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

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

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

Exhibit the first, Ms. Morgenson:

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

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

The possibility that Countrywide may have to buy back mortgages that it sold comes on the heels of its announcement last week that the tightening credit markets had forced it to draw on its $11.5 billion line of credit from a consortium of banks, a move that sent the market plummeting.

Pretty exciting stuff.

Countrywide, with its stock depressed, had been seen as a prospect for a takeover. But any obligation the company has to buy back loans may complicate discussions with potential investors or buyers.

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

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

It is unclear how many modified loans are involved. But it would cost $1.2 billion for the company to repurchase 1 percent of the loans in the pools at issue. Repurchasing 5 percent would cost $6.1 billion. When such buybacks are made, the original amount of the loan is paid into the pool and divided among the investors.

And if they had to repurchase 100%, that would be gajillions o' dollars! This is not "unclear," it's actual math! Besides, while "in general" it's difficult to get a mod, CFC went out and wrote servicing agreements that make it easier! I call foul!

Here are paragraphs 21-23 of the 26-paragraph article. The emphasis, of course, has been added by Tanta:

Under most agreements, the amount of loans that can be modified in any pool is limited to 5 percent, unless the mortgage borrowers are defaulting or seem to be about to default. Mr. Simon said that the pooling agreements indicating that Countrywide was obligated to buy back modified loans applied only to mortgages that are not in danger of defaulting.

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

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

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

Exhibit the second, chosen randomly, is CWAB's prospectus for 2006-01:

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

Here's the same section ("Certain Modifications and Refinancings") from CWAB 2007-12

Countrywide Home Loans is permitted under the Pooling and Servicing Agreement to solicit borrowers for reductions to the Mortgage Rates of their respective Mortgage Loans. If a borrower requests a reduction to the Mortgage Rate for the related Mortgage Loan, the Master Servicer is required to agree to that reduction if (i) Countrywide Home Loans, in its corporate capacity, agrees to purchase that Mortgage Loan from the issuing entity and (ii) the Stated Principal Balance of such Mortgage Loan, when taken together with the aggregate of the Stated Principal Balances of all other Mortgage Loans in the same Loan Group that have been so modified since the Closing Date at the time of those modifications, does not exceed an amount equal to 5% of the aggregate initial Certificate Principal Balance of the related Certificates. Countrywide Home Loans will be obligated to purchase that Mortgage Loan upon modification of the Mortgage Rate by the Master Servicer for a price equal to the Purchase Price. Countrywide Home Loans will remit the Purchase Price to the Master Servicer for deposit into the Certificate Account within one Business Day of the purchase of that Mortgage Loan. Purchases of Mortgage Loans may occur when prevailing interest rates are below the Mortgage Rates on the Mortgage Loans and borrowers request modifications. Countrywide Home Loans will indemnify the Trust Fund against liability for any prohibited transactions taxes and related interest, additions or penalties incurred by any REMIC as a result of any such modification or purchase.

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

Here's the deal.

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

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

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

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

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

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

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

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

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

by Calculated Risk on 8/23/2007 11:40:00 AM

UPDATE2: CNBC video of Mozilo (hat tip crispy&cole)

From Market Update:

CEO Angelo Mozilo [said] in an interview on CNBC there is still a tremendous liquidity problem and that he thinks the housing slump will lead [U.S.] into a recession.

From Reuters: Indexes drop as Countrywide sees tough market

[Countrywide CEO Angelo Mozilo, , speaking on CNBC television] said the market environment was "certainly not getting better." ... [he] also said the commercial paper market isn't improving.

UPDATE: for those interested in the BofA investment in CFC, here is the Form 8-K filing with the SEC. Not much detail.

by Calculated Risk on 8/23/2007 10:15:00 AM

I don't believe the Fed will cut rates until there is clear evidence of a more general economic slowdown. The Fed's Poole recently 'cited the monthly jobs, retail sales and industrial production reports as key gauges he'll be watching'.

One of the indicators the Fed will probably be watching is the four week moving average of weekly unemployment claims. The average has been moving up slightly in recent weeks, but the level is still fairly low.

From the Department of Labor:

In the week ending Aug. 18, the advance figure for seasonally adjusted initial claims was 322,000, a decrease of 2,000 from the previous week's revised figure of 324,000. The 4-week moving average was 317,750, an increase of 4,750 from the previous week's revised average of 313,000.

Click on graph for larger image.

This graph shows the weekly claims and the four week moving average of weekly unemployment claims since 1989. The four week moving average has been trending sideways for months, and the level is low and not much of a concern.

My view is the two most important areas to watch in the coming months are consumer spending and non-residential investment (especially in structures). To me labor related gauges are at best coincident indicators.

by Anonymous on 8/23/2007 10:13:00 AM

The Financial Times reports on these "SIV-lite" things that have been confusing us all:

More than $4bn worth of bonds backed by residential mortgages and other structured debt products could soon hit the market as a result of forced sales by the so-called SIV-lite sector – a type of vehicle hurt by the recent short-term debt market turmoil.

Many market participants have struggled to raise funds in the asset-backed commercial paper market but the problem has proved critical for two particular SIV-lite vehicles.

Mainsail II, a $2bn vehicle run by Solent Capital in London, has been forced to begin selling assets, while Golden Key, a $1.9bn vehicle run by Avendis of Geneva, had its commercial paper notes downgraded to the market equivalent of junk status on Friday by Moody’s Investor Services, the ratings agency, and is also expected to sell its assets.

