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Showing posts with label Subprime. Show all posts
Showing posts with label Subprime. Show all posts

Monday, July 06, 2009

S&P Increases Loss Estimates for Alt-A and Subprime RMBS

by Calculated Risk on 7/06/2009 04:49:00 PM

From Reuters: S&P raises loss expectations for risky US mortgages

Standard & Poor's on Monday boosted its expectations for losses on risky loans backing U.S. mortgage securities ... [this] "significantly impact" bonds originally carrying AAA ratings, S&P said in a report.
S&P boosted loss projections for subprime loans made at the peak of the market in 2006 and 2007 to 32 percent and 40 percent from 25 percent and 31 percent, respectively. For 2005 loans, loss projections rose to 14 percent from 10.5 percent.

For Alt-A loans ... loss projections for 2006 and 2007 mortgages rose to 22.5 percent and 27 percent from 17.3 percent and 21 percent, respectively. S&P expects Alt-A loans from 2005 to post losses of 10 percent, up from its previous estimate of 7.75 percent.

Loss severities ... are expected to rise to 70 percent for 2006 and 2007 subprime bonds and 60 percent for Alt-A bonds issued in those years, S&P added.
According to the article, S&P noted a surge in the inventory of bank-owned properties. Here is the S&P report.

Update: From the S&P report: Standard & Poor's Chief Economist David Wyss expects "home prices will decline by an additional 5%-7% from the 2006 peak before residential real estate prices start to stabilize in the first half of 2010, marking an overall decline of approximately 37% from the July 2006 peak."

Monday, December 08, 2008

Credit Suisse Forecast: 8.1 million foreclosures by 2012

by Calculated Risk on 12/08/2008 06:19:00 PM

In a research note titled "Foreclosure Update: over 8 million foreclosures expected" (no link, hat tip Frank) updated last week, Credit Suisse analysts are now forecasting 8.1 million homes will be in foreclosure by the end of 2012, representing 16% of all households with mortgages.

The analysts projected this could be as low as 6.3 million in a mild recession, with a somewhat successful loan modification program (re-default rates at around 40%), and as high as 10.2 million in a more severe recession. Note: the Comptroller of the Currency John C. Dugan noted this morning that re-defaults rates appear to be well in excess of 50% for recent mods, much higher than the hoped for 40%.

What really stood out in the forecast was the shift from mostly subprime foreclosures to non-subprime (Alt-A and Prime) foreclosures. This fits with some of the housing themes we've been discussing - that foreclosures will now be moving up the price chain.

Default rates for Modifided LoansClick on graph for larger image in a new window.

This graph shows the Credit Suisse estimate of loans in Foreclosure and REO as of Sept 2008 (in blue) and their base forecast for new foreclosures by the end of 2012, for both subprime and other mortgages (Alt-A and Prime).

Credit Suisse believes 2008 will be the peak year for subprime foreclosures, although subprime foreclosures will remain elevated over the next few years. However they are forecasting a significant increase in foreclosures over the next couple of year for non-subprime loans.

When I spoke at the Inman Real Estate conference in July 2008, I suggested that real estate agents should expect increasing foreclosures in high end areas. As I've previously mentioned, my comments were greeted with incredulity. I wonder if views have changed? We're all subprime now!

Thursday, August 21, 2008

S&P: Home-Loan Delinquencies Keep Rising

by Calculated Risk on 8/21/2008 03:26:00 PM

Dow Jones reports (no link yet): Most Home-Loan Delinquencies Kept Rising In July

S&P said as of the July distribution date, delinquencies on subprime deals ... for 2006 and 2007 ... were up 2% to 7% compared with June.

For jumbo loans ... delinquency rates were up 5.6% to 13% from June, with the biggest increase from the 2006 vintage. Delinquency rates also increased for Alt-A deals, led by those originating in 2007.
Also Housing Wire reports on the Clayton InFront numbers for July: Subprime Delinquencies Surge in July
An early look at subprime RMBS performance in July, courtesy of Clayton Fixed Income Services, Inc., suggests that a recent lull in subprime delinquencies may be coming to an end. The percentage of subprime borrowers 60 or more days in arrears at the end of last month surged for both the 2006 and 2007 vintages, up nearly 7 and 11 percent compared to June, respectively.
Part of the reason, sources told HW Thursday morning, is a that a large volume of repayment plans put into place earlier this year for troubled subprime borrowers are now failing ...
And on Alt-A:
Alt-A delinquencies continued to worsen in July as well. The 2005 vintage — which should be seasoned by now — saw delinquencies jump an eye-opening 29 percent to 9.72 percent of remaining loans in the vintage ...

Tuesday, August 12, 2008

Subprime and Alt-A: The End of One Crisis and the Beginning of Another

by Tanta on 8/12/2008 05:00:00 PM

Clayton has kindly given us permission to excerpt some information from their monthly RMBS performance newsletter, InFront. Clayton's report suggests that we may have now seen the beginning of the end of the subprime meltdown, but we are only at the end of the beginning of the Alt-A wave that is following it.

According to Clayton, subprime delinquencies appear to have peaked in December of 2007, and subprime foreclosure starts may have peaked in January of 2008. The volume of foreclosures in process will remain elevated for a long time as these things work their way through lengthy foreclosure timelines, but the peak in FC starts is good news.

Unfortunately, Alt-A seems nowhere near its peak yet. Clayton's report, based on May data, indicates that both new delinquencies and foreclosure starts in Alt-A pools are still rising. Fannie Mae's recent conference call suggesting that Alt-A deteriorated even more sharply in July is yet more evidence that the Alt-A mess is still ramping up.

These two charts from Clayton, on subprime and Alt-A ARM resets, tell the same tale.

Clayton Subprime

Click on graph for larger image in new window.

Based on remaining active loans, we are at about the peak for subprime rate resets. However, Alt-A is a different picture:

Clayton Alt-A

As Housing Wire reported yesterday:
When it comes to RMBS, it’s not about the sheer volume of securities issued; it’s about the credit enhancement that exists to protect investors once collateral defaults occur. And comparing Alt-A issues to subprime, it’s no contest: Alt-A is so much thinner in its padding for losses that a lower default rate could hurt investors in Alt-A deals far worse than anything we saw in subprime. The only saving grace here is reach; because Alt-A deals didn’t yield what subprime did, fewer got pulled into CDO issues.

There are large chunks of Alt-A that didn’t get securitized, but instead were held in portfolio for the interest income benefits: and that would be your option ARMs. Which means that while mushrooming defaults may not hit RMBS investors, they will hit the loan portfolios of more than a few commercial banks.
If the "subprime crisis" was about "exotic securities," the "Alt-A crisis" is going to be about bank balance sheets. And the fun is only beginning.

Monday, August 11, 2008

Reflections on Alt-A

by Tanta on 8/11/2008 03:30:00 PM

Since for media and headline purposes "Alt-A" is the new subprime--the most recent formerly-obscure mortgage lending inside-baseball term to become a part of every casual news consumer's working vocabulary--it seems like a good time to pause for some reflection on what the term might mean. Much of this exercise will be merely for archival purposes, as "Alt-A" is now pretty much officially dead as a product offering and is highly unlikely to return as "Alt-A." Eventually, after the bust works itself out and the economy leaves recession and the bankers crawl out from under their desks and stretch out those limbs that have been cramped into the fetal position, a kind of "not quite quite" lending will certainly return. I am in no way suggesting that the mortgage business has entered the Straight and Narrow Path and is going to stay on it forever because we have Learned Our Lessons. Credit cycles--not to mention institutional memories and economies like ours--don't work that way. It's just that whatever loosened lending re-emerges après le deluge will not be called "Alt-A."


Subprime will eventually come back, too. The difference is that it will come back--in some modified form--called "subprime." That term is too old, too familiar, too, well, plain to ever go away, I suspect. "Subprime" is a term invented by wonky credit analysts, not marketing departments. It is not catchy. It is not flattering nor is it euphemistic. You may console yourself if your children "have special needs" rather than "are academically below average." If you get a subprime loan, you may console yourself that you got some money from some lender, but you can't avoid the discomfort of having been labelled below-grade.

Actually, the term "B&C Lending" used to be quite popular for what we now universally refer to as "subprime." (It was also called "subprime" in those days, too. We didn't have to pick one term because nobody in the media was paying any attention to us back then and there were no blogs and even if there had been blogs if you had suggested that a blog would generate advertising revenue by talking about the nitty-gritty of the mortgage business you would have been involuntarily institutionalized.) In mortgages as in meat, "prime" meant a letter grade of A. These were the pre-FICO days, when "credit quality" was determined by fitting loans into a matrix involving a host of factors--whether you paid your bills on time, how much you owed, whether you had ever experienced a bankruptcy or a foreclosure or a collection or charge-off, etc. "B&C lending" encompassed the then-allowable range of sub-prime loans that could be made in the respectable or marginally respectable mortgage business. It was always possible to find a "D" borrower, but that was strictly in the "hard money" business: private rather than institutional lenders, interest rates that would make Vinny the Loan Shark green with envy. "F" was simply a borrower no one--not even the hard-money lenders--would lend to.

