by Tanta on 11/06/2007 11:10:00 AM

I know how disappointed everyone would be if I passed on an opportunity to publically describe Gretchen Morgenson as a tendentious writer with only a marginal grasp of her subject matter and what appears to be an insatiable desire to make uncontroversial facts sound sinister. So here we go again.

Obligatory declamation: I hate sloppy mortgage servicers, I think fee gouging is criminal, and nothing would make me happier than to see bankruptcy judges slapping some servicers around a little. Morgenson's article, "Borrowers Face Dubious Charges in Foreclosures," brings up one particular thing, payoff fees, that I have been bitching about for fifteen years and that I'd be happy to see outlawed. (News flash: those fees are charged by servicers to everyone who requests a payoff quote, including everyone who has ever refinanced a mortgage. This isn't just something that happens in bankruptcy or foreclosure. If there is a more normal course of business process than calculating what one is owed, which should therefore be a matter of general servicing fee compensation, I can't think of one. Total Ick.)

As usual, though, Morgenson's valid points are drowning in a sea of sensational swill:

Because there is little oversight of foreclosure practices and the fees that are charged, bankruptcy specialists fear that some consumers may be losing their homes unnecessarily or that mortgage servicers, who collect loan payments, are profiting from foreclosures.

The article presents exactly zero evidence, anecdotal or otherwise, that any of the foreclosures or bankruptcies in question were "unnecessary." There is certainly the implication here that servicers profit more from a foreclosure than from simply servicing a performing loan. That idea could use some evidence. It may be true that once a loan defaults, the servicer loses less by foreclosing (where its costs are reimbursed by the noteholder out of the liquidation proceeds) than by working the loan out; this is a big problem with the modification thing, in which servicers generally have to absorb the costs of the modification. But if the accusation here is that servicers drive borrowers into default in order to foreclose, I'd like to see some evidence for that. (Really, I would. That would be a serious indictment of the servicing industry.)

Bankruptcy specialists say lenders and loan servicers often do not comply with even the most basic legal requirements, like correctly computing the amount a borrower owes on a foreclosed loan or providing proof of holding the mortgage note in question.

Perhaps our attorney friends will tell me how it is that servicers have to prove that they are noteholders in a bankruptcy. I suspect that's news to all investors in mortgage bonds, who think they are the noteholders. Are we talking about sloppy filings, in which the servicer failed to include a copy of the note? Or are we really talking about servicers who cannot cough up an assignment of mortgage or deed of trust to show standing to foreclose? Is this predation by servicers who don't even have the right to collect on the debt, trying to worm their way into BK court, or botched paperwork?

In an analysis of foreclosures in Chapter 13 bankruptcy, the program intended to help troubled borrowers save their homes, Ms. Porter found that questionable fees had been added to almost half of the loans she examined, and many of the charges were identified only vaguely. Most of the fees were less than $200 each, but collectively they could raise millions of dollars for loan servicers at a time when the other side of the business, mortgage origination, has faltered.

In one example, Ms. Porter found that a lender had filed a claim stating that the borrower owed more than $1 million. But after the loan history was scrutinized, the balance turned out to be $60,000. And a judge in Louisiana is considering an award for sanctions against Wells Fargo in a case in which the bank assessed improper fees and charges that added more than $24,000 to a borrower’s loan.

These are not impressive examples of servicer competence, and I don't object to public humiliation of any servicer who can make errors like that. But does anyone seriously think that these were attempts to "raise millions of dollars for loan servicers at a time when the other side of the business, mortgage origination, has faltered"? (Keep reading to get to the details of the Wells Fargo case, and notice that the inappropriate charges were overwhelmingly fees or charges that would not be payable to Wells as servicer but would be passed through to the investor or someone else.)

But that's the thing: once again, Morgenson displays her profound ignorance of the industry she spends so much time writing about:

Loan servicing is extremely lucrative. Servicers, which collect payments from borrowers and pass them on to investors who own the loans, generally receive a percentage of income from a loan, often 0.25 percent on a prime mortgage and 0.50 percent on a subprime loan. Servicers typically generate profit margins of about 20 percent.

I have no idea where the 20 percent "profit margin" comes from or what it means in this context. I also do not know what "extremely lucrative" means in the context of a 25 bps servicing fee. But here's the kicker:

Now that big lenders are originating fewer mortgages, servicing revenues make up a greater percentage of earnings. Because servicers typically keep late fees and certain other charges assessed on delinquent or defaulted loans, “a borrower’s default can present a servicer with an opportunity for additional profit,” Ms. Porter said.

The amounts can be significant. Late fees accounted for 11.5 percent of servicing revenues in 2006 at Ocwen Financial, a big servicing company. At Countrywide, $285 million came from late fees last year, up 20 percent from 2005. Late fees accounted for 7.5 percent of Countrywide’s servicing revenue last year.

But these are not the only charges borrowers face. Others include $145 in something called “demand fees,” $137 in overnight delivery fees, fax fees of $50 and payoff statement charges of $60. Property inspection fees can be levied every month or so, and fees can be imposed every two months to cover assessments of a home’s worth.

When other sources of revenue go down, servicing revenue does, in fact, make up a larger percentage of total revenue even if servicing revenues are unchanged. Remember that you get that lordly 0.25-0.50% in servicing fees only as long as you have a loan to service. No new originations, no new servicing fees.

But of course, we are talking revenue here. For instance, those late fees are revenue: they aren't "income" until you back out the expenses of collecting on late loans and the carrying costs of the payments servicers have to advance to the noteholders on time regardless of whether they're collected or not. Do servicers actually make a profit, at the end of the day, on late fees? I suspect most do. Is it less than 100% of revenue? Yes. How much less? Pity Morgenson didn't ask.

You get no argument from me that junk fees like payoff fees, fax fees, demand fees, and unnecessary overnight charges are a horror. I am less convinced that doing away with periodic property inspections for a home in the foreclosure or bankruptcy process is such a great idea: you need to know that the home is still occupied and that it hasn't been vandalized. There's surely a reasonable argument that inspection costs should come out of general servicing revenue, not pass-through fees to the borrower. If you did that, of course, I'd guess that servicing fees would probably go up, so you'd pay it anyway. However, unless the servicer owns the inspection company and makes a big markup (which is possible, although no evidence is presented here), then it's "revenue" with a matched expense. Mortgage servicers can be amazingly dumb at times, but if they're beefing up income with that strategy, you can rest assured it won't last long.

Here's the part of the article based on actual data from a researcher:

In 96 percent of the claims Ms. Porter studied, the borrower and the lender disagreed on the amount of the mortgage debt. In about a quarter of the cases, borrowers thought they owed more than the creditors claimed, but in about 70 percent, the creditors asserted that the debt owed was greater than the amounts specified by borrowers.

The median difference between the amounts the creditor and the borrower submitted was $1,366; the average was $3,533, Ms. Porter said. In 30 percent of the cases in which creditors’ claims were higher, the discrepancy was greater than 5 percent of the homeowners’ figure.

Based on the study, mortgage creditors in the 1,733 cases put in claims for almost $6 million more than the loan debts listed by borrowers in the bankruptcy filings. The discrepancies are too big, Ms. Porter said, to be simple record-keeping errors.

Well, we don't know what the total amount of the loan debts listed is. Let's assume an average loan debt of $200,000. That gives us $346,600,000 in debts. A $6 million discrepancy is 1.7%. You have to assume that at least some of these are "discrepancies" because the borrowers simply have no idea how much back interest they owe (like all those folks who thought the accrual rate on their OA was 1.00%). There certainly seem to be some big outliers there, given a median of $1,366 and a mean of $3,533. I'm guessing that the one loan of $60,000 with a servicer balance of $1MM is probably throwing that off. End of the day, the discrepancy due to intentional servicer padding of fees has to be less than 1.0%.

Is that an impressive track record for the servicing industry? No. Are we relieved that bankruptcy judges are challenging these charges? Yes, we are: $1,366 might be small beer for a trillion-dollar servicer, but it's money no one needs to squeeze out of a bankrupt consumer. Does it support the contention that servicers are making up for a drop in origination income by loading up on inflated revenues that have no offsetting expenses? Not as far as I can see.

I realize that this will hurt the feelings of the conspiracy-minded, but I do believe that high rates of foreclosure and bankruptcy are money-losers for mortgage servicers, not profit centers. This is not a plea for sympathy for the servicing industry: I have wasted eleventy-jillion of your pixels on the subject of how the industry created this mess with ridiculous lending standards and dereliction of risk management duty. No one is happier than I am to see the little punks take it in the bottom line, and my enthusiasm for things like cram-downs and workouts--the cost of which is borne by the parties who got us into this mess--is an example of that.

It strikes me as quite plausible that some servicers are trying to make some lemonade by charging every fee they can think of. In a foreclosure of an upside down loan, of course, those fees come out of the investor's or insurer's pockets, not the consumer's. In a Chapter 13, these are fees borrowers are expected to repay, and with the cram-down prohibition, there's little incentive for servicers to control costs. So cram the damned things down.

The sad fact of the matter is that there are many businesses and industries that "profit off misfortune." There's money to be made in divorce lawyering, funeral parloring, and broken bone-setting, as well as default mortgage servicing. When profiting becomes profiteering, then yes, that should be punished to the fullest extent of the law. I suggest it also helps to create legal and regulatory structures that remove as many incentives for profiteering as possible in the first place. In order to do that, we have to understand how the business works. Nerdiness matters.

