pooling and servicing agreements that cover about $122 billion worth of mortgages packaged and sold to investors from early 2004 to April 1 of this year.

The agreements said that Countrywide Home Loans, a unit of Countrywide Financial, would buy back mortgages in the pools if their terms were changed to help borrowers remain current. Such changes are known as loan modifications. In general, it is difficult for homeowners to get loans modified if they are in a securitization pool.

It is unclear how many modified loans are involved. But it would cost $1.2 billion for the company to repurchase 1 percent of the loans in the pools at issue. Repurchasing 5 percent would cost $6.1 billion. When such buybacks are made, the original amount of the loan is paid into the pool and divided among the investors.
And if they had to repurchase 100%, that would be gajillions o' dollars! This is not "unclear," it's actual math! Besides, while "in general" it's difficult to get a mod, CFC went out and wrote servicing agreements that make it easier! I call foul!

Here are paragraphs 21-23 of the 26-paragraph article. The emphasis, of course, has been added by Tanta:
Under most agreements, the amount of loans that can be modified in any pool is limited to 5 percent, unless the mortgage borrowers are defaulting or seem to be about to default. Mr. Simon said that the pooling agreements indicating that Countrywide was obligated to buy back modified loans applied only to mortgages that are not in danger of defaulting.

But the language in the pooling agreements from 2004 through much of 2007 does not state this clearly. Only as of April 1 do Countrywide’s pool terms begin stating that the company is not required to repurchase modified loans.

Mr. Simon said this change in language was made to clarify the original intent of the agreements.

Now, I keep telling you people not to believe everything you read in the papers or on the internet, so do not take my word that this is much ado about nothing much. Let's go to the SEC and read the prospectuses.

Exhibit the second, chosen randomly, is CWAB's prospectus for 2006-01:
Countrywide Home Loans will be permitted under the Pooling and Servicing Agreement to solicit borrowers for reductions to the Mortgage Rates of their respective Mortgage Loans. If a borrower requests such a reduction, the Master Servicer will be permitted to agree to the rate reduction provided that (i) Countrywide Home Loans purchases the Mortgage Loan from the Trust Fund immediately following the modification and (ii) the Stated Principal Balance of such Mortgage Loan, when taken together with the aggregate of the Stated Principal Balances of all other Mortgage Loans in the same Loan Group that have been so modified since the Closing Date at the time of those modifications, does not exceed an amount equal to 5% of the aggregate Certificate Principal Balance of the related Certificates. Any purchase of a Mortgage Loan subject to a modification will be for a price equal to 100% of the Stated Principal Balance of that Mortgage Loan, plus accrued and unpaid interest on the Mortgage Loan up to the next Due Date at the applicable Net Mortgage Rate, net of any unreimbursed Advances of principal and interest on the Mortgage Loan made by the Master Servicer. Countrywide Home Loans will remit the purchase price to the Master Servicer for deposit into the Certificate Account within one Business Day of the purchase of that Mortgage Loan. Purchases of Mortgage Loans may occur when prevailing interest rates are below the Mortgage Rates on the Mortgage Loans and borrowers request modifications as an alternative to refinancings. Countrywide Home Loans will indemnify the Trust Fund against liability for any prohibited transactions taxes and related interest, additions or penalties incurred by any REMIC as a result of any modification or purchase.
Here's the same section ("Certain Modifications and Refinancings") from CWAB 2007-12
Countrywide Home Loans is permitted under the Pooling and Servicing Agreement to solicit borrowers for reductions to the Mortgage Rates of their respective Mortgage Loans. If a borrower requests a reduction to the Mortgage Rate for the related Mortgage Loan, the Master Servicer is required to agree to that reduction if (i) Countrywide Home Loans, in its corporate capacity, agrees to purchase that Mortgage Loan from the issuing entity and (ii) the Stated Principal Balance of such Mortgage Loan, when taken together with the aggregate of the Stated Principal Balances of all other Mortgage Loans in the same Loan Group that have been so modified since the Closing Date at the time of those modifications, does not exceed an amount equal to 5% of the aggregate initial Certificate Principal Balance of the related Certificates. Countrywide Home Loans will be obligated to purchase that Mortgage Loan upon modification of the Mortgage Rate by the Master Servicer for a price equal to the Purchase Price. Countrywide Home Loans will remit the Purchase Price to the Master Servicer for deposit into the Certificate Account within one Business Day of the purchase of that Mortgage Loan. Purchases of Mortgage Loans may occur when prevailing interest rates are below the Mortgage Rates on the Mortgage Loans and borrowers request modifications. Countrywide Home Loans will indemnify the Trust Fund against liability for any prohibited transactions taxes and related interest, additions or penalties incurred by any REMIC as a result of any such modification or purchase.

In addition, the Master Servicer may agree to modifications of a Mortgage Loan, including reductions in the related Mortgage Rate, if, among other things, it would be consistent with the customary and usual standards of practice of prudent mortgage loan servicers. Such modifications may occur in connection with workouts involving delinquent Mortgage Loans. Countrywide Home Loans is not obligated to purchase any such modified Mortgage Loans.

Here's the deal.

A "modification" is a legally-binding change or emendation to a previously-executed legally-binding contract. Once you and your lender execute a mortgage note together, the lender cannot just go changin' stuff on you willy nilly. Any agreement at all that you and the lender jointly and severally agree to involving your loan terms requires a "Modification of Mortgage" contract to be executed by all parties.

"Loss mitigation" modifications are used for defaulting or about-to-default loans to mitigate the loss to the noteholder.

Just plain old modifications are used to do things like give borrowers a cheap alternative to a refi, fix up construction loans, "drop" LPMI for those LPMI loans, remove a co-borrower from a loan when someone gets divorced, recast the payments for someone who makes a big partial prepayment, and approximately 100 other common or not very common situations.

Servicers would, if you let them, modify every securitized loan out there. They'd even "solicit" this by calling borrowers and offering them lower rates, instead of waiting for borrowers to call them. How come? Because this keeps the loan on the books, which keeps the servicer's income stream going. It would more or less suck for the noteholder, whose yield would go bye-bye.

You would not want to let them do that, were you a noteholder. You therefore do one of two things: you prohibit non-loss-mit mods (we will call these "retention mods," since that's really the issue here), or you make the servicer buy the loan out of the pool if the servicer wants to do them. After all, they are designed as a cheap alternative to refis. If market rates are low enough, the borrowers will refi. That would be prepayment at par to the noteholder. Making the servicer buy the loan out of the pool would also be prepayment at par. Six of one. Half dozen of the other.

The servicer who exercises this option either keeps the modified loans in portfolio, or resecuritizes them later in a "seasoned" deal.

This is so "heard of" that it's not funny. To Gretchen Morgenson, it is apparently "unheard of." So now it's "misheard of" to every reader of the NYT, and I'm writing a long tedious blog entry about it. "How come Tanta's always so snarky, huh?" I keep getting in the comment section from certain reporters.

That Countrywide guy probably tried his level best to explain this to her, but he clearly didn't make any headway. What CFC did was re-write the prospectus to make it clear to anyone like, well, Gretchen, that we were not talking about loss-mit here. On a loss-mit deal, the servicer does not have to buy the loan back. I have been trying to say since dirt that it has been this way since dirt, but there's dirt to report!

With this buyback-and-mod deal, you get: servicers who can manage their servicing portfolios in a falling rate environment. Noteholders who are not penalized for it. Consumers who get a cheaper, faster deal than with a refi. Sucks, doesn't it? Call the SEC! Someone is cheating!