As in the academic world, of course, there was always the problem of grade inflation and too many fine distinctions. You had your "A Minus," which is actually the term Freddie Mac settled on back in the late 90s for its first foray into the higher reaches of subprime. Discussing the difference between "A Minus" and "B Plus" was just one of those otiose pastimes weary mortgage bankers got into over drinks at the hotel bar when the conversational possibilities of angels dancing on the head of a pin or whether "down payment" was one word or two had been exhausted. More or less everyone agreed that there wasn't but a tiny smidgen of difference between the two, except that "A Minus" sounded better. Same with the term "near prime," which wasn't uncommon but never became as popular as "A Minus." "Near prime" is also "near subprime." "A Minus" completed the illusion that it was nearer the A than the B, even if the distances involved were sometimes hard to see with the naked eye.

But all of that grading and labelling was still basically limited to considerations of the credit quality of the borrower, understood to mean the borrower's past history of handing debt. Residential mortgage lending never, of course, limited itself to considering creditworthiness; we always had "Three C's": creditworthiness, capacity, and collateral. "Capacity" meant establishing that the borrower had sufficient current income or other assets to carry the debt payments. "Collateral" meant establishing that the house was worth at least the loan amount--that it fully secured the debt. It was universally considered that these three things, the C's, were analytically and practically separable.

That, I think, is very hard for people today to understand. The major accomplishment of last five to eight years, mortgage-lendingwise, has been to entirely erase the C distinctions and in fact to mostly conflate them. For the last couple of years, for instance, you would routinely read in the papers that "subprime" meant loans made to low-income people. Or it meant loans made to people who couldn't make a down payment or who borrowed more than the value of their property--that is, whose loans were very likely to be under-collateralized. This kind of characterization of subprime always struck us old-timer insiders as bizarre, but it seems to have made sense to the rest of the world and it stuck. After all, the media didn't really care about or even notice this thing called "subprime" until it began to be obvious that it was going to end really really badly. It therefore seemed perfectly obvious to a lot of folks that it must primarily involve poor people who borrow too much.

Those of us who were there at the time tend to remember this differently. In the old model of the Three C's, a loan had to meet minimum requirements for each C in order to get made. We didn't do two out of three. The only lenders who ever did one out of three were precisely those "hard money" lenders, who cared only about the value of the collateral. This was because they mostly planned on repossessing it. Institutional lenders' business plan still involved making your money by getting paid back in dollars for the loans you made, not by taking title to real estate and selling it.

The difference between a prime and a subprime lender was simply how low you set the bar for one of the C's, creditworthiness. Unless you were a hard-money lender, you expected to be paid back, so you never lowered the bar on capacity: everybody had to have some source of cash flow to make loan payments with. Traditional institutional subprime mortgage lenders were even more anal-compulsive about collateral than prime lenders were, a fact that probably surprises most people. Until very recently, historically speaking, institutional subprime lending involved very low LTVs and probably the lowest rate of appraisal fraud or foolishness in the business.

That isn't so surprising if you think about the concept of "risk layering," which is also an industry term. In days gone by, with the three C's, you didn't "layer" risk. If the creditworthiness grade was less than "A," then the capacity grade and the collateral grade had to be "summa cum laude" in order to balance the loan risk. It wasn't until well into the bubble years that anybody seriously put forth the idea that you could make a loan that got a "B" on credit and a "B" on capacity and a "B" on collateral and expect not to lose money.

Of course there has always been a connection between creditworthiness and capacity. Most Americans will pay back their debts as agreed unless they experience a loss of income. People rack up "B&C" credit histories most commonly after they have been laid off, fired, disabled, divorced, or just generally lost income. But this was true at any original income level: upper-middle-class people can lose income and become "B&C" credits. Lower-income folks may well be most vulnerable to income loss--first fired, first "globalized"--but then lower-income folks until recently had smaller debts to pay back out of reduced income, too. What is so dishonest about the association of "subprime" and "poor people" is that it simply erases the fact that a lot of rich people have terrible credit histories and a lot of poor people have never even used credit. The "classic" subprime borrower is Donald Trump as much as it is "Joe Sixpack."

Traditional subprime lending was what you might think of as "recovery" lending. That is, while the borrower's past credit problems were due to some interruption in income or catastrophic loss of cash assets with which to service existing debts, the subprime lenders didn't enter your picture until you had re-established some income. If you want to know what a "D" or "F" borrower was, it was basically someone still in the financial crisis--still unemployed, still underemployed, still unable to work. "B" and "C" borrowers had resumed income, but they still had a fresh pile of bad things on their credit reports--charge-offs, collections, bankruptcies. Prime lenders wouldn't make loans to these borrowers because even though they had resumed capacity, their recent credit history was too poor. Prime lenders want to you "re-establish" your credit history as well as your income, which pretty much means that those nasty credit events have to be several years old, on average, without recurrence in the most recent years, before you can be an "A" again. Absent subprime lenders, that means going without credit for those years.

This is where the idea came from--much promoted by subprime lenders during the boom--that subprime loans were intended to be fairly short-term kinds of financing that helped a borrower "re-establish" his or her creditworthiness. The whole rationale for the famous 2/28 ARM was that after two years of good payment history on that loan, the borrower could refinance into a prime loan and thus never have to pay the "exploding" interest rate at reset. (If you didn't keep up with the payments in the first two years, you were thus "still subprime" and deserved to pay that higher rate.) That was a perfectly fine rationale as long as subprime lenders used rational capacity and collateral requirements--reasonable DTIs during the early years of the loan, low LTVs--to make those loans. When all the "risk layering" started, it was less and less plausible that these borrowers would ever "become prime" in two years by making on-time mortgage payments, and what we got was a class of permanent subprime borrowers who survived by serial refinancing, each time into a lower "grade" loan product, until the final step of foreclosure.

You're probably still wondering what all this has to do with Alt-A. Alt-A is sort of a weird mirror-image of subprime lending. If subprime was traditionally about borrowers with good capacity and collateral but bad credit history, Alt-A was about borrowers with a good credit history but pretty iffy capacity and collateral. That is to say, while subprime makes some amount of sense, Alt-A never made any sense. It is a child of the bubble.

"Classic" subprime lending worked because, while it always charged borrowers a higher interest rate, it found a way to restructure payments such that the borrower's overall prospects for making regular payments improved. A classic "C" loan, for instance, was also called a "pre-foreclosure takeout." The borrower had had a period of reduced or no income, got seriously behind on her mortgage payment, and was facing loss of the house. Even though income had resumed, it wasn't enough to make up the arrearage while also making currently-due payments. So the subprime lender would refinance the loan, rolling the arrearage into the new loan amount, and offset the higher rate and larger balance with a longer term or some kind of "ramping up" structure. The "ramp-up," by the way, was not, historically, mostly by using ARMs. There were all kinds of old-fashioned exotic mortgages that you don't hear about any more, like the Graduated Payment Mortgage and the Step Loan and the Wraparound Mortgage and so on, all of which involved some way of starting off loans with a lower payment that slowly racheted up over three to five years or so into a fully-amortizing payment. It certainly wasn't always successful, but its intent was exactly to enable people to catch up on an arrearage and then actually begin to retire debt.

Alt-A, we are regularly told, is a kind of loan for people with good credit but weak capacity or collateral. It overwhelmingly involved the kind of "affordability product" like ARMs and interest only and negative amortization and 40-year or 50-year terms that "ramps" payment streams. But it doesn't do this in order to help anyone "catch up" on arrearages; people with good credit don't have any arrearages. Alt-A was and has always been about maximizing consumption, whether of housing or of all the other consumer goods you can spend "MEW" on. If subprime was supposed to be about taking a bad-credit borrower and working him back into a good-credit borrower, Alt-A was about taking a good-credit borrower and loading him up with enough debt to make him eventually subprime.

The utter fraudulence of the whole idea of Alt-A involves the suggestion that people who have managed debt in the past that was offered to them in the past on conservative "prime" terms must therefore be capable of managing debt in the future that is offered to them on lax terms. FICOs or traditional credit analyses are good predictors of future credit performance, but only if the usual terms of credit-granting are similar in the past and in the future. Think of it this way: subprime borrowers had proven that they couldn't carry 50 pounds, so the subprime lenders found a way to restructure their debts so that they were only carrying 40. Alt-A lenders took a lot of people who had proven they could carry 50 pounds and used that fact to justify adding another 50 pounds to the burden.