Are we to believe that payoff quote fees were OK until now? That late fees have never until the bust been a money-maker for servicers? That favorable bankruptcy treatment for mortage lenders was fine until 2007? That sloppy business practices have nothing to do with outsourcing, temping, mass layoffs, misguided technology projects, and any of the other myriad forces that corporate America has unleashed in its endless quest to enrich CEOs and keep you on hold for ten hours as you struggle to understand all that crap on your phone bill or locate your lost luggage? Mortgage servicing isn't any better or any worse than the rest of corporate America when it comes to half-assed business practices. It is, however, beginning to suffer the consequences of a huge boom, and I for one predict that we will get to see just how poorly managed a lot of these operations really were: there will be more than a few lost copies of promissory notes and misapplied payments. I'm sure it's too much to hope that everyone who bought shares of these outfits based on their impressive "cost management" will have to pay for it all.

Until justice does finally arrive, I guess we'll have to remember these words of wisdom:

No one likes to face ugly realities like financially ailing borrowers who are so strapped that nothing can save them. Not the lenders, not the Wall Street firms that sell the securities, not even the holders. But experienced investors know that a reliance on fantasy will only prolong the pain that is racking the huge and important mortgage market.

by Tanta on 11/03/2007 12:12:00 PM

Good morning, everyone. I slept better than Citicorp's board did last night. But didn't we all?

Yves at naked capitalism has an interesting post up this morning on risk perception. The text is this essay, "Researchers study how people think about what is and isn't risky," at PhysOrg.com, which takes as its point of departure the question of why people live in fire-hazard areas like Disneyland. And thereabouts.

I was struck by this paragraph:

Researchers found people link perceived risk and perceived benefit to emotional evaluations of a potential hazard. If people like an activity, they judge the risks as low. If people dislike an activity, they judge the risks as high. For example, people buy houses or cars they like and find emotionally attractive, then downplay risks associated with the purchase.

Without having seen the original research, I can't tell if the word "activity" here is meant literally or is simply infelicitous phrasing. My intuition, at least, is that what people like in the above examples is more usefully described as a state of being rather than an activity: people like owning nice homes and cars, not the activity of purchasing homes and cars. In fact, my intuition is that on the whole most people seriously dislike at least certain parts of the activity of purchasing such things. It is only the emotional lure of getting past the purchasing activity that keeps them going.

Anyone who has purchased a home knows that once you get past the early steps--perusing the McMansion porn in the Sunday papers, touring the open houses with a flattering, obsequious real estate agent--it gets to unpleasantries like contracts, inspections, lawyers, financing. Recreational home shopping certainly exists as a phenomenon, as any disappointed broker or home seller will tell you, but recreational home buying is certainly rare. It's just not like whipping out the Visa to snap up another pair of Nikes that you don't really need. Not even the most devoted flipper or serial homebuyer can pull that off every weekend.

I bring this up because I have contended, for some time now, that it is a mistake to see lowering of credit standards as the only real problem we've had going in the mortgage industry lately. It is the attempts to make the process of financing or refinancing a home quick and "painless" that is at the root of the problem. Certainly part of the way you make it "painless" is by relaxing credit standards; these things are related. But the important effect is that borrowers no longer feel put under a microscope (or a proctoscope, as those who borrowed mortgage money ten years or more ago are likely to describe it).

How does that change a prospective mortgagor's perception of the risk of buying a home or refinancing an existing mortgage? It doesn't seem unreasonable to conclude that making the activity less intrusive, in the borrower's subjective experience of it, means that the borrower is less likely to take seriously the written disclosures that describe the risks.

Back when the mortgage process was a great deal more "intrusive," borrowers used to complain bitterly about it. This perception of "intrusiveness" didn't arise simply in the matter of the borrower's credit and financial history; borrowers would routinely moan about lenders "interfering" in sales contracts. Why does some appraisal matter? I should be able to pay whatever I decide the property is worth. Why should the lender delve into my "side agreements" with the seller? Why should the lender be able to delay closing over incomplete items? If I don't care whether the driveway is done or the sod laid, why should the lender care?

The usual lender retort was always that you're doing all these things with someone else's money, and that you pay a lower interest rate for secured money than for unsecured money, implying that the lender has to care as much about the quality of the collateral as about the quality of the borrower. Don't like the lender's view of your collateral? Put it on the Visa; Visa doesn't care what you buy with the loan proceeds. But one of our most powerful ripostes, particularly in the case of cash-out refinances, was the old "paternalistic" standby: you are hocking the roof over your family's head! Take this seriously, will you?

Of course all of that lender "interference" and borrower complaining made for some tense, unpleasant transactions for both sides. And since no "sales oriented culture," which is what even depository mortgage lending operations became once the consultants got done with us, can stand to have unpleasantness, we began easing up on precisely those credit and collateral processing standards that drew the most complaints.

I've heard a number of folks argue that the genesis of recent wretched lending standards is the growth, over the last 20 years or so, of "affordable lending" programs, as if those efforts, led mostly by HUD and the GSEs, to put first-time homebuyers in low-down programs were the main impetus, a number of years later, for stated wage-earner programs using an AVM to offer 1-hour approval for a 95% LTV cash-out refinance on a jumbo property. There may be some truth to the idea that the success of older affordable housing programs was used as a justification for letting subsequent homebuyers and current homeowners do any stupid thing they wanted to do, but to argue that none of it would have happened if those "government" programs hadn't existed is to display one's political biases.

The fact is that those older "government" programs were the most "intrusive," "red-tape"-laden loans that have ever existed. FHA and the GSEs steadily lost market share in the purchase-money mortgage business over the last seven to ten years, as did the private mortgage insurers, even in those markets in which loan amount limits weren't an issue, and even when the rates on their products (30-year fixed) were highly competitive and attractive. "Private" programs were being developed to meet a fairly specific "need," encapsulated by the name of the famous Countrywide product, "Fast and Easy."

I think you can argue that consumers paid more attention to disclosures, spent more time reading documents, and generally proceeded with more fearfulness when things were "Slow and Difficult." It's not because they used to be smarter or we used to disclose more; in fact, just about every year the number and timing of mortgage- and RE-related disclosures has increased in the last two decades. But because the activity of getting a mortgage was painful, the seriousness with which borrowers viewed the risks of it was heightened.

This implies that more disclosure, or more vivid disclosure, is not the answer. We have to go back to a mortgage process that is, intellectually and emotionally, commensurate with its risks. This position can easily be mocked as a suggestion that we do our civic duty by providing wretched customer service. Of course you have to argue, rather than merely assert, that "good customer service" includes removing all visible traces of risk assessment from the process. Nobody is saying you should be rude when you demand those W-2s, or that you should "forget" to ask for them up front, and badger some borrower the day before closing about it. At least one of us is willing to say that that kind of half-assed "customer service" is most likely to thrive precisely in an environment in which our view of risk analysis is totally incoherent to start with.

There's a perfectly silly e-mail making the rounds, asking people to sign a petition opposing H.R. 3519, which the authors of the petition believe would outlaw yield spread premiums (money paid to a broker in exchange for a customer taking a higher rate). The unproven assertion is that all YSP is used to "pay" the borrower's closing costs via a credit, and therefore outlawing YSP would make loans more expensive to consumers. (Yes, the "closing costs" that are "paid" by the YSP include the broker's fees. This is different from the broker just taking YSP from the wholesaler in cash and not charging its compensation in the closing costs because.) It's really a lovely composition, purporting to be from "President" of mortgage company, not third-grader of Mother Khazakstan:

I need all the help I can get this morning. We have U.S. House of Representatives that are considering changing law that would eliminate the use of yield spread premiums in the mortgage place. This bill, H.R. 3915 will affect every one of us weather you are in the mortgage industry or if you are a consumer. This will allow the banks to take full control of all pricing and products available to all Americans. This would make it impossible for third party mortgage loan origination, which would reduce the number of real estate transactions for attorneys, appraisers and home inspectors. This bill would make it impossible for anyone to negotiate an interest rate with lower closing costs associated with the loan or if a borrower has credit issues may not get a loan at all.

Nobody is asking what the effect on consumer perception of risk is in a situation in which not only is no cash down payment required for a purchase, no actual cash outlay for closing costs on a refi is required. It is unpleasant to cough up even a token contribution toward closing costs in actual cash. But that moment of concentration of the mind--writing a check for a thousand or two to a mortgage lender--has been eliminated from the process. It really isn't that the financial facts of this are not disclosed: the TILA disclosures do pretty clearly show the effect on APR of these "no cost" deals. But people do not perceive that "real money" is at risk when they are not asked to pay "real money" in order to close the transaction.

Back in the old days, we referred to that deposit that a property seller requires before signing a sales contract as "earnest money." As in, proof that the buyer is in earnest about going through with the transaction, as it was nonrefundable. Earnest money weeds out recreational and impulse buyers, and also forces serious buyers to pay attention to the process. (It appears to have little effect on manic speculators, but how manic do speculators get when 20% down payments are required on non-owner-occupied properties?)