This has not worked out well.

The "Alt" in Alt-A is short for "alternative." Alt-A is one of the purest examples of a "new paradigm" thingy you can find. The conceit of Alt-A is that there is another way to approach "prime" lending that is equivalent in risk (assuming risk-based pricing) but--amazing!--way more painless. Toss out verifications of income and assets, and you are no longer evaluating capacity. Toss out down payments and careful formal appraisals and analysis of sales contracts and you are no longer evaluating collateral. But lookit that FICO!

A lot of folks see the failure of Alt-A as a failure of FICO scores. I don't see it that way. FICO scoring is just an automated and much more consistent way of measuring past credit history than sitting around with a ten-page credit report counting up late payments and calculating balance-to-limit ratios and subtracting for collection accounts and all that tedious stuff underwriters used to do with a pencil and legal pad. I have seen no compelling evidence that FICO scoring is any less reliable than the old-fashioned way of "scoring" credit history.

To me, the failure of Alt-A is the failure to represent reality of the view that people who have a track record of successfully managing modest amounts of debt will therefore do fine with very high amounts of debt. Obviously the whole thing was ultimately built on the assumption that house prices would rise forever and there would always be another refi. There was also the assumption that people are emotionally attached to their FICO scores--in more old-fashioned terms, that borrowers care about their "reputation" and don't want to ruin it by defaulting on a loan. The trouble with that assumption was that we were busy building a credit industry in which there was plentiful credit--on easy terms--for people with any FICO, any "reputation." A bad credit history is only a strong deterrent to default when credit is rationed, granted only to those with acceptable reputations, or--as in the case of "classic" subprime--granted only to those with poor reputations but strong capacity and collateral, and at a penalty rate. Unfortunately, the consumer focus (encouraged, of course, by the industry) on monthly payment rather than actual cost of credit meant that for a lot of people the fact of the "penalty rate" just didn't register. In such an environment, the fear of losing your good credit record isn't much of a deterrent to default.

I should point out that besides the "stated income" and no-down junk, the other big segment of the Alt-A pool was "nonstandard" collateral types. One of the biggies in that category were what insiders call "non-warrantable condos." (The warranties in question are the ones the GSEs force you to make when you sell a condo loan; in essence a non-warrantable condo means one the GSEs won't accept.) What was wrong with these condos? Not enough pre-sales. Not enough sales to owner-occupants rather than investors. Inadequately funded HOAs with absurd budgets. Big blocks of units owned by a single entity or individual. In other words, speculator bait. This kind of thing isn't an "alternative" to "A." It is commercial or margin lending masquerading as long-term residential mortgage lending. It may well be "prime" commercial lending. It just isn't residential mortgage lending.

Part of the terrible results of Alt-A lending is that this book took on risks that historically were taken only on the commercial side, where the rates were higher, the cash-flow analysis was better, and the LTVs a lot lower. (Not that commercial real estate lending didn't also have its dumb credit bubble, too.) The thing is, as long as the flipping of speculative purchases worked--and it did for several years--it worked. Meaning, those Alt-A loans prepaid quite quickly with no losses. That masked the reality of Alt-A--that it was largely a way for people to take on more debt than they ever had before--for quite some time.

Of course we all know now--I happen to think a lot of us knew then--that Alt-A is chock-full o' fraud. My point is that even without excessive "stated income" or appraisal fraud, the Alt-A model was essentially doomed. "Alt-A" is the kind of lending you would only do after a real estate bust, not during a real estate boom--that is, when housing costs and thus debt levels are dropping, not rising. Unfortunately, we're going to have a hard time using something like Alt-A to stimulate our way into recovery once the housing market has actually bottomed out, because Alt-A is too implicated in the bust. I don't think anyone is going to be allowed to get away with moving all that REO off their books by making loans on easy terms to someone who managed to maintain a good FICO during the bust, even though that might actually make some sense.

One of the main reasons we are in a mortgage credit crunch is that two possible models of "recovery" lending--subprime and Alt-A--got used up blowing the bubble. I think it will be a long time before lending standards ease significantly, and I think subprime will come back first. But I do suspect we've seen the last of Alt-A for a much longer time.

I want the rest of a VERY long post! And I want it now!

Monday, July 14, 2008

Moody's on Modification Re-Defaults

by Tanta on 7/14/2008 03:57:00 PM

Sez Bloomberg (thank you, Brian!):

July 14 (Bloomberg) -- More than two of every five subprime borrowers whose mortgages were reworked in the first half of 2007 are defaulting anyway, Moody's Investors Service said.

Among subprime adjustable-rate mortgages modified in the first half of last year, 42 percent were at least 90 days late on March 31, the ratings firm said in a report today.

Modifying loans granted to consumers with poor credit records has gained favor as record numbers fail to keep up with payments and home prices tumble. Loans reworked more recently may perform better than ones modified in early 2007 because lenders are increasingly lowering interest rates and offering changes to consumers with fewer missed payments, Moody's said. That's different from 2007, when lenders focused on enforcing repayment plans.
I have not yet gotten my hands on the detailed Moody's report on this subject. However, I did look at Moody's press release, and it doesn't exactly attribute the issue for the early 2007 modifications to repayment plans. Per the press release (no free link), the majority of modifications done in the first half of 2007 involved simple deferral of principal/capitalization of past-due interest (that is, the borrower got "brought current" by having past-due interest added to the loan balance) without other changes in the loan terms. Modifications like that result in the same or even a slightly higher monthly payment than under the original loan terms.

If modifications processed in the second half of 2007 and later mostly involve 1) significantly lowered payments and 2) significantly less delinquent loans, then certainly theory predicts they will have a better re-default rate. On the other hand, it's early to be confident that the 40% redefault rate on the earlier mods will hold; generally speaking you need at least two years of "seasoning" on a group of modifications before you get useful numbers on re-default. That said, Moody's servicer survey from last year predicted a redefault rate of around 35% based on past experience of the servicers. It will be curious to see how high that redefault rate can go before the "least loss" models tip back toward foreclosure. So far Moody's is simply saying that the impact on cumulative losses of the early modifications has been "modest." That suggests to me that it may not take a much higher redefault rate for this "modest" lowering of cumulative losses to disappear.

I know that I for one am looking forward to Hope Now and the OCC to start reporting on re-defaults in their metrics (although I'm not going to hold my breath). Moody's is reporting strictly on subprime ARMs; while these have been the focus of modification efforts, we still need to know what's happening in the prime and Alt-A segments.

Otherwise, Moody's reports that as of March 2008, nearly ten percent of subprime ARMs with a reset date in the preceding 15 months had been modified.

Tuesday, May 27, 2008

NPR on Mortgage Quality Control

by Tanta on 5/27/2008 04:49:00 PM

This is a sobering, if rather overstated, segment on mortgage loan sale due diligence and the pressures to accept even the most dubious of loans.

Tracy Warren is not surprised by the foreclosure crisis. She saw the roots of it firsthand every day. She worked for a quality control contractor that reviewed subprime loans for investment banks before they were sold off on Wall Street. . . .

Warren thinks her supervisors didn't want her to do her job. She says that when she would reject, or kick out, a loan, they usually would overrule her and approve it.

"The QC reviewer who reviewed our kicks would say, 'Well, I thought it had merit.' And it was like 'What?' Their credit score was below 580. And if it was an income verification, a lot of times they weren't making the income. And it was like, 'What kind of merit could you have determined?' And they were like, 'Oh, it's fine. Don't worry about it.' "

After a while, Warren says, her supervisors stopped telling her when she had been overruled.
I have no particular reason to question Ms. Warren's abilities or her take on the situation; I have no doubt that for any number of reasons marginal loans were pushed back into pools over the objections of perfectly competent auditors. I have also had experience with staff whose supervisors stopped telling them when they had been overruled, because . . . life is too short. I suspect I am not the only one who has had this experience. Whatever the merits of this story may be, this I think is an overstatement:
"This is a smoking gun," says Christopher Peterson, a law professor at the University of Utah who has been studying the subprime mess and meeting with regulators. "It suggests that auditors working for Wall Street investment bankers knew how preposterous these loans were, and that could mean Wall Street liability for aiding and abetting fraud."
Forgive me for being a shill for Wall Street, but this strikes me as silly. The investment banks, including Bear Stearns, published loan underwriting guidelines detailing what they would accept in mortgage pools, and everybody in the industry had a copy at the time. The things came right out and said that things like stated income for a wage earner were acceptable. Was Mr. Peterson calling that "preposterous" at the time? I was. And I never had to look at a single loan file.