Removing all the unpleasantness as well as the cash outlays from mortgage transactions, and speeding them up enough to seriously cut into the "cooling off period," is like removing earnest money from RE transactions. I seriously doubt that any study of consumer ability to read and comprehend mortgage loan disclosures is going to tell us anything useful, unless and until the researchers can find a way to approximate stakes for it: the experimental subjects need to have the emotional pull (buying the house, getting the cash) as well as the emotional push (you forfeit your privacy, your time, and a hefty check in the process). It would be enlightening to see a control group with the pull but not the push (no docs required, 1-hour approval, no cash fees). My guess is that more people can spot the difference between the APR and the "payment rate" on an Option ARM if you tell them they forfeit $1,000, payable immediately in cash, if they get the wrong answer, than if they face a monthly payment that is $5.00 higher (because the $1,000 is financed in the loan).

There really isn't anything you can do about the pull: as long as people like to own homes--this isn't an intellectual matter at this level--the pull will be there, as it will be for that big fat check you get in a cash-out. There isn't any particular reason for people not to enjoy those things. My point is that you can waive disclosure documents in front of people all day long, but if the pull is strong enough and the process is so painless that there is no countervailing pain in the activity of getting what you want, the disclosures will strike people as involving remote, rare, manageable risks if they bother to read them at all.

There is some evidence to suggest that borrowers don't actually read them, based on oral representations by interested parties that they are "just legalese": a perfect illustration of an attempt to make the homebuying or refinancing process "painless" (don't subject yourself to the unpleasantness of having to read awkwardly-written, math-heavy documents). A common sense response to this is to make the first disclosure a one-sentence form in 36-point boldface on neon orange paper that says "ANYONE SUGGESTING THAT YOU NOT READ EVERY WORD OF EVERY DOCUMENT YOU SIGN 24 HOURS PRIOR TO CLOSING IS NOT YOUR FRIEND AND IS TRYING TO MAKE MONEY OFF OF YOUR FOOLISHNESS AND IS VIOLATING FEDERAL LAW." But if you did that, you would, well, be taking the "Fast and Easy" part out of the whole transaction.

I expect, by the way, that a real-world example of this dynamic is underway around some preternaturally-waxed conference table in some climate-controlled high-rise office building in New York as we speak. The risk of all those CDOs was undoubtedly presented in the board packets, but the CEO assured the board members that it was just a bunch of "legalese."

by Tanta on 10/26/2007 06:00:00 PM

The Joint Economic Committee report discussed in the Times yesterday, "The Subprime Lending Crisis: The Economic Impact on Wealth, Property Values and Tax Revenues," is now available online.

There's lots in here to discuss, but I just noticed one little snippet while I was skimming that answers a question I had a while back. In 2006, 29% of all mortgage loans were originated through mortgage brokers, but 63% of all subprime mortgages were originated through brokers (page 17).

Otherwise, enjoy the graphs, charts, and maps.

by Tanta on 10/26/2007 11:47:00 AM

This is killing me:

PHILADELPHIA (Dow Jones/AP) - Bankrupt lender American Home Mortgage Investment Corp. has sued Lehman Bros., accusing the investment bank of essentially stealing from the company as it struggled to stay on its feet.

The lawsuit, filed Wednesday in the U.S. Bankruptcy Court in Wilmington, Del., accuses Lehman Bros. of hitting American Home with improper margin calls in July and demanding money the company says it did not owe.

When the Melville, N.Y.-based lender couldn't meet Lehman's second margin call, for $7 million, Lehman foreclosed on $84 million worth of subordinated notes issued in American Home's structured-finance operation. . . .

American Home is relying in part on the frozen market for mortgage-industry paper to make its case against Lehman Bros. Without actual trades to show the value of the notes had declined, American Home argues that Lehman Bros. should have obtained an independent valuation before issuing the margin call.

That's an interesting theory of levering up your "assets": if the market says "no bid," you apparently get "no mark" and therefore "no call" and hence "no bankruptcy."

The thing is, in a nutshell, that AHM was using these borrowings to fund new mortgage origination operations. A "frozen market for mortgage-industry paper" means no money to make new loans with (proceeds from sales of commercial paper backed by the warehouse of held-for-sale loans) until you can sell the loans you've already made. But you can't sell the loans you've already made, unless you want to take a nasty hit on them, because nobody's buying decent whole loans in a "frozen market," and there is excellent reason to think AHM's warehouse held a boatload of not exactly decent loans. We know this because AHM was forced to visit the confessional about its massive number of buybacks of loans that didn't make the first three payments sucessfully.

So Lehman wanted out of its exposure to AHM's held for sale pipeline, as far as I can tell, because unlike your usual "pipeline," this one was a pipe to nowhere (kind of like the bridge to nowhere). It sounds like AHM is now saying that Lehman made up some ugly mark to model valuation instead of getting "independent" verification of the fact that there were no bids--or horrible ones--for the AHM loans. I guess the fact that AHM couldn't get 'em sold in the first place, which is the whole point of having a "held for sale pipeline," is insufficient evidence that the stuff was worthless.

I look forward to hearing about Lehman's response to this.

(Many thanks to the indefatiguable Clyde)

by Tanta on 10/25/2007 06:15:00 PM

Mr. Lewis is not a happy camper:

CHARLOTTE, N.C. - In addition to scaling back its investment banking operations, Bank of America Corp. is exiting the wholesale mortgage business and eliminating about 700 jobs, bank officials said Thursday.

The nation's second-largest bank will stop offering home mortgages through brokers at the end of the year to focus on direct-to-consumer lending through its banking centers and loan officers. The move also eliminates the jobs in the bank's consumer real estate unit. . . .

The cuts are part of a 3,000-job reduction engineered by Chief Executive Ken Lewis after the nation's second-largest bank reported a huge decline in third-quarter earnings.

"When Ken talks about a top-to-bottom review in five days time, you can't make that happen. These cuts were in the works, and expect more," said Tony Plath, an associate professor of finance at the University of North Carolina at Charlotte. "Don't underestimate the depth of Lewis' disappointment in earnings. This guy is pissed." . . .

"Ken says he likes the retail business, he likes getting to know customers, underwriting, and managing his risk," said Plath, the university professor. "He just doesn't like the securitization and servicing sides of the business."

Hey, I can relate, Ken. These days nobody likes being a servicer . . .

by Tanta on 10/23/2007 09:19:00 AM

Thanks to Anonymous, our attention is directed to BankUnited's visit to the confessional. Somehow loan loss reserves went from $8-10MM in pre-release to $19.1MM in the official release. It's the sort of thing that can happen to anyone, you know.

Because we were talking about Option ARMs yesterday, I thought I'd share this bit:

As of Sept. 30, 2007, BankUnited’s option-ARM balances totaled $7.6 billion, which represented 70% of the residential loan portfolio and 60% of the total loan portfolio. For the quarter ended Sept. 30, 2007, the growth in negative amortization was $48 million, compared to $46.4 million for the quarter ended June 30, 2007. Of the $7.6 billion in option-ARM balances, $6.5 billion had negative amortization of $270 million, or 3.55%, of the option-ARM portfolio.

If I'm reading that correctly, it means that 87% of the OA portfolio, by balance, is negatively amortizing, and the total amount of negative amortization is 4.1%. Without the weighted average age of the loans, there is no way to calculate an annual rate of negative amortization. I would be surprised if the average age is more than 24 months, which would produce a rate of around 2.00% annual average balance growth.

by Tanta on 10/19/2007 09:30:00 AM

Given the questions in the comments to yesterday's post on seller-funded down payment assistance (DAP), I thought I'd offer a very simplified example of what the issue is. Yes, this is simplified; FHA loan calculations are pretty complex, even though they aren't as complex these days as they used to be.

Currently, FHA requires a minimum cash investment from borrowers equal to 3.00% of the contract sales price. The effective LTV can still exceed 97% even with a 3.00% investment, because borrowers can finance a portion of allowable closing costs, including their up-front mortgage insurance premium (UFMIP), in the loan amount. (FHA borrowers with a base LTV of more than 90% also pay an additional mortgage insurance premium in the monthly payment of 0.50% annually.) The current UFMIP with 3.00% down is 1.50% of the loan amount.

The administration's proposed zero-down program would have UFMIP of at least 2.25% and a monthly premium of at least 0.55%.

FHA does allow the borrower's down payment to come from gift funds provided by relatives, employers, governmental agencies or true charitable organizations. The point here is that 1) these are supposed to be true gifts with no expectation of repayment, not disguised loans, and 2) they may come only from parties who do not have an interest in the transaction.

Property sellers may contribute up to 6.00% of the sales price to an FHA borrower without affecting the appraised value of the property, but this contribution may be applied only to closing costs and points, repairs, etc., not to the minimum investment (i.e., the down payment). If the seller contributions exceed 6.00%, the excess amount is subtracted from the sales price of the property (as a "sales inducement"), which lowers the maximum loan amount accordingly. HUD has never allowed property sellers to directly provide funds for the minimum 3.00% down payment.

The seller-funded DAP programs get around this problem by having the property seller contribute the down payment funds to a "nonprofit" company which then "gifts" the funds to the borrower. Sellers are generally charged a fee of at least $400 for "processing" their contributions. Every reputable study (non-industry-sponsored) of the resulting loans (like this one) shows that 1) the sales prices of the properties are inflated by the amount of the "assistance" and that 2) the loans default at least twice as often as those with bona-fide gifts from a disinterested party. Even worse, because they are processed with the standard UFMIP charged to loans with a 3.00% down payment, this additional risk is not offset by a higher premium.