What I suspect Ms. Warren is overlooking is, precisely, that the due diligence on those Bear Stearns pools--like every other pool for every other investor--was based on evaluating the individual loans' compliance with the specific guidelines agreed to for the pool. If the guidelines allowed utter stupidity, it isn't likely that the project supervisors would kick out a loan for displaying that particular kind of stupid. If there's something preposterous here, it was in plain sight in the prospectuses to every one of these loan deals. I am having a hard time with the idea that "the smoking gun" didn't show up until this week.

And then there is this part, which has made it all over the web today:
A bankruptcy examiner in the case of the collapsed subprime lender New Century recently released a 500-page report, and buried inside it is a pretty interesting detail. According to the report, some investment banks agreed to reject only 2.5 percent of the loans that New Century sent them to package up and sell to investors.

If that's true, it would be like saying no matter how many bad apples are in the barrel, only a tiny fraction of them will be rejected.

"It's amazing if any investment bank agreed to a maximum number of loans they would kick back for defects. That means that they were willing to accept junk. There's no other way to put it," says Kurt Eggert, a law professor at Chapman University.
Now, I actually plowed my way through that New Century report, and I have to say that there's a reason this claim was, um, "buried" therein. From page 135 of the report (Warning! Big Honkin' pdf that will take forever to download!):
[K]ickout data may not be a true indication of loan quality trends because New Century was able, particularly when the subprime market was strong and housing prices were rising, to negotiate understandings with certain loan purchasers to limit kickouts to a maximum rate, such as 2.5%. Flanagan [NEW's former head of loan sales] was explicit in stating to the Examiner that such understandings were reached. The Examiner was unable to establish corroboration for this statement. Nevertheless, such understandings may have limited kickouts, masking loan quality problems that existed but were not reported.
The report goes on to document that NEW's typical kickout rate was north of 5.00% and in many months much higher than that; except in securitization (not whole loan) deals where NEW retained residual credit risk, the kickout rate of 2.5% was, to quote the report, "probably more aspirational than real." The fact that no one could produce a contract or set of deal stips or e-mail or sticky note "corroborating" this claim suggests to me that it may have existed only in Mr. Flanagan's mind.

There are, of course, situations in the whole loan sale world in which people have perfectly respectable reasons to agree to limit "kickouts" up front. Occasionally pools are offered for bid with the stipulation of no kickouts: these are "as is" pools and it is expected that the price offered will reflect that. I have myself both offered and bid on no-exclusion loan pools. This is mostly an issue in the "scratch and dent" loan market, where one might have a mixed pool of pretty good and pretty botched up loans to sell. Allowing a buyer to "cherry pick" the deal just leaves you with all the botched up loans to sell separately, which is never anyone's preferred approach. Of course any buyer of loans can decline to bid on a no- or limited-kickout basis. Those who do bid on these deals tend to lower the bid price accordingly. The NEW report also documents the steady deterioration in NEW's profit margin on its whole-loan sales, and trying to get investors to take packages of loans with limited or no kickouts might explain some of that. My guess, from reading the report, is that while NEW might have thought it wanted a 2.5% kickout rate, it ended up accepting a much higher one because the price discount was more than it could face.

I am not trying to suggest that anyone is particularly innocent here. This all just has a sort of Captain Renault quality to it: we are shocked, shocked! that gambling went on in these casinos. The published underwriting guidelines that were available to everyone involved made explicit what was going on with these loans, and those guidelines were published with the deal prospectuses. Now we have a bunch of investors--including institutional ones with absolutely no excuse--wanting to grab hold of stories like Ms. Warren's about cruddy individual loans, as if the pool guidelines weren't themselves a big flaming hint that the loans were absurd.

Saturday, April 26, 2008

Miss Busta and the Death of Satire

by Tanta on 4/26/2008 07:57:00 AM

Regulars may remember this little post about Accredited Home Lender's new Chief Advisor of Things Both Relevant and Interesting in the Non-Conforming Loan Market, Miss Busta.

Well, Miss Busta's website is up and running. I confess to complete and utter disappointment; after the build-up in the announcement email, I really expected this to be funnier:

Dear Miss Busta,
Given the crazy events of the last year or so, it seems that the subprime loan market is dead. Please tell me the truth. I can take it.
—Grieving in Grand Rapids

Dear Grand,
Dry your tears and stop that annoying sniveling. The rumors that Subprime is dead are greatly exaggerated. Granted, it was tough going there for a while and some serious intervention was needed, but it’s been brought back from the brink. Seems Subprime was hanging around with a bad crowd and fell victim to some wicked peer pressure. After the deadbeats were run off and a few warts were removed, things have started to get a lot better, thank you very much. In fact, Accredited has closed more than $150 million in subprime loans since January. That’s a lot of clams. And we’re back doing business with some solid friends—nice brokers who predict steady growth over the next year. So enough with the hand-wringing. Let’s get to work. Something you might want to try.
$150MM since January might be a lot of clams, but it isn't very many mortgage loans. In Q1 2006 Accredited originated $3.6 billion.

Accredited may be targeting the "nice broker" demographic, but if this kind of thing either amuses or reassures their broker base, then they're also dealing with the dim broker demographic. There is a long and storied history in the mortgage business of both overpaying the sales force and simultaneously treating them like not very bright fifth graders. Fly them to Hawaii, put them up in an expensive hotel, and then send them to pep rallies with the intellectual content of an episode of The Brady Bunch. That sort of thing. My own view is that people tend to live up to the expectations you have of them, which is why there are so many overpaid fifth graders in the business.

You'd think Accredited might have reflected a bit on that strategy, but apparently not. I am not known as a humorless person, but I'm actually mildly surprised that any subprime lender thinks the time has already come to be merely cute about the whole thing. I would have thought they might still be trying to prove to the world that the grownups are, in fact, in charge now. Perhaps investing some time into actual training of brokers in credit analysis, acceptable loan documentation, and responsible disclosure practices. Putting some honest effort into understanding what went wrong and why. Guess not. It's all about attitude and platitude, any fleeting breakthrough of seriousness instantly stifled with chicken casserole recipes. The warts have been removed, the clams are back, and the same anti-intellectual drivel that papered over the problem in the first place returns to cheer everyone up.

On the other hand, at $150MM a quarter, that "overpaid" thing will no longer be a problem.

Friday, April 25, 2008

Subprime in Greenwich

by Tanta on 4/25/2008 06:55:00 AM

Well, no, they're "affluent." And they're not like us.

From "Pain of Foreclosure Spreads to the Affluent," in the ever-dependable NYT:

“We never had a case that had gone through three separate sales attempts,” he said, still dazed that the auction failed to take place. “Greenwich being Greenwich, foreclosures are a rare occurrence.”

Rare, perhaps, but not unheard-of, as the housing industry collapse starts to claim victims among the affluent. Personal traumas like business reversal, illness and divorce play a role. There’s no real pattern, with people as diverse as builders, restaurateurs and poker players at risk of losing their homes.
And us plebes outside of Greenwich, on the other hand, fit into nice neat categories? I see.

Well, I for once have seen this "real pattern" before:
As for the four-bedroom colonial that just avoided going on the block, Zbigniew Skwarek, the 41-year-old owner, came up with his own money to postpone the auction. Court records show he stopped paying on his mortgage on Feb. 1, 2007. But three days before the scheduled auction, he said, he gave his lender a check for $50,000.

Mr. Skwarek may not live in one of Greenwich’s most coveted neighborhoods. But like many residents here, he owns other properties, including an apartment in Greenwich and a home in Florida, and he can tap into that equity.

“I don’t want to lose this house,” Mr. Skwarek said in a telephone interview.

Mr. Skwarek rented out the house after he divorced his wife, Renata, in 2004, because, he said, it felt too big to live in alone. But last year, he said, his renters, John and Arline Josephberg, stopped paying their monthly rent of $10,000.

While living there, Mr. Josephberg — who previously ran the financial firm Josephberg Grosz & Company — was put on trial, accused of not paying his taxes for 29 years. He was sentenced to 50 months in prison. By the time the couple moved out in January, they owed Mr. Skwarek $90,000. Calls made to Mrs. Josephberg and to the couple’s daughter were not returned.

But public records show that Mr. Skwarek had trouble paying his bills even before he rented out his home. Court documents show that he also owes construction and supply companies more than $200,000 for unpaid bills on his home.