Here's how it works. First, here's a "typical" FHA loan with a 3.00% down payment (we'll assume that the seller pays closing costs other than UFMIP in cash, just to keep things simple):

• Original list price: $100,000
• Contract sales price: $100,000
• Appraised value: $100,000
• Required borrower down payment: $3,000
• Base Loan Amount: $97,000
• UFMIP: 1.50% or $1,455
• Total loan amount: $98,455
• Effective LTV (based on original list price): 98%

Here's how it works with a typical seller-funded down payment:

• Original list price: $100,000
• Contract sales price: $103,505 (list price plus $400 processing fee, divided by 0.97)
• Appraised value: $103,505 (or any amount above that, as LTV is calculated on the lower of appraised value or contract sales price)
• Required borrower down payment: $3,105 (provided by the seller via the DAP)
• Base loan amount: $100,400
• UFMIP: 1.50% or $1,506
• Total loan amount: $101,906
• Effective LTV (based on original list price): 102%

If the DAP loan were treated as the same risk as the proposed zero down program, you would get UFMIP of 2.25% or $2,259, resulting in a total loan amount of $102,659 and effective LTV of 103%. That would actually produce a higher loan amount than a true zero down program would, because of that $400 "processing fee" to the "nonprofit" (zero down base loan amount of $100,000, UFMIP of $2,250, total loan amount of $102,250, or $409 less than the "assistance" loan).

What happens if the appraiser refuses to play along with this scheme? Well, that would create a problem: the maximum loan amount is calculated on the lesser of the sales price or appraised value, and so the borrower could not borrow enough to pay the inflated sales price if it were greater than the appraised value.

What if the seller simply reduced the contract price by $3,505 (the cost of assistance plus processing fee)?

• Original list price: $100,000
• Contract sales price: $96,495
• Appraised value: $100,000
• Required borrower down payment: $2,895
• Base Loan Amount: $93,600
• UFMIP: 1.50% or $1,404
• Total loan amount: $95,004
• Effective LTV (based on original list price): 95%

The problem with that last scenario, of course, is that the borrower still has to come up with a down payment. The whole purpose of seller-funded DAPs is to get borrowers with no funds into loans, not merely to facilitate legitimate seller concessions.

Does it really matter whether gift funds come from an interested party? Yes, it does. A party without an interest in the transaction has no incentive to induce or persuade the borrower to pay more than the fair market value of the property; in fact, a distinterested party has an incentive to assure otherwise, since the lower the appraised value and contract sales price, the less the third party has to contribute. Government agencies and true nonprofits who provide such assistance are known for being mean and skeptical reviewers of appraisals and sales contracts, you see. (They also generally have income limits and other rules designed to keep speculators and other non-needy folks out of their programs.) Seller-funded DAPs avoid all that "red tape" and "excessive processing time."

I personally have never had any enthusiasm for the proposed zero down FHA program. But even it is better than the DAP scam. Those who claim that DAP loans provide a benefit to borrowers without funds are making no sense even if you grant that making loans to people without even minimal skin in the game is a good idea: the DAP programs simply keep contract sales prices inflated, channel fees into the pockets of "nonprofits" who provide no other service than laundering money, and result in lower insurance premiums than FHA should be getting for loans with riskier profiles. If you care at all about the long-term survival of the FHA program, you would be doing everything you can to protect it from this kind of damage.

By their own logic, the Congressional defenders of DAPs should be pursuing the zero down program, and/or funding for true nonprofits and local governments who provide forms of down payment assistance that don't inflate sales prices and that offer real, useful homebuyer counseling services. One of the arguments for DAP is that it is available for borrowers who aren't lucky enough to have family, an employer, or a local agency or true nonprofit who can provide gift funds. That's right: if you aren't lucky enough to receive a true gift that enables you to buy a market-priced property, you can be thrown to a bunch of sharks who will provide you with a "gift" with a hidden price tag. This is a good thing, since owning an overpriced home and making the higher payments is, I guess, a major blessing.

Supporting DAPs means supporting property sellers--particularly but not limited to builders and developers--and the "entrepreneurs" who form "nonprofits" to extract fees from naive homebuyers, not to mention loan originators who pocket higher commissions, with the risk being carried by government insurance. It is, precisely, the kind of sleazy, conflict-ridden, self-serving "initiative," overtly "faith-based" or its sort-of secular equivalent "dream-based," that thrives in an environment where regulation is dismantled or unenforced and "government" is bashed with one hand and milked with the other. It is an "innovation" just like plainer, older-fashioned forms of money-laundering are "innovations." It takes a profound ideological blindness to march behind the DAP banner in the name of "helping first time homebuyers."

by Tanta on 10/18/2007 09:38:00 AM

Shall we start a pool on whether Congress caves in or not? National Mortgage News via absnet.com:

The Department of Housing and Urban Development has stuck to its guns regarding seller-funded downpayment assistance on Federal Housing Administration-insured mortgages. But third-party conduits which funnel financial aid from buyers to sellers are not going away without a fight.

Practically before the ink was dry last week on the final rule prohibiting anyone except family members, employers, government entities or true charitable organizations from giving would-be buyers money to cover the 3% downpayment required on FHA loans, the two largest DPA providers filed separate suits in Federal Court seeking to overturn the controversial rule.

Scott Syphax, president of the Nehemiah Corp., Sacramento, Calif., called the rule "outrageous," saying it removes practically the only "lifeline" left for working families to achieve ownership.

"Privately funded downpayment assistance programs have helped over 600,000 families become home owners and have been credited not only for helping people buy homes, but also stabilizing neighborhoods and cities and creating stronger families," he said.

AmeriDream, Gaithersburg, Md., another major DPA provider, expressed "great confidence" on its website that HUD will be overturned in court. "HUD's action makes no sense," said chair Ann Ashburn.

Several lawmakers also cried foul, as did the Mortgage Bankers Association and the U.S. Conference of Mayors.

In an interview with Bloomberg News, Rep. Al Green, D-Texas, said the program "could have been fixed and need not have been nixed." Reps. Gary Miller, R-Calif., and Maxine Waters, D-Calif., joined Rep. Green in registering their disapproval and calling on HUD to correct whatever problems exist in the program rather than simply can it.

"If there are concerns with certain downpayment assistance providers, HUD should address these individual providers, and put the controls in place to weed out the bad actors, rather than completely eliminating a program that has successfully expanded homeownership opportunities for millions of families," the three congressmen said.

They also vowed "to fight every effort to eliminate rather than reform this important tool that has built financial strength and formed lasting communities."

Nevertheless, unless the court or Congress goes against HUD - the House-passed FHA reform bill sets new standards for DPA providers but the Senate Finance Committee's version prohibits such assistance - the prohibition that bans anyone who has a stake in the transaction from providing buyers with cash for a downpayment takes effect Nov. 1. . . .

Mr. Montgomery told reporters during an unusual conference call set up by HUD - "We wanted to give you folks a little advance notice," he said at the outset - that nonprofits can still provide downpayment assistance in the form of a gift "so long as they don't collect 'donations' from sellers."

And therein lies the rub, the FHA commissioner said, for in most cases, there is "a clear quid pro quo" between the purchase of a house and the seller's "contribution."

The so-called gift often functions as an incentive to buy the house, the FHA contends, but the gift is ultimately paid for by the buyer through a higher mortgage amount because sellers tend to raise their asking prices to cover the amount they are giving away.

Mr. Montgomery said in the current slow housing market, sellers are "more willing than ever to participate" in these programs, even though they "circumvent our restrictions" and buyers "are often unaware that the gift is something they end up paying for and not a gift at all."

The FHA also maintains that loans to those who rely on seller-funded don't perform nearly as well as they should. Indeed, the agency says they are almost two and a half times more likely to fail than other FHA-insured mortgages.

by Calculated Risk on 10/16/2007 04:02:00 PM

Quote of the day from the Mortgage Bankers Association's (MBA) new Chairman Kieran Quinn (no link):

"We're going back to lending the way it was in the 1950s and 60s. Mortgages will be made mostly by bankers and their employees, and compensation will be based on who's making good loans and who's not."

Securitization is here to stay; Quinn is saying third party origination is mostly going away.

by Tanta on 10/16/2007 02:00:00 PM

From the OFHEO Press Release:

Washington, DC – The Office of Federal Housing Enterprise Oversight (OFHEO) announced today three actions regarding the calculation of the conforming loan limit, which establishes the maximum mortgage loan value eligible for purchase by Fannie Mae and Freddie Mac.

OFHEO Director James Lockhart announced that, based on provisions in the proposed guidance, the current conforming loan limit will not be reduced for 2008. If the index used to calculate the maximum loan level should increase, the amount of the increase in 2008 would be reduced by the decline calculated in 2006 of 0.16%. Under no circumstance, however, would the maximum loan level for 2008 drop below the 2006 and 2007 limit of $417,000.

Background information on the conforming limit history and calculations from OFHEO is here.

by Tanta on 10/16/2007 12:46:00 PM

There has been a fair amount of reporting in the last two days on a survey of ARM borrowers commissioned by the AFL-CIO. As is often the case, what we learn seems to be more about the press's ignorance than anything else.

The clearest description of the results that I've found comes from the AFL-CIO's blog (surprised?):

The poll shows that of those homeowners whose ARMs had reset, 37 percent had interest rates at 8 percent or higher, above the current market rate for prime, fixed-rate loans, and 16 percent had interest rates at 10 percent or higher. After the reset, the average increase in monthly mortgage payments is approximately $291, a 10 percent cut in after-tax pay for a family earning $50,000 a year.