In the past four years, he has been in court several times over unpaid bills. He has a felony conviction for not paying wages to his workers and a misdemeanor for issuing a bad check. He was sued in small claims court for not paying his divorce lawyer. His former wife said that his money troubles contributed to the end of their marriage.

“I was sick about how he took care of the bills,” Ms. Skwarek said. “He didn’t change.”
I am not sure we have established that Mr. Skwarek is "affluent," but he is clearly "subprime." He just has a rather larger subprime loan than us average Joes and Joettas--you know, the kind Mr. Skwarek failed to pay wages to, the kind who may have needed those wages to make their own mortgage nut. This does, though, create one difference--unlike your run of the mill subprime borrower, Mr. Skwarek fervently believes in the kindness and decency of lenders:
Mr. Skwarek has still not figured out how he will hold on to his home. He will try to rent it again, he said. If that doesn’t work, he plans to move in and rent out his apartment. He remains optimistic that foreclosure will never happen and that his lender will help him find a way to escape his financial trap.

“They want to work with people like me,” he said.
I'll bet they do.

Wednesday, April 16, 2008

We Are NOT All Subprime Now, Thank You

by Tanta on 4/16/2008 07:44:00 AM

Kind reader AK (bless you) sent me the link to this awful Slate piece on "walking away." It's a fact-free rehashing of the increasingly popular "walkaways are the new subprime" meme, worthwhile only as a kind of crystallization of everything that is wrong with this "story." Its burden of wisdom is the simple assumption that while those subprimers couldn't afford their mortgages, the Option ARM borrowers just don't want to be underwater after their loans recast and, um, they either can or can't afford their mortgages depending on how you do or do not look at it.

What kind of logic do you expect from an essay that begins:

California is to mortgage lending what Chicago is to pork bellies.
California (the whole state) has a famous exchange on which future prices of mortgage lending are determined? Well, no:
For years, that meant it was a place with soaring house values; today, the foreclosure rate across the state is twice the national average and going up fast.
"That meant"? Home prices in California bubbled and then busted because homes were traded like commodities futures? We're two sentences into the piece here and the wheels have already come off the logical wagon. The tone is set for the lede:
California should be the poster child for a mortgage-loan bailout. In few other places have so many taken on such onerous debts with so little equity. Unfortunately, the crisis in California is going to get much worse, and there is no bailout that will solve it. Why? Because if the first stage of the foreclosure crisis was about people who could not afford their mortgages, the next stage will be about people who have every reason not even to try to pay their mortgages.
As usual, I'm amazed at how short memories are, since the "subprime crisis" was only just last year. And why just last year, when we had been originating large volumes of subprime loans for years prior to that? Well, 2007 was when those people who couldn't afford their mortgage payments suddenly lost the ability to refinance or to sell the home ahead of foreclosure. And why was that? Because home values were sliding in high-subprime-concentration markets. So maybe the price declines as of a year ago were "only" single-digits, as opposed to the "40%-50%" our intrepid Slate reporter forecasts for California. So? Underwater is underwater: if you cannot or do not wish to bring cash to the closing in order to sell your home, and you cannot maintain the payments, you end up in foreclosure, whether you're 5% under or 50% under.

Insofar as there's any sort of point here, it seems to be the unsurprising one that so-called "prime" borrowers last longer in an RE bust than subprime borrowers do. By the time prime borrowers get to the end of their ability to handle crushing mortgage payments, RE values have dropped further than they had for subprime borrowers. What else are we to make of this:
The most common subprime loans were known as "2/28" in the industry: 30 years, including a two-year teaser rate before the interest rate rose. Now these loans have reset, and we're seeing the fallout.

But prime borrowers, too, got loans that started out with low payments; if you bought or refinanced your house in the last few years, it's not unlikely that you have one. With an "option ARM" loan you have the "option" (which most borrowers happily take) of paying less than the interest; the magic of "negative amortization." The loan grows until you hit a specified point—the exact point varies with the lender; with Countrywide, it'll come after about four and a half years—when the payment resets to close to twice where it was on Day 1. . . .

The really amazing thing is that the meltdown in California is already happening and virtually none of these loans have yet reset.

Option ARM loans were heavily marketed to upper-tier home buyers in California. It's hard to know how bad the option ARM crisis will be before it actually happens, but Moe Bedard, an advocate in Southern California who advises homeowners on foreclosure and blogs about the crisis at says that the difference in the time until the rate rises is the main reason that upper-middle-class Orange County (now facing foreclosures at a rate merely twice the national average) hasn't yet been hit as badly as places like Riverside.
The 2/28 "subprime" foreclosure crisis also started well before most of those loans had reset, as the failed flippers and borrowers with crushingly high DTIs even before reset were trapped by even modest drops in value. It shouldn't be surprising that Option ARM failures are beginning to occur before the payment recast.

But, as with the CBOT analogy, what's the point here? That well-heeled Orange County OA borrowers will not be able to afford doubled mortgage payments when their OAs reset, and that by then they will be underwater by 40%? This makes them "walkaways," whereas the subprime borrowers were just plain old "foreclosures"? The way I see it, we have two choices here. We can take the perspective that "we're all subprime now," or we can insist that in fact "we" aren't subprime, "we" are walkaways, and that's different.

Such "rebranding" leads inexorably to this sort of fantasy:
Consider, too, that, yes, going through a foreclosure kills your credit rating and makes it a lot harder to buy a new house—but as more and more prime borrowers go into foreclosure, it's perfectly possible that buying a new home a year later will in the near future be as routine and unsurprising as the once inconceivable idea that you can get a whole batch of new credit cards two years after a bankruptcy.
What a foreclosure and a "killing" of your credit rating does to you is make you "subprime." "Prime" is not a birthright; it is not an immutable characteristic like having blue eyes. The confident assertion that credit will be easily and quickly available to these borrowers formerly known as prime rests on a hidden assumption that they are unlike any other "subprime" borrower, and therefore will get preferential treatment in a year or two.

Mystification aside, this is a prediction that the subprime mortgage lending industry--and the investors therein--will have recovered sufficiently in just a year that this new large crop of subprime borrowers with a year-old FC on their records will be deluged with mortgage offers. Perhaps that will happen, but what makes anyone think it will happen just because these were once "prime" borrowers? Most subprime borrowers were once prime. With the exception of borrowers who have never had any credit, which is a fairly small group, subprime borrowers once had prime credit, and did not manage it well, and therefore now have cruddy credit records and FICOs. How, exactly, will these "walkaways" be any different from any other subprime borrower?

The whole thing is so nonsensical that I am forced to the conclusion that for this (and many other writers), "subprime" is code for "poor people" and "prime" is code for "middle and upper class people," hence the need for distinguishing terms for loan failure: "foreclosure" for the poor, "walkaway" for the non-poor. Foreclosure is something that happens to you against your will; "walkaway" is something you do to the bank as an exercise of control over your finances. If we can maintain these illusory distinctions, we can maintain "our" distance from "them."

In the realm of rhetoric, that is. I for one suspect that the economics of mortgage lending in a year or two will be somewhat less fantasy-driven than that.

Tuesday, April 01, 2008

Fed Releases New Mapping Tool for Alt-A and Subprime Loans

by Calculated Risk on 4/01/2008 03:23:00 PM

From the Federal Reserve:

The Federal Reserve System on Tuesday announced the availability of a set of dynamic maps and data that illustrate subprime and alt-A mortgage loan conditions across the United States.

The maps, which are maintained by the Federal Reserve Bank of New York, will display regional variation in the condition of securitized, owner-occupied subprime, and alt-A mortgage loans. The maps and data can be used to assist in the identification of existing and potential foreclosure hotspots. This may assist community groups, which can mobilize resources to bring financial counseling and other resources to at-risk homeowners. Policymakers can also use the maps and data to develop plans to lessen the direct and spillover impacts that delinquencies and foreclosures may have on local economies. Local governments may use the data and maps to prioritize the expenditure of their resources for these efforts.

To access the data visit: Monthly updates are planned.

The maps show the following information for subprime and alt-A loans for each state and most of the counties and zip codes in the United States:
• Loans per 1,000 housing units
• Loans in foreclosure per 1,000 housing units
• Loans real estate owned (REO) per 1,000 housing units
• Share of loans that are adjustable rate mortgages (ARMs)
• Share of loans for which payments are current
• Share of loans that are 90-plus days delinquent
• Share of loans in foreclosure
• Median combined loan-to-value ratio (LTV) at origination
• Share of loans with low credit score (FICO) and high LTV at origination
• Share of loans with low- or no documentation
• Share of ARMs with initial reset in the next 12 months
• Share of loans with a late payment in the past 12 months
Accompanying data tables report further statistics for states. The maps and data are drawn from the FirstAmerican CoreLogic, LoanPerformance Loan Level Data Set. For more details, see the website's technical appendices to the map and the data tables.