Two in three (64 percent) of those whose rate has reset do not recall their lender telling them how much more their payment would increase, and 32 percent don’t recall being told when their interest rate would increase. Twenty-three percent of all respondents say they had been late making a mortgage payment at least once in the past 12 months. That proportion jumps to 37 percent among those whose rate has increased.

The poll also found substantial support for government action to protect consumers. Fifty-one percent say they think the government should assist people with ARMs facing foreclosures, and 77 percent say the government should do more to regulate the mortgage industry.

Despite a general lack of understanding about their adjustable rate mortgages, 79 percent say they believe the information they received from their lenders was mainly accurate and truthful. Sixty percent say they got their ARMs from mortgage brokers, and 39 percent directly from banks. [Emphasis added]

Without seeing the actual survey question, I am at a loss to know what, precisely, we are to make of the fact that two thirds do not remember the lender disclosing how much the payment would rise. That implies that one third of the respondents seem to remember the lender disclosing an unknowable "fact." ARMs adjust on specified dates, and the rate (and hence payment) are adjusted to a specified formula (index plus margin, subject to caps), but since the index at adjustment is a future value, there is no "disclosure" of how much the payment will increase. If a third of respondents remember being told what their future payment would be (not, say, what it might be if the index value does not change, which is the standard disclosure), then we got some serious problems here, but I don't think it's the same problem that the press thinks it is.

It's also curious that 79% of people feel that the lender disclosed facts honestly, when it seems clear that a majority of borrowers aren't sure what the facts are. There are several possibilities here, one being that borrowers on the whole are likely to trust people who work in financial services and talk in numbers, whether that trust is misplaced or not. Another is that borrowers recognize that they were in fact given truthful information, they simply do not understand it. They don't even know what they're supposed to "know": you cannot, in fact, "know" what your future payment will be with an ARM. If you think you "know" that, you are confused. Similarly, if you don't remember being told when your ARM will adjust, you can actually look at your copy of the note you signed. Do people rely on memories of oral explanations because they do not know how to read these notes? Would they ever have known how to read these notes?

However, press reports don't seem to see the real problem here:

A study commissioned by the AFL-CIO shows that nearly half of homeowners with ARMs don't know how their loans will adjust, and three-quarters don't know how much their payments will increase if the loan does reset.

Nearly three quarters of homeowners (73%) with ARM's don't even know how much their monthly payment will increase the next time the rate goes up.

Not a single one of these sources explains how a person with an ARM might go about finding the information and the calculator necessary to determine what the adjusted payment might be if the index value available today is the one that will be used in a future adjustment.

Is that whole process over a lot of folks' heads? Sure it is. That's why offering ARMs in the mass market to people without much financial sophistication, who probably do really need to know what their payment will be in the future to budget around it, and therefore should be put in fixed rate loans, remains a thoroughly stupid idea. I, however, remain stunned that the press can report that "only" 73% of borrowers do not claim to know the unknowable as if that's the problem.

by Tanta on 10/12/2007 11:14:00 AM

Courtesy of Thomas Zimmerman of UBS, whose PowerPoint presentation is available here. There's quite a bit of interesting data for the nerds.

These charts are mini-vintages (quarterly rather than annual) of 2/28 subprime ARMs.

The first shows serious delinquency (60 or more days delinquent, FC, or REO) for first lien purchase money loans using 100% financing (CLTV greater than or equal to 100%) with less than full documentation in states with "stable" HPA. (I don't know exactly what universe of states that is.)

The second chart shows the same loan type for California properties only:

To put this into some context, the third chart shows what we might call the more "traditional" subprime loan: a 2/28 ARM cash out, with full doc and CLTV less than or equal to 80%. This third chart is California properties only.

I think I've said this before, but it bears repeating: I have never, in my hundreds* of years in this business, worked with any mortgage model--pricing, credit analysis, due diligence sampling--that did not consider cash-out an additional risk factor. That is, historically speaking, cash-out refinances always performed worse than purchase money or rate/term refinances, and the models therefore would give a worse risk-weighting to a pool with a majority of cash-outs than a purchase-heavy pool. There were two main reasons for this: cash-out does correlate with heavy debt use (obviously), and also, historically speaking, cash-out refi appraisals were the least reliable, most subject to "hit the number" pressures. This was true even when lenders allowed substantially lower LTVs on cash-outs than recently has been the case.

In my view, a whole lot of the failure of the rating models to adequately account for the risk of these recent pools is that they used "historical" assumptions about the risk of purchase transactions.

*Mortgage years are like dog years, only worse.

by Tanta on 10/11/2007 10:18:00 AM

This is a follow up to CR's post last night on the WSJ article using HMDA data to make some observations about "subprime" loans.

Trust the Wall Street Journal to fail to understand the point of reporting regulation. They are not the only media outfit to have made a major logical error using HMDA data, but they make a nice poster child for the problem. The WSJ's basic point of departure:

The analysis of loan data by The Wall Street Journal indicates that from 2004 to 2006, when home prices peaked in many parts of the country, more than 2,500 banks, thrifts, credit unions and mortgage companies made a combined $1.5 trillion in high-interest-rate loans. Most subprime loans, which are extended to borrowers with sketchy credit or stretched finances, fall into this basket.

Of course, if you simply assume that borrowers get a high interest rate for a good reason--they are subprime credits--then the fact of "high interest rates" needs no explaining, and the fact that such loans may be concentrated in low-income or minority borrower groups can be explained as something other than discrimination (if you simply assume that low-income or minority borrowers are more likely to have subprime credit profiles than other borrowers).

I guess we're going to have to take a walk down memory lane here. There was a time --around 1975 to be precise--when Congress was a bit concerned about anecdotal evidence that banks and thrifts were engaging in "redlining," or refusal to lend money at all in certain (mostly minority or low-income) neighborhoods. (The idea is that a lender drew a red line on a map around areas in the "wrong side of town," and loans would not be made for properties in the red areas.) In a rare recognition by Congress that anecdotal evidence is unsatisfactory, the Home Mortgage Disclosure Act (HMDA) was born. Its original incarnation required lenders to report data on the geographical location (down to census tract level) of loans originated. This data could be analyzed to see if apparent redlined areas appeared.

In 1989, HMDA got an overhaul which required lenders to report on denied applications, as well as originated loans. Further, the borrower's race, sex, and income level had to be reported on all loans. This change grew out of more anecdotal evidence--some of which was being probed in courts of law--that minority and female applicants were being turned down at disproportionate rates. Congress also gave the Federal Reserve the authority to augment HMDA reporting requirements.

In 2002, the Fed used that authority to require price data on loans originated. You see, there was anecdotal evidence that some classes of borrowers were getting higher rates on loans in ways that couldn't be explained by the loan or borrower characteristics.

This whole dynamic may be hard for the WSJ and its fellows in the Big Paid Media, so let me explain this very clearly. In 1975, some folks accused lenders of redlining, which means not granting credit at all to some people. The lenders said they weren't doing that. Congress passed HMDA, and then there was actual data about geographic lending patterns to analyze instead of anecdotes. Once we got some HMDA data under our belts, the Community Reinvestment Act came into being (in 1977) precisely because it was clear that redlining had been going on. CRA in essence forces lenders to show that they are willing to make loans in neighborhoods in which they are willing to take deposits (i.e., those deposits need to be "reinvested" in the neighborhood they came from in the form of loans, not just mortgage loans, to that neighborhood. You can't extract deposits from poor people and use them exclusively to fund loans to rich people.) CRA does not mandate price levels, or even address the question of price levels.

You may be surprised to hear this, but over time accusations of discriminatory lending practices did not go away. In a number of cases, "mystery shopper" tests were performed, in which a white applicant and a black applicant each applied for credit at the same instutition with identical credentials (employment, income, credit history, loan terms), and the results showed that black applicants were more likely to be turned down. This cast some doubt on the lenders' claims that loan rates in minority neighborhoods were a function of the lower credit quality of those borrowers. That became a hypothesis in need of some testing, you see, not an accepted explanation.

So the 1989 revision to HMDA forced collection of demographic data, for the precise purpose of testing the assumption that poor and minority people are just always bad credit risks. This resulted, as you might expect, in conjunction with CRA and other fair lending laws, in much higher rates of home mortgage lending in those areas that were once redlined.

But were these poor and minority people happy, at last? Why no, they weren't. Turns out, anecdotal evidence began to emerge that while these good people were finally getting loans, they were getting them at much higher interest rates than higher-income folks and whites generally got, and that this could not be accounted for by the difference in creditworthiness of the borrowers or the quality of the collateral (the latter proxied by census tract).

So the 2002 change to HMDA, to collect data on mortgage loan pricing, was an attempt to collect empirical data on pricing patterns to test claims about what might explain higher loan pricing, not to accept them without further probing. The whole point of the HMDA dataset is to ask if wide disparities in loan pricing exist, in the same geographical area at the same time. If they do, the data can be analyzed controlling for income level, race, and sex, to see if any of those things correlate with loan pricing. If they do--and they certainly do--there is still the question of why this happens.

The lending industry will tell you without fail that this correlation exists because low-income and minority borrowers have lousy credit histories. But the HMDA data does not support (or disprove) that claim. The HMDA data shows that these borrowers get higher rates on average, but since the HMDA dataset does not include FICO or any other reliable measure of credit history, it cannot be used to conclude that these higher rates are explained by the subprime credit of the borrowers.

And you cannot use subprime mortgage lending patterns to prove or disprove this claim, either. You are trying to test whether "subprime mortgages" are being given only to truly "subprime borrowers." Your test results will look funny if you assume your conclusion.

So. There is no measure of borrower creditworthiness, specifically, in the HMDA data. The "high priced lending" data is an attempt to quantify the number of loans made at a threshold which is usually going to be unexplainable except in terms of either the risk factors of the loan or discrimination. (That is, the threshold is set to "weed out" spikes in market rates during which everybody gets high rates. If risk factors cannot explain the difference, the presumption must be discrimination).

It also uses APR, not note rate, as its measure. APR is calculated by taking into account fees and points over the stated term of the loan, and so using an APR measure lets you pick up loans that appear to have a low note rate, but that still involved unusually high charges to the borrower. APR on an ARM is calculated by assuming that the original index value is unchanged over the life of the loan, and then by using an interest rate in the APR calculation that takes into account scheduled rate increases up to the "fully indexed" value (that is, it's kind of a "blended rate" of the initial discounted rate and subsequent rates on the loan). So you can't evade high-cost loan reporting by putting people into teaser-rate ARMs, or by offsetting low note rates with outrageous fees, because the APR measure cannot be fooled like that.

The trouble, of course, is that an absolute level of APRs isn't very helpful: we all know that what counted as a "high rate" in 2003 is not the same as what counts as a high rate today, because market rates change. We also know that second liens get higher rates than first liens, and that the term of the loan affects rate. So the threshold was set based on the price of comparable-maturity Treasury securities at the approximate time the loan application was made, with a spread of 3.00% for first liens and 5.00% for second liens. If the APR on the loan exceeds these thresholds, it is reported as "high rate."

However, since the 2002 change to HMDA did not force lenders to collect other data that could account for pricing differences, such as LTV, doc type, FICO, or DTI, you have a set of pricing data but you're back to square one in terms of using it to decide whether this pricing is fair or predatory or discriminatory. (And yes, the Fed initially proposed collecting more loan level data, and yes, the industry lobbied long and hard over the "reporting burden" this would create.)

You also find that the data itself can be weirdly skewed when a lot of loans are ARMs and the yield curve is flat or inverted. Without the other data on borrower credit quality and loan terms, it's very hard to sort out the noise.

So we have data from HMDA showing that high-priced lending is not necessarily limited to low-income and minority neighborhoods. The WSJ takes this to mean that subprime lending is not necessarily limited to low-income and minority neighborhoods.

Subprime mortgages were initially aimed at lower-income consumers with spotty credit. But the data contradict the conventional wisdom that subprime borrowers are overwhelmingly low-income residents of inner cities. Although the concentration of high-rate loans is higher in poorer communities, the numbers show that high-rate lending also rose sharply in middle-class and wealthier communities.

First of all, I take major exception to the claim that "subprime mortgages were initially aimed at lower-income consumers with spotty credit." Near-prime programs like FHA were until quite recently the backbone of lending to lower-income consumers with "spotty" credit. Subprime mortgages were aimed at people with terrible credit, and if you think that problem is limited to those with low income, you'll have to explain to me how these low income folks racked up enough credit to have major problems with it in the first place. If people won't lend to you, you don't have a credit report full of late payments and charge-offs. I bring up the whole history o' HMDA to point out that the concern has always been as much about whether credit was granted at all to some folks as it has been about the terms on which that credit is granted. I will also note that FHA loans, because of HUD and Ginnie Mae rules, can rarely end up in the "high rate" category in HMDA. You can write FHA loans all day and not worry that your HMDA report will make you look like a predator. Yes, FHA loans have higher rates than conforming conventional loans, to account for their riskier nature, but they're comfortably within that "spread" used in the HMDA definitions, because they are near-prime or "spotty" credit, not terrible credit.

Further, the WSJ "contradicts" the "conventional wisdom" that subprime is mostly a matter of urban poor folk by showing that some suburban middle-and-upper income folk get high rate loans, too. However, because they accept without question that "subrime falls into the basket" of high-rate loans, they manage to assume that increasing numbers of high-rate loans to the suburban middle class means that these loans are "subprime." As CR notes, the whole phenomenon of "Alt-A" seems to have escaped them.

The possibility also seems to have escaped them that maybe subprime is, at the end of the day, just "high rate lending." If that's the only constant we can find in that category called "subprime"--if income, credit history, property location and price in that bucket is apparently rather random--then you begin to suspect that "subprime" is "loans to naive or desperate borrowers," not this ballyhooed "risk based priced" stuff of recent legend.

If you don't find that idea perfectly convincing, then you will indeed have to collect and analyze the data on LTV, FICO, doc type, etc. to establish that the category "subprime" means risk-based price, not just high-price.

The bottom line is, as CR notes, that "high-risk" lending was everywhere in the boom years. Of course there is a desire to collapse it all into the easy category of "subprime." And there has for a long time been a lot of political pressure to keep the association of "subprime" and "urban minorities" in place, because it has functioned as a good excuse for the subprime lenders (they "help" the poor and minorities, remember?). My view is that a whole lot of parties are very interested in maintaining rather than seriously analyzing a lot of faulty assumptions about risk, rates, and borrower credit characteristics. If this ain't "just a subprime problem," then an entire debt-based economy in which even the middle and upper middle class cannot afford homes given RE inflation and wage stagnation is suddenly in question. The last thing certain vested interests want to hear is that, basically, "we are all subprime now."

by Tanta on 10/10/2007 09:40:00 AM

More unattractive little snips from my unattractive spreadsheet collection (earlier posts here and here). What can I say? UberNerds don't need no steenkin' fancy formatting.

Item one gives you some sense of the size of the residential first lien securitization market since 1988.

I have been avoiding the terms "agency" and "nonagency" on this blog, but I'm breaking down and using them here. These are an established and pretty old-fashioned way of describing things inside the biz, but they are traps for the unwary. In this particular context, "agency" means Ginnie Mae (which securitizes FHA, VA, and a few other government-insured loans), Fannie Mae, and Freddie Mac, even though only Ginnie Mae is actually an agency of the government (Fannie and Freddie are GSEs, Government-Sponsored Enterprises, not actual agencies). But we used to call them all agencies, and the term survived reality by about a generation and a half, so there. "Nonagency" just means any private issuer.

The column "Issues / Originations" is simply that: one annual number divided by another annual number. That is a very, very approximate way to describe the rate of securitization of originated loans. You would get a number much closer to reality if you used quarterly numbers with a one quarter lag, but I don't have quarterly origination numbers handy. So do throw this number around with a high degree of caution.

What we learn from this spreadsheet is something like the approximate size of the segment of mortgage outstandings that have been in the news lately. The nonagency category (in these charts) includes Jumbo A, Alt-A, and Subprime, primarily first liens. (It includes some MBS that have a small percentage of second liens in them, but excludes MBS that are exclusively second liens. I complain regularly about the "lumpy" or Bridge Mix nature of recent nonagency MBS issues, and this is one reason why.) Basically, all the reporting you are seeing that is based on securitized nonagency loans is discussing around a third of securitized loans outstanding, or 19% of all loans outstanding (as of Q4 2006). Because there is so little data available on unsecuritized loans, it is extremely difficult to answer the question of the extent to which "nonagency" unsecurtized (these are mostly but not exclusively bank and thrift portfolio loans) will perform like their securitized brethren. Most of us believe that the securitized loans were written to much riskier standards than the unsecuritized loans, although as I noted yesterday in reference to the C of the C's last exasperated speech, I do believe that portfolio lending standards have loosened significantly in the last several years. You may in any case draw your own conclusions.

Item two is all the information I have on the break-out of the nonagency category. I got nuthin' on outstandings prior to 2000, but you can guess from what's here that they were rather modest in relation to total mortgage outstandings in those years.

I do not have a refi mix breakout by product for Jumbo A and Alt-A, so I didn't include it. But you can get a sense for how much of new origination is refinance (turnover in the outstandings rather than net additions to it) by comparing issues to the change in outstandings in a given year.

You can also get an idea for why people like me have been snorting derisively for years over this claim that "Alt-A" has a stellar performance history. It barely has a "history" at all. Furthermore, the definition of "Alt-A" in 1995 bears little resemblance to the definition of "Alt-A" in 2006. Remember that "Alt-A" means "alternative" to "A," and so whatever it is, its composition will change as the definition of "A" or "prime," to which it is an "alternative," changes. Back in the mid-90s, SIVA (stated income/verified asset) or--gasp!--CLTVs of 95% were the big "alternatives" and "interest only" was the sort of thing you ran into in commercial lending. Not only do you have, nowadays, IO SIVA with 100% CLTV in "A" (conforming or Jumbo), you have stuff in Alt-A that was simply unimaginable in 1995. So as "A" gets more "alty" over time, "alt" gets waaay more "alty" over time. What people are trying to get at by asking how "Alt-A" can "revert to normal" is, as far as I'm concerned, not very clear. I have no idea what other people think "normal" Alt-A is.

by Tanta on 10/09/2007 01:45:00 PM

Here's a classic example of why some of us are simply beyond disgusted with the mortgage industry. It comes from an American Banker (not online) article on FDIC Chairman Sheila Bair's recent proposal to a mortgage banking conference that servicers use their ability to modify loans to "freeze" endangered subprime ARMs at the start rate.