Additional mortgage foreclosure resources, including helpful information and links to agencies and organizations that may provide assistance to consumers experiencing difficulty making their mortgage payments, are available on the Board's website at:

Tuesday, February 05, 2008

S&P cuts Fremont General Rating

by Calculated Risk on 2/05/2008 06:30:00 PM

From MarketWatch: S&P cuts Fremont General to CCC+; warns on liquidity (hat tip Carlomagno)

Standard & Poor's downgraded Fremont General to CCC+ from B- late Tuesday and warned that the Californian lender may not be able to meet its debt obligations. "Liquidity at the holding company has deteriorated substantially," S&P credit analyst Adom Rosengarten said in a statement. Liquidity remains strong at the company's banking business.
Here is a memo that was sent to me in Feb, 2007 when many people first started realizing there really was a mortgage problem. Of course, back then, many people mistakenly thought it was just a "subprime problem".

A couple of weeks after sending out that memo, Fremont announced they were postponing the release of results. And a couple of weeks later, the FDIC issued a Cease and Desist Order.

Ahhh, memories.

Sunday, January 13, 2008

We're All Subprime Now

by Calculated Risk on 1/13/2008 09:41:00 PM

From Wolfgang Münchau at the Financial Times: This is not merely a subprime crisis (hat tip FFDIC)

If this had been a mere subprime crisis, it would now be over. But it is not, and nor will it be over soon. The reason is that several other pockets of the credit market are also vulnerable. Credit cards are one such segment, similar in size to the subprime market. Another is credit default swaps, relatively modern financial instruments that allow bondholders to insure against default.
The article focuses on Credit Default Swaps (CDS) and suggests the current downturn could be longer than most anticipate (including me):
The German experience has taught us that persistent problems in financial transmission channels cause long economic downturns. Today, the really important question is not whether the US can avoid a sharp downturn. It probably cannot. Far more important is the question of how long such a downturn or recession will last. An optimistic scenario would be a short and shallow downturn. A second-best scenario would be for a sharp, but still short, recession.

A truly awful scenario would be a long recession.
And from Robin Sidel and David Enrich at the WSJ: High-End Cards Fall From Grace (hat tip Brian)
The luster on all those silver, gold and platinum credit cards is getting tarnished.

For the past few years, banks that issue credit cards have aggressively wooed affluent customers with lavish perks and fat credit lines. Now, that high-end strategy is coming back to bite the banks: There are growing signs that some of those consumers are having a hard time paying their bills.
Affluent customers aren't paying their credit card bills? How did the credit card companies define "affluent"? The same standard as the mortgage lenders: Fog a mirror, get a Platinum card?

We're all subprime now.

Wednesday, January 09, 2008

Foreclosure Investigator

by Tanta on 1/09/2008 09:45:00 AM

Elizabeth Warren at Credit Slips has an interesting post up inviting reader comments. I thought our readers might have some ideas about this.

Because subprime lending was not evenly spread around the country (or even around a state or city), individual neighborhoods are bearing the brunt of the meltdown. When several homes in one community go into foreclosure, a neighborhood can rapidly shift from a safe, comfortable area with well-tended lawns to a place where no one wants to live. Mayors are on the front lines in dealing with the fallout.

Like most academics, we at Credit Slips tend to talk about what the federal government could do to deal with the subprime crisis. The feds have the power, if not the will, to make some big changes. But what about mayors? Can anything be done at the city level? This isn't an academic question, so put on your thinking caps and volunteer some ideas. Here's mine:

A mayor could appoint a Foreclosure Investigator. Announce that any person anywhere in the city who has received a notice of foreclosure or similar document should immediately call the city officer who will investigate all the paperwork to make certain that every aspect of the mortgage and the mortgage foreclosure comply with the law--at no expense to the homeowner.

This would be a powerful tool for three reasons: 1) Many of the worst mortgages have bad documentation, illegal provisions, etc. But if homeowners don't know that, and if they don't go to very good lawyers, the mortgage companies will foreclose and the homeowner's rights will be lost. 2) Even if the mortgage paperwork is in order, any push back from a homeowner makes is more likely that a deal can be negotiated to keep the homeowner in the house (if the homeowner really can afford it). A Foreclosure Investigator can inform the homeowner about a range of options. 3) If one city has the reputation as a lousy place to bring a foreclosure action, mortgage companies have lots to do right now, and they may put that city's foreclosures lower on their to-do lists. I realize the last point simply externalizes the problem, but for a mayor working hard to save neighborhoods in his or her city, that may be an issue for another day.

What are your ideas? What other tools are available? If a highly motivated mayor asked you what to do, what would you suggest?
I confess to wondering why homeowners would have to contact this Foreclosure Investigator in the first place. The first step of any foreclosure is to file a Notice of Default or Lis Pendens (or whatever the jurisdiction/foreclosure type requires) in the land records of the county (or city or town, depending). Homeowners can actually miss these things if they no longer occupy or for some other reason don't get served. The recorder's office doesn't miss them.

The legal issue, I assume, is giving the Foreclosure Investigator the right to demand documents or information from the lender/servicer/investor, either on behalf of the homeowner or in its own right. I have no idea how that would work technically.

I'm not sure I'd push for having a Foreclosure Investigator being charged with things like "informing the borrower about options." If these municipalities need legal aid services or homeowner counseling services, models for such things already exist and should be funded. It seems to me the point of the proposal is to have a party who represents the interests, first of all, of the city (or whatever jurisdiction this is), not the lender or the homeowner. In other words, it is precisely formalizing the "externalized" interest.

After all, while it's obvious to me (at least) that cities might have interests that don't exactly align with big national servicers and mortgage investors, it also seems obvious that they might have interests that don't always align with individual homeowners, either. At some level this proposal may well be a recognition of the socially crucial function of judicial foreclosures, which are rarer and rarer in many states as lenders elect "power of sale" or trustee sale foreclosures (because they're faster and cheaper to the lender). The judicial foreclosure is slow and expensive, but it gives the borrower "a day in court" and it tries, at least, to make sure that the state's interest in the process is protected.

Even in states where judicial foreclosures are still the only way to foreclose--like Ohio--we're seeing huge court backlogs. We've all heard about the uproar the Federal District judges have been creating with their attempts to make sure the lenders' paperwork is straight. Warren's proposal for a Foreclosure Investigator sounds a bit to me like a kind of officer of those foreclosure courts. In states where lenders can elect non-judicial foreclosure, it would insert the level of scrutiny of the loan paperwork back into the process.

I would guess that the loudest and first complaint will be about "spending taxpayer money" on cleaning up the mortgage mess. That's why I'd be inclined to think that any such Foreclosure Investigator needs to represent the city, not the individual or the lender, and that it needs to be quite explicit whose interests are being protected and why. It's probably easy enough for foreclosure-ridden cities to cost-justify the expense versus the gain to the taxpayers of preventing neighborhood foreclosure crises.

But it isn't going to be just subprime, and it isn't going to be just old core neighborhoods teetering on the brink for long. It's going to be fancy new half-built half-sold suburban developments full of "prime" mortgages and half-built schools and streets too far from core-city employment centers and the lovely politics of development. I envision the Foreclosure Investigator running up against not just "business environment" types who don't want Our Fair City to see "lender flight," but against those back-room deals with the developers and builders for tax abatements and permits and what have you, and suddenly the Foreclosure Investigator is drawn into the muck of whether some of these new neighborhoods are worth finishing, not "saving." That could be ugly.

Not that that's an argument against doing it, mind you. Ugly is going to arrive whether we fund an Investigator or not.

Monday, January 07, 2008

A Rolling Loan Gathers No Loss

by Tanta on 1/07/2008 10:12:00 AM

And when the music stops, everyone has to sit down. Ours is a cliché business, but then again there may be some new life in the old saws at the ignominious ending of a "New Paradigm."

American Banker has an interesting piece out on troubles in mortgage servicing land (subscription only, alas):

In recent weeks problems at servicing units contributed to profit warnings by First Horizon National Corp. and Regions Financial Corp. If such hits were to develop into a full-blown trend, it might undermine the conventional wisdom on the inherent hedging that servicing provides originators, and it could cool some of the acquisition interest that servicers have continued to enjoy. . . .

On average, servicers are paid a fee of about 50 basis points annually for subprime loans in securitizations, Mr. Sepci said. "Traditionally in an adequately performing credit market, like 2004 or 2003 or even 2005," that rate "basically was fair and adequate compensation," but in the current environment, "for a lot of participants … maybe it's not enough."