The day before the interview, Ms. Bair had done some jawboning in a speech at a New York mortgage investor conference sponsored by Clayton Holdings Inc. Her proposal is "a clear, categorical move that can be applied on a wholesale basis by servicers," she told nearly 100 professionals at the conference. "I don't think servicers have the time or the resources to go through these case by case, renegotiate, [and] restructure every single one."

Moreover, "if the industry doesn't do it themselves, either Congress is going to do it for them, or a bankruptcy judge is going to do it for them," she said, a reference to legislative proposals to allow bankruptcy courts to modify mortgages. "I'm trying to make one suggestion at least for a certain category of loans where I perceive these to be more sympathetic borrowers, and show policy makers that the industry is working to find a solution."

But questions from the audience revealed a reluctance in some corners to cut subprime homeowners much slack.

"The behavior of a subprime borrower, the reason they became subprime, is because they get themselves into [a] credit issue," one audience member told Ms. Bair. "If you, in turn, fix a liability that they have, they will max out their credit card. There will be another event that they will put themselves in trouble, in default. You're just going to postpone" the inevitable and, "in a declining housing market, just make things worse."

See, this is how it all started:

Dude with "credit issues" wanders into a branch of Subprime R Us, wanting a loan to buy a house. Loan officer looks at the fact that Dude has a history of getting into credit messes, and says, "there will just be another event you will put you in default. By buying a house and adding to your living expenses, you are just going to end up inevitably in foreclosure. Loan application denied."

Oh, it didn't happen that way? OK, so Dude got the purchase money loan. Then the credit card bills started racking up, just like the loan officer didn't predict would happen.

Dude goes back to Subprime R Us, wanting a cash-out refi to consolidate debt. Loan officer looks at the fact that Dude has a history of getting into credit messes, and says, "there will just be another event you will put you in default. By fixing a liability that you have by giving you a cash-out, I would just allow you to max out your credit card again. It would just be postponing inevitable default. Loan application denied."

Oh, it didn't happen that way? OK, so Dude got the cash-out refi. Then the combination of the expensive mortgage and the credit card bills started racking up, just like the loan officer didn't predict would happen.

Dude calls up mortgage servicer, because Subprime R Us has apparently filed for bankruptcy and does not answer phone calls. Dude asks for a workout of loan terms. Servicer says . . . sorry. We only make loans to people we know will default when home prices are rising. Now that home prices are falling, the fact that we "know" that you will just max your credit cards out later is relevant. The fact that it used to be irrelevant is immaterial.

You listen to these people and you get the impression that subprime loans are kind of like the Messiah: an immaculate conception and a virgin birth. No lender was apparently involved the first time; the borrowers just made these loans to themselves. Now that reality has intervened to show how stupid some of these lending practices are, it's time to remember that we "know" what subprime borrowers will do if you lower their monthly payments.

Yeah, sure we "know" that. That's why you find so many mortgage servicers advocating outlawing subprime mortgage lending, on the grounds that they know it never works out.

by Tanta on 10/09/2007 11:52:00 AM

John Dugan, Mr. I Hate Stated Income and also Comptroller of our Currency, is on the warpath again:

San Diego, CA – Comptroller of the Currency John C. Dugan said today that banks need to strengthen their underwriting standards, particularly on loans sold to third party investors.

“I am here to say that bank underwriting standards for these products, in many cases, moved too far away from what they would have been if the bank had held those loans on its own books,” Mr. Dugan said in a speech to the American Bankers Association’s Annual Convention.

Mr. Dugan noted the many positive aspects of the “originate-to distribute” model, but said there can be negative effects on underwriting standards, including relaxing significantly the incentives to use caution and prudence in underwriting loans sold to third parties.

“When a bank makes a loan that it plans to hold, the fundamental standard it uses to underwrite the loan is that most basic of credit standards that I’ve already talked about: the underwriting must be strong enough to create a reasonable expectation that the loan will be repaid,” the Comptroller said. “But when a bank makes a loan that it plans to sell, then the credit evaluation shifts in an important way: the underwriting must be strong enough to create a reasonable expectation that the loan can be sold—or put another way, the bank will underwrite to whatever standard the market will bear.”

Comptroller Dugan outlined what needs to be done. “I am here to say that banks need to strengthen their underwriting standards so that they move back towards the fundamental principle of maintaining a reasonable expectation that loans will be repaid, even if the loans are to be sold to third parties – and that goes for mortgage loans, leveraged loans, or any other syndicated credit,” Mr. Dugan said.

What Dugan neglects to mention--or at least, what isn't in the reported summary of the speech--is the vicious feedback loop that goes on with this model. The problem is that for many years, banks often used a standard for determining an "investment quality loan" based on what secondary market investors--traditionally, Fannie and Freddie--would purchase. So when the GSEs and private investors relax standards for what counts as "capacity to repay," banks find themselves with a widening gulf between their own portfolio standards and "what the market will bear." This begins to suggest to portfolio managers that internal credit standards are "too tight," and so the banks don't just lower standards for loans they intend to sell, they lower standards for their own portfolio production.

(Hat tip FFDIC)

by Tanta on 10/09/2007 10:04:00 AM

More stuff from the spreadsheet collection. This one looks at characteristics and some performance measures of securitized subprime loans from 2000-2006. Unfortunately, there is very little publically available data on unsecuritized subprime.

Comments:

1. Total MBS issued on this chart is mostly, but not exclusively, first liens. (It includes securities that have some second liens, but excludes securities that are exclusively second liens.)

2. The average loan amount is based on first liens.

3. WAC is weighted average coupon or "interest rate" in English.

4. "Reported" DTI simply means that's what was reported. While I have some doubts about the accuracy of that number when the full doc percentage is dropping, do notice that it is climbing even so. The historical maximum acceptable DTI for conforming agency-quality loans was 36%.

5. Historically, subprime was a refinance business, not a purchase money business. This chart shows that very clearly.

6. "Serious Delinquency" means 60 or more days delinquent, FC, REO, or BK. Because this is calculated on the current balance of these securities, this number will be much higher than what you see reported based on original balance. You should be aware that the remaining current balance of these older vintages is very low; the average "pool factor" or balance remaining for 2000, for instance, is around 5%, as opposed to 83% for 2006.

7. "Default" is a very specific technical measure here. A loan is reported as a default in a month when its balance is reported as zero and its last reported status was in foreclosure, REO, delinquent more than 150 days, or any other status and a loss of more than $1000 was recorded at payoff. In other words, "default" is the final disposition of a loan, and it includes things like short sales and short refis as well as foreclosures. It does not include active modifications or forbearances, since these loans still have a reported balance. It is a loss measure, and because it involves the final disposition of a loan, it is always much lower for new issues than for older issues, even if they are performing equally.

8. Cumulative loss is based on the original security balance, and is equal to default times severity.

Now, about that FICO average. On the one hand, the fact that the average FICO is rising can be filed under "I sure as hell hope so." When you look at the steadily rising risk factors of CLTV, documentation level, DTI, and so on, you would certainly expect that higher FICOs were being required as some kind of risk offset.

On the other hand, those average FICOs are getting awfully close to near-prime or even prime territory, depending on your definition (620-660 being the usual floor for prime). That means that a lot of these loans have FICOs clearly in prime range. In order to rule out the possibility of predatory steering, you have to trust that the subprime industry has been scrupulous about giving subprime loans to higher-FICO borrowers only when the other loan characteristics are clearly non-prime. This question cannot be solved by looking at averages or even really good stratifications; it takes loan-file-level reviews to really understand what's going on. As those loan-file-level reviews were, apparently, not done by aggregators and raters and investors, they are now being done by servicers and courts.

by Calculated Risk on 10/08/2007 05:51:00 PM

From Fannie Mae chief economist David Berson's Weekly Commentary

"... lenders reported a lack of investor demand for high credit quality jumbo mortgages and other mortgages not eligible for agency purchase. This dislocation pushed the cost of prime jumbo financing significantly higher relative to rates on conforming loans. Figure 1 shows the spread between rates being offered by lenders on prime jumbo and prime conforming 30-year fixed-rate mortgages. In mid-August this spread spiked to above 90 basis points after fluctuating between 15 and 25 basis points for the prior year-and-a-half (about equal to its historic spread). This spread has moderated somewhat over the past couple of weeks, however, and fell below 80 basis points in late September, suggesting some modest improvement in the market conditions for prime loans with balances above the conforming loan limit. Even so, the spread remains historically wide -- suggesting that the prime jumbo market remains in distress."

The key sentence: "the spread remains historically wide -- suggesting that the prime jumbo market remains in distress."

by Tanta on 10/08/2007 11:30:00 AM

I've been updating some old spreadsheets of mine, and I thought some of you might be interested in having some of the numbers. Data like the following, which involve national averages over entire years, are awfully blunt instruments for a lot of analytical purposes; I'm not offering these as "proof" of any particularly detailed claim about the world, nor am I suggesting that any particular set of numbers in this table can "explain" any other set in completely reliable ways.

Nonetheless, broad-brush numbers like these do provide a kind of context for certain discussions of the mortgage market. I tend, personally, to cringe a lot when certain numbers are reported in the press, because I possess a sense of context that, frankly, non-insiders don't have. It is second nature to me, for instance, to distinguish between origination volume and level of loans outstanding at the end of a period, but you will find press reports moving back and forth from originations and outstandings in blithe disregard of the issues.

So make of this what you will. A few nerdly observations about the data:

1. Total originations are hard to pin down; there's often a lot of vapor as well as volatility in those numbers. I pick what I think is the most reliable, but you should know that data collection and reporting practices change over time, and so a lot of the older numbers are pretty approximate. That's one reason why I don't care to go back before 1988.

2. The ownership rate statistical calculation changed significantly in the early 90s. The pre-1993 numbers should be thrown around with even more caution than the 1993-2006 numbers.

3. There are a lot of different rates you can use to establish an average mortgage interest rate. I chose the FHFB conforming fixed contract rate because it can be considered an index of "refinance incentive."

4. Mortgage FOR is a statistical measure of mortgage debt, property taxes, and insurance divided by disposable personal income for all homeowners with a mortgage. As a level, it's not particularly helpful, but it does help establish trends, and it is certainly more consistently calculated than DTI.

5. Refinance percent is all refinances. I am not yet ready to try to sort out the cash-out issue over this time period, and I may never be. But general refi share is a useful bit of context for those changes that you see in the other numbers.

A couple of general observations I would make about this data:

1. Notice the volatility of origination volume compared to mortgage outstandings. A large part of some of the knotty issues we've talked about on this blog, like use of brokers, barriers to entry (or the lack thereof) for mortgage originators, and historical changes in quality of mortgage origination personnel (including loan officers and appraisers), has to do with that volatility. The short version is that originators staff up and staff down in the cycle, and that loan quality (not just borrower credit quality, but accuracy of paperwork, depth of documentation, clarity of disclosures) zigs and zags along that cycle. In the early part of those big booms, for instance, you can see a lot of novice work. In the troughs, you can see a lot of desperate commission-paid people doing desperate things. That's something to take into account when you look at, say, vintage charts of loan performance. I believe, for instance, that a lot of the problems with the (in)famous 2001 vintage had to do with a huge crop of brand-new brokers and loan officers and appraisers getting into the business to cope with the volume. A lot of the problems with the 2000 vintage is that a bunch of originators who had been, in the past couple of years, making plenty of money off the refi boom started scraping the bottom of the barrel when volume dropped off. The 1993-1994 period had a similar problem.

2. There has always been much more stability on the servicing side; the problems there in terms of expertise are more a function of technological "productivity" changes and outsourcing reducing the cadre of gray-haired veterans of past crises. The thing to notice here is the level of turnover in the outstandings. In 2003, for instance, around a third of the outstanding mortgage book turned over in refinances. Mortgage sevicers can do a lot of work to stay in the same place, let alone to grow a servicing portfolio.

3. Whatever generalizations you want to make about earlier periods, the 2004-2006 period confounds them.

by Tanta on 10/07/2007 11:09:00 AM

A lot of people have raised questions in the comments regarding proposed changes to federal bankruptcy law to accommodate modifications of mortgage loans.

Here's the issue, in a nutshell. Until the 2005 bankruptcy reform, insolvent homeowners could choose Chapter 7 (liquidation) or Chapter 13 (repayment plan) bankruptcy. After the reform bill, for practical purposes most homeowners are limited to Chapter 13.

Chapter 7 filings usually do not result in borrowers keeping their homes, although they can (if the borrower reaffirms the mortgage debt, the court accepts the reaffirmation, and the borrower has the financial capacity to continue to make mortgage payments). In most cases, the BK stay is lifted and the loan is foreclosed.

You can think of Chapter 13 as itself a kind of loan modification: the court establishes a 3-5 year repayment plan for all the borrower's debts, with the unpaid remainder discharged at the end of the repayment plan period. In Chapter 13, the debtor can keep a mortgaged home, as long as he continues to make mortgage payments throughout the plan period, and makes up any past-due amounts (including fees) during the repayment period as determined by the repayment plan. If the borrower does not or cannot continue to pay the mortgage, the stay is lifted and the lender can foreclose.

However, secured debts can be restructured or modified in a Chapter 13 bankruptcy, and secured creditors, except the mortgage lender on a principal residence, can be subject to what is called a "cram down." This happens when the amount of the debt is greater than the value of the collateral securing it; the court reduces the value of the secured debt to the market value of the collateral, with the remainder being treated as unsecured (and subject to the same repayment plan/discharge terms as any other unsecured debt). The prohibition of court-ordered modifications for mortgages on principal residences was created in 1978; between 1978 and 1993 most bankruptcy courts interpreted the law to mean that while interest-rate reduction or term-extension modifications were not allowed, home mortgages could still be crammed down.

In 1993, with Nobleman v. American Savings Bank, the Supreme Court held that the prohibition on modifications of principal-residence mortgage loans also included cram downs. The result is that borrowers who are upside down and who have toxic, high-rate mortgages are simply, in practical terms, unable to maintain their homes in Chapter 13.

According to the Center for Responsible Lending:

The language we seek to change was enacted in 1978, a time when virtually all home mortgages were fixed-interest rate instruments with low loan-to-value ratios. The loans were rarely the source of a family’s financial distress. As originally introduced, the House legislation permitted a plan to modify any secured indebtedness, including that represented by a home mortgage.21 During Senate hearings on the proposed legislation, advocates for secured lenders suggested that home-mortgage lenders were “performing a valuable social service through their loans,” and “needed special protection against modification.” At their urging, the original proposal was subsequently amended to insert the exception for mortgages on primary residences. 22 This claim likely succeeded through effective lobbying since, as described below in section III, the merits of the argument are groundless. Whatever the merits of this claim in 1978, however, when home mortgage loans were responsibly underwritten thirty-year fixed rate loans, it plainly does not apply to the practices of subprime mortgage lenders during the last decade.

As far as I'm concerned, if you believe that prior to 1978, when modifications of home mortgages were unrestricted, and in the period of 1978-1993, when term modifications were restricted but cram downs were widely practiced, mortgage lenders offered higher-rate (relative to prevailing market), higher-LTV mortgage terms than they have in the post-1993 period, when they are safe from any restructurings, I would like to discuss a bridge purchase with you. Nonetheless, that reliable source of comic relief, the Mortgage Bankers Association, wants you to think that allowing cram downs or other kinds of loan restructuring would, um, ruin the party:

“Giving judges free rein to rewrite the terms of a mortgage would further destabilize the mortgage backed securities market and will exacerbate the serious credit crunch that is currently hindering the ability of thousands of Americans to get an affordable mortgage,” said Kurt Pfotenhauer, Senior Vice President for Government Affairs and Public Policy for MBA. “The current legislation gives no guidance as to the proper parameters for judges to modify existing loan contracts.”

By allowing judges to rewrite loan contracts and provide whatever relief they individually deem appropriate, HR 3609 would cast doubt on the value of the asset against which the mortgage loan is secured. As a result, lenders and investors would likely demand a higher premium for offering these loans. This premium could come in the form of higher fees, a higher interest rate or the requirement for a larger downpayment, all of which would serve to make the American dream of homeownership less attainable for many Americans.

In other words, the MBA implicitly admits that in the post-1993 era lenders have made low- or no-down loans at interest rates that, while high enough in terms of the blood they extract from strapped borrowers, are still lower than what they would have been if the lenders had had a healthy fear of BK court restructurings. Of course it's beyond ludicrous to argue that being forced to take what they can reasonably get by a BK judge is the "destabilizing" factor here, but you can count on the mortgage industry be ludicrous when dollars are on the table.

In fact, I have some sympathy with the view that mortgage lenders "perform a valuable social service through their loans." That's why, when they stop doing that and become predators, equity strippers, and bubble-blowers instead of valuable social service providers, I like seeing BK judges slap them around. Everybody talks a lot about moral hazard, and the reality is that you're a lot less likely to put a borrower with a weak credit history, whose income you did not verify and whose debt ratios are absurd, into a 100% financed home purchase loan on terms that are "affordable" only for a year or two, if you face having that loan restructured in Chapter 13. If you are aware that your mortgage loan can be crammed down, I'm here to tell you that you will certainly not "forget" to model negative HPA in your ratings models, and will probably pay more than a few seconds' attention to your appraisals. You might even decide that, if a loan does get into trouble, you're better off working it out yourself, via forbearance or modification or short sale, rather than hanging tough and letting the BK judge tell you what you'll accept. That would be a major bummer, right?

But I think my favorite part of the MBA lament is this: "HR 3609 would cast doubt on the value of the asset against which the mortgage loan is secured." Translation: lenders mark to model, but if you let them, BK judges will mark to market.

Is it possible that BK judges would use the lowest plausible "distressed liquidation value" to determine the secured part of the mortgage loan? Sure it is. BK judges don't have parts of their job descriptions that refer to supporting home values or keeping those comps up or controlling "price discovery." The cram down is, precisely, the "mark to market" you don't want to get, which is why the risk of it used to function as a brake on lender stupidity.

I am fully in favor of removing restrictions on modifications of mortgage loans in Chapter 13, but not necessarily because that helps current borrowers out of a jam. I'm in favor of it because I think it will be part of a range of regulatory and legal changes that will help prevent future borrowers from getting into a lot of jams, which is to say that it will, contra MBA, actually help "stabilize" the residential mortgage market in the long term. Any industry that wants special treatment under the law because of the socially vital nature of its services needs to offer socially viable services, and since the industry has displayed no ability or willingness to quit partying on its own, then treat it like any other partier under BK law.