For instance, "when you modify a loan, and you contact a borrower, basically re-underwrite the loan, and work with them through their issues, you're incurring costs of anywhere from $700 to $1,000 dollars per interaction," he said.

In addition to advancing principal and interest, servicers also typically are required to cover a variety of costs during foreclosure, though eventually they are reimbursed.

"The advances are going up in general, and for nonbanks, financing those advances has become more difficult and more expensive," said Jeffrey M. Levine, a managing partner with Milestone Advisors LLC of Washington. . . .

However, some observers said that rising servicer expenses have been counterbalanced by slower prepayments and late fees, and that much depends on the individual characteristics of the servicing portfolio and the servicer's capacities.

Delinquencies "can be very profitable for the servicer," said Charles N. McQueen, the president of McQueen Financial Advisors, a Royal Oak, Mich., investment advisory firm that performs mortgage servicing valuations. "It should work that way if you're a large enough servicer, due to economies of scale — your fees more than cover your expenses."

Mr. Levine said that it would be "fair to say" that servicing costs are increasing, "but in terms of the overall economic picture, you'd be telling an incomplete story if you felt that was just net negative on the value of servicing."

For example, a slowdown in prepayments and a revenue boost from late fees act as counterweights, he said.

But Mr. Sepci said late fees may not be enough.

"On average, late fees are approximately 10 basis points," he said, but those fees, even when combined with the standard 50-basis-point servicing rate, would not cover what some servicers are asking to take on some very high-delinquency portfolios.

And slowing prepayments also may have negative consequences for servicers.

The slowdown may be "contributing to the higher delinquencies as more accounts have a higher probability of default now, and therefore higher cost," said John Panion, a senior manager in KPMG's financial risk management practice.
I remain amused by the idea that 50 bps for subprime servicing is adequate in an "adequately performing credit market, like 2004 or 2003 or even 2005." If the height of an unprecedented boom is "adequate" for existing subprime servicing valuations, then you have a serious mispricing problem on your hands.

This does point to what I have always considered the basic function of the "Hope Now" teaser-freezer plan, with its distressing provisions for doing "streamlined" modifications. It has always been about servicers not being in any position to absorb the costs of responsible processing of workouts. If you don't really underwrite it up front, you have to really underwrite it in back, but apparently that's a challenge on 50 bps servicing. So the next big problem is going to be writing down the value of those MSRs (servicing rights as an asset on the balance sheet) if and when we blow through that relatively small number of mortgagors who qualify for the "streamlined" workout and get to the ones who will really eat operating expense.

Similarly, while 10 bps in late fees sounds like a lot (at least, it does to old prime lenders like me), one begins to suspect that late fee income, also, was calculated based on the kinds of collection costs you had in that "adequate" market of 2003-2005.

We're certainly seeing an interesting shift in assumptions here regarding prepayments. Historically, slowing prepayments have always been good for servicers, and that's why a servicing portfolio was always a "counter-cyclical" hedge for your origination platform: the lack of new refinance and purchase transaction income on the front end is made up for in longer loan life on the back end, and because so much of the cost to service a loan is front-loaded, and because new mortgage loans amortize pretty slowly, the longer it stays on the books the more money you make.

That conventional wisdom is being challenged by the fact that 2003-2005 might have been "adequate," but only because short loan lives (rapid prepayment) masked inadequate credit quality to the extent that servicers staffed themselves for acquisition and payoff processing--much cheaper operations than delinquent and default servicing--and prepared to greet a slowing prepayment environment with the usual cheerfulness of servicers. That cheerfulness wears off when extended loan lives produce not net servicing fee income but overwhelming collections, workout, and foreclosure costs.

Finally, we need to remember that servicer advances are one side of the coin, and float is the other. Servicers collect principal and interest payments for performing loans on and around the first of the month, but do not usually remit to the investor until around the 20th-25th. Advances have borrowing costs, too. So what's the value of the float on however many performing subprime loans we still have left? You'd have to ask Dr. Bernanke . . .

(Hat tip, Clyde!)

Saturday, January 05, 2008

For 2008 I Nominate "Bongwater"

by Tanta on 1/05/2008 01:41:00 PM

Via sterlingirl: AP

Subprime was chosen as 2007's word of the year.

Thursday, January 03, 2008

The Un-re-dis-inter-mediation Blues

by Tanta on 1/03/2008 08:06:00 AM

We all knew that technology would solve our productivity problems, and National Mortgage News has the proof:

One question some of you might be asking is this: if subprime volumes have screeched to a halt, what are all those traders on Wall Street doing? Good question. We're told that come January there will be a wholesale shakeup at several firms. Sources tell us that Deutsche Bank, Lehman Brothers and Merrill Lynch all are conducting reviews (or soon will) of their entire mortgage operations. As for where the most drastic changes might occur, Merrill Lynch might be a good bet. An account executive there told us recently about conditions at Merrill's First Franklin Financial Corp. He said many offices are not funding loans while awaiting training for Fannie Mae products. "So far, there's been no training," he told us. The AE, requesting his name not be used, painted a bleak picture, saying business is so slow that employees pass the day playing Scrabble and PlayStation on the conference room projector screen. He said FFFC AEs and executives keep asking Merrill why they can't just originate loans and put them on the balance sheet of Merrill's FDIC-insured bank. "We're not getting any answers," he said.
Aside from the idea of loan officers having sufficient spelling skills to play Scrabble, which is new to me, here we have the two same old dumb ideas that emerge in any mortgage downturn, with a delicious twist that it's Wall Street getting it instead of Main Street.

First, there's the old "let's retrain a bunch of subprime loan officers to be prime GSE loan officers." You civilians might think this should be fairly easy, but the fact is that training a lot of these people to be prime loan officers basically means training them to be loan officers. If they had any basic depth of understanding of the business they're in, they could move to prime origination by just reading that other rate sheet. The reality is that they've been doing no-doc no-down no-sweat stuff for so long--some of them have never done anything but--that they're sitting around with the PlayStation waiting for someone to tell them how a 30-year fixed rate loan with a down payment and verified income actually works. Which is to say, their bosses are sitting around in the busier conference rooms trying to figure out if it's possibly worth the time and money to turn these people into mortgage experts instead of corner-cutting order-takers.

Item the second causes a deep belly laugh in anyone who ever worked for a depository in a mortgage downcycle: "Why can't we just put the loans on the balance sheet?" I know it makes me a bad person, but the thought of Merrill getting this one from its mortgage people is floating me heavenward on a warm tide of schadenfreude. I suspect that it may well be tickling the folks at National City, insofar as they have anything to laugh about these days. In case you don't remember, Merrill bought First Franklin from National City just over a year ago--but apparently nobody explained to the First Franklin folks that they no longer had a parent with a big fat hold-to-maturity portfolio with which loan originators can be subsidized in a low-volume period.

That is--or once was--an old strategy for depositories: when you can't sell your loans, hunker down, stuff 'em on the books and wait for the tide to turn. We are seeing depository after depository shutting down its wholesale and correspondent lending divisions, meaning it will, as always, only allocate those portfolio dollars to keeping an expensive but much safer retail operation alive. If you're a mortgage broker right now, you are staring in the face of hunger.

But Merrill really really wanted to be a retail originator in its own right. Welcome to the other side of the mortgage world, Mother Merrill, and try turning in some tiles. Maybe you'll get a vowel.

Monday, December 31, 2007

Gambling? In A Casino?

by Tanta on 12/31/2007 07:01:00 AM

It's shocking. Via naked capitalism, this jewel from the WSJ on subprime lender-sponsored lobbying efforts against predatory lending regulation:

Washington lobbyist Wright Andrews and his wife, Lisa, coordinated much of the industry's lobbying. Mr. Andrews's firm, Butera & Andrews, collected at least $4 million in fees from the subprime industry from 2002 through 2006, congressional lobbying reports indicate. Mr. Andrews didn't represent Ameriquest directly. He ran three different subprime-industry trade groups: the National Home Equity Mortgage Association, of which Ameriquest was a member; the Coalition for Fair and Affordable Lending, which spent $6.3 million lobbying against state laws before it dissolved earlier this year, according to federal filings; and the Responsible Mortgage Lending Coalition.

In 2003, Lisa Andrews was appointed senior vice president for government affairs at Ameriquest. Her public-relations firm, Washington Communications Group Inc., claims credit on its Web site for coordinating the industry's victory in New Jersey, as well as its overall strategy at the state level. Ms. Andrews left Ameriquest in 2005 and returned to her firm. . . .

In the wake of the collapse of the subprime market, Mr. Andrews's subprime lobbying business has withered. The three trade groups he ran are gone, and most of his subprime clients have stopped lobbying.

"I certainly was not aware of the degree to which many in the industry clearly failed to follow proper underwriting standards -- the standards which they represented they were following to those of us who were lobbying," Mr. Andrews says.
Here's a hint, Mr. Andrews. When a regulation is proposed that says lenders should adopt a certain underwriting standard, and the industry responds by saying "we already do it that way," and then pays you $4 million to stop that regulation from being enacted, you actually have some reason to believe they're pulling your leg. No, really.

Friday, December 28, 2007

Fed gives Tanta a Hat Tip

by Calculated Risk on 12/28/2007 07:00:00 PM

From Adam Ashcraft and Til Schuermann: Understanding the Securitization of Subprime Mortgage Credit

See page 13:

Several point raised in this section were first raised in a 20 February 2007 post on the blog entitled “Mortgage Servicing for Ubernerds.”
Note: there is link in the menu bar for Tanta's UberNerd series: The Compleat UberNerd.

Here is the introduction:
How does one securitize a pool of mortgages, especially subprime mortgages? What is the process from origination of the loan or mortgage to the selling of debt instruments backed by a pool of those mortgages? What problems creep up in this process, and what are the mechanisms in place to mitigate those problems? This paper seeks to answer all of these questions. Along the way we provide an overview of the market and some of the key players, and provide an extensive discussion of the important role played by the credit rating agencies.

In Section 2, we provide a broad description of the securitization process and pay special attention to seven key frictions that need to be resolved. Several of these frictions involve moral hazard, adverse selection and principal-agent problems. We show how each of these frictions is worked out, though as evidenced by the recent problems in the subprime mortgage market, some of those solutions are imperfect. In Section 3, we provide an overview of subprime mortgage credit; our focus here is on the subprime borrower and the subprime loan. We offer, as an example a pool of subprime mortgages New Century securitized in June 2006. We discuss how predatory lending and predatory borrowing (i.e. mortgage fraud) fit into the picture. Moreover, we examine subprime loan performance within this pool and the industry, speculate on the impact of payment reset, and explore the ABX and the role it plays. In Section 4, we examine subprime mortgage-backed securities, discuss the key structural features of a typical securitization, and, once again illustrate how this works with reference to the New Century securitization. We finish with an examination of the credit rating and rating monitoring process in Section 5. Along the way we reflect on differences between corporate and structured credit ratings, the potential for pro-cyclical credit enhancement to amplify the housing cycle, and document the performance of subprime ratings. Finally, in Section 6, we review the extent to which investors rely upon on credit rating agencies views, and take as a typical example of an investor: the Ohio Police & Fire Pension Fund.

We reiterate that the views presented here are our own and not those of the Federal Reserve Bank of New York or the Federal Reserve System. And, while the paper focuses on subprime mortgage credit, note that there is little qualitative difference between the securitization and ratings process for Alt-A and home equity loans. Clearly, recent problems in mortgage markets are not confined to the subprime sector.
This report is recommended reading to understand the entire securitization process. Congratulations to Tanta, and hopefully she will comment on the report.

Also note the last two sentences of the introduction: "... while the paper focuses on subprime mortgage credit, note that there is little qualitative difference between the securitization and ratings process for Alt-A and home equity loans ... recent problems in mortgage markets are not confined to the subprime sector."

Thursday, December 27, 2007

Out of Foreclosure, In Reverse

by Tanta on 12/27/2007 10:00:00 AM

The WSJ (sub only, I'm afraid) had a piece yesterday on a process it never actually names--the "short refi" (related to the "short sale"). What makes these short refis--refinance transactions where the new loan is less than the balance due on the old loan, with the old lender agreeing to call the loan paid in full and write off the difference--so unusual is that the old loans are nasty high-rate subprime loans to old people, and the new loans are reverse mortgages.

The strategy worked recently for Gloria Forts, a 62-year-old retired federal worker in Forest Park, Ga., a suburb of Atlanta. After refinancing her home in August 2006 with a $106,500 mortgage from Fremont Investment & Loan in Brea, Calif., Ms. Forts was facing monthly payments of $950.41. That consumed 70% of her monthly income from Social Security and a pension. Intending to start a new job, she found herself kept at home by diabetes complications and back surgery. In June, she sought help from the Atlanta Legal Aid Society.

There, she found William J. Brennan Jr., a veteran housing attorney who, over the past 18 months, has developed a sophisticated model for settling subprime debts with reverse mortgages. After Ms. Forts received a foreclosure warning in October, Mr. Brennan connected her with Genie McGee, a reverse-mortgage specialist with Financial Freedom Senior Funding Corp., an Irvine, Calif., unit of IndyMac Bancorp Inc. She determined that Ms. Forts would qualify for a reverse mortgage of about $61,000.

Mr. Brennan sent Fremont's loss-mitigation department a letter proposing that the company agree to take that sum and cancel its plans to foreclose on the house. On Dec. 3, the day before the foreclosure sale was supposed to take place, Fremont agreed to the deal and stopped the foreclosure.
Using a reverse mortgage as a foreclosure workout is certainly unusual. I've written about reverse mortgages here if you're not familiar with the beast. They were designed for older borrowers (the minimum age is 62 for all products I know about) who are house-rich but cash-poor. Using them for borrowers who are house-poor, to prevent foreclosure, isn't exactly what they were intended for. And using them to "create" an equity cushion that they can then absorb in deferred interest is quite the innovation. (Of course the "equity" here isn't being "created"; it's being "donated" by the old lender.)

Then again, it isn't every historical moment in which lenders are willing to accept 57 cents on the dollar on a short refi, either. The key to the reverse mortgage is that the maximum loan amounts are much lower, on the whole, than they are for forward mortgages. (Because the amount that can be borrowed is a function of both the value of the home and the age--the likely remaining lifespan--of the borrower, only the very very old can borrow as much with a reverse mortgage as with a forward mortgage.) The WSJ doesn't give the current appraised value of Ms. Forts' property, but I'd guess that the original LTV of the new $61,000 reverse mortgage is not much more than 50% (suggesting that the old $106,500 mortgage, which apparently carried an interest rate of 10% or so, was around 90% of current value). It says a lot about Fremont's estimate of loss severity that they took the money and ran.

Is this a good deal for Ms. Forts? Well, she gets to stay in her house. (She might describe this as getting to "keep" her house, but the way a maximum-balance reverse mortgage to a 62-year-old borrower is likely to work, statistically, what she just did, in effect, was give the deed to IndyMac while reserving a life estate.) She is highly unlikely ever to be able to withdraw cash again from it; at her age and that loan balance, my guess is that compounding interest on the original balance will far outstrip any possible positive appreciation on that property in Ms. Forts' lifetime, and her heirs will simply hand over the deed to the bank.

What I find mildly amusing is that the WSJ reporter almost, but not quite, gets the issue here:
With a reverse mortgage, the bank makes payments to the homeowner instead of the homeowner making payments to a bank. The loan is repaid, with interest, when the borrower sells the house, moves out permanently or dies. The products are complex and have high fees -- typically about 7% of the home's value -- and they make it difficult for homeowners to leave the property to their heirs. But they may be the best option for people who have built up equity in their home and would otherwise lose it.
Actually, a reverse mortgage doesn't make probate any harder than a forward mortgage does. It's not that it's "difficult" to leave the property to the heirs; it's that the loan amount is likely to be equal to or more than the property's value at that point. Notice the odd phrasing of that last sentence: grammatically, "it" probably refers to "equity," but that of course is going to be lost in all cases (except for borrowers unfortunate enough to die prematurely; one hopes that doesn't make the heirs happy). The only thing a reverse mortgage borrower "keeps," in practical terms, is occupancy.

This is also curious:
The transaction illustrates one of the biggest challenges in getting lenders to accept payouts from reverse mortgages: taking less money than the house may be worth.
My sense is that the WSJ reporter just can't really wrap her mind around the reality of the mortgage and housing markets today. This business of "taking less money than the house may be worth" (as opposed to "taking less than the loan amount") may just be sloppy phraseology, but I think it's kind of sypmtomatic of how hard it really is for some folks to shed the assumptions of the Boom. Short refis are going on all around us, not just with reverse mortgages: a lot of the loans going into FHASecure, for instance, are short (by the amount of some or all of a second lien, often, but in some cases even the first lien payoff is short). I'm surprised that you still have to say this out loud to people, but what "the house is worth" is no longer a particularly relevant concern for a lot of people. The issue is what you owe, and as long as there are places in the world where expected loss severity to lenders can be in the neighborhood of 47% of the loan amount, you probably owe too much.