SIV-lites are essentially collateralised debt obligations which pool together bonds backed by mortgages and other asset-backed debt. The main difference is that other CDOs sell long-term senior debt to fund their assets while SIV-lites raise senior debt in the short-term ABCP markets.

SIV-lites are a relatively recent market development and only five have so far been launched. . . .

I'd say something useful about this, but I haven't been drinking coffee long enough. The first time through I read "Solent" as "Soylent." The second time I read it as "Salient" (in the military sense). I'm not going to read it again until after noon.

by Anonymous on 8/23/2007 09:31:00 AM

Sorry I'm up so late this morning. This, however, is probably the best Bloomberg headline I have ever seen.

Bernanke Using `All Tools' to Calm Markets, Dodd Says

by Calculated Risk on 8/22/2007 07:46:00 PM

From the WSJ: Bank of America Invests $2 Billion in Countrywide

Bank of America Corp. acquired a $2 billion equity stake in Countrywide Financial Corp., a move aimed at dispelling a crisis of confidence among creditors and investors in the nation's largest home-mortgage lender.

The move illustrates how amid the current shakeout among mortgage lenders, some financial heavyweights -- including Bank of America and Wells Fargo & Co. -- are gaining a firmer grip on the home-mortgage business even as smaller rivals with less-secure financing and capital bases fall by the wayside or are forced to retrench.
...
Bank of America's investment involved Countrywide nonvoting convertible preferred stock yielding 7.25% annually. The preferred can be converted into common stock, subject to restrictions on trading for 18 months. A full conversion would give Bank of America a 16% to 17% stake in Countrywide's common shares...

by Calculated Risk on 8/22/2007 02:52:00 PM

From Bloomberg: Lehman Brothers Shuts Down Subprime Unit, Fires 1,200 Employees (hat tip Viv)

Lehman Brothers Holdings Inc., the biggest underwriter of U.S. bonds backed by mortgages, became the first firm on Wall Street to close its subprime-lending unit and said 1,200 employees will lose their jobs.

... Lehman acquired Irvine, California-based BNC [Mortgage] in 2004 and used it to expand in lending to homeowners with poor credit or heavy debt loads. ...

Accredited Home Lenders Holding Co., a subprime specialist, announced 1,600 job cuts earlier today in an effort to outlast the credit crunch that has forced dozens of rivals out of business. HSBC Holdings Plc is eliminating 600 positions in its U.S. operations and closing a mortgage office in Indiana, and Capital One Financial Corp. is closing GreenPoint Mortgage because it can't make money anymore lending to homeowners and then selling those mortgages to investors.

The beat goes on.

by Calculated Risk on 8/22/2007 12:42:00 PM

From MarketWatch: U.S. banking giants borrow $2 bln from Fed

... Citigroup Inc., J.P. Morgan Chase, Bank of America and Wachovia Corp. said on Wednesday that they borrowed $2 billion from the Federal Reserve ...

Citibank said it took out a $500 million, 30-day loan from the New York Fed's discount window program for its clients. ... "Citibank stands ready to continue to access the discount window as client needs and market conditions warrant," the bank said in a statement.

by Calculated Risk on 8/22/2007 11:49:00 AM

"In single-family communities, we typically do not start a home until we have a contract in place and a significant non-refundable down-payment. ...

Even with these policies, during this downturn, we have experienced a much higher rate of cancellations than at any time in our twenty-one-year history as a public company."
Bob Toll, CEO Toll Brothers, Aug 22, 2007 (emphasis added)

So even with significant non-refundable down-payments, Toll Brothers is experiencing record cancellation rates for Toll (this is 24% for Toll, below many other builders because of the larger non-refundable deposits). And this was for the period ending July 31st - so this is the "pre-turmoil" cancellation rate.

"Through our third-quarter-end [July 31st, pre-turmoil], our buyers generally were able to obtain both conforming and jumbo loans (loans over $417,000).

Nevertheless, tightening credit standards will likely shrink the pool of potential home buyers: Mortgage market liquidity issues and higher borrowing rates may impede some customers from closing, while others may find it more difficult to sell their existing homes."

Translation: "Look out below!"

"We believe that reducing new home production until the current oversupply is absorbed is a key step in bringing housing markets back into equilibrium."

Translation: "If everyone else would stop building, maybe we would be OK."

Watch for housing sales and starts to decline precipitously in the coming quarters. Yesterday, BofA analysts forecast new home sales to fall to 700K per year (SAAR). My forecast is for starts to fall to around a 1.1 million SAAR.

Update: Herb Greenberg had almost the same reaction: For Whom the Market Tolls (As in Homebuilder)

by Anonymous on 8/22/2007 11:05:00 AM

I'm going to get all detailed and nerdy about this, but it's a huge matter of current policy debate. And, frankly, the cheerleaders for stated-income lending get by with the quickie soundbites that might sound plausible to those who are not well-versed in traditional methods of mortgage underwriting. Those arguments don't hold up to scrutiny, but not enough people are doing that scrutinizing.

My text today is "Should Stated-Income Loans Be Barred?" by Jack Guttentag, who calls himself "The Mortgage Professor." No way that kind of hubris is going unpunished today.

The "Professor" believes that stated income loans, or what he refers to as "SILs," should remain widely available. He offers some examples of "legitimate" SILs:

Full documentation generally requires that applicants show that the income they claim was actually earned in each of the two prior years. This is usually done by presenting W-2s or tax returns for two years. Self-employed borrowers usually have the most trouble meeting this requirement; stated-income loans were originally designed to deal with them, but other legitimate cases quickly emerged.

Many applicants with incomes from salaries can't meet full-doc requirements. They may not have held their position long enough, or their latest increase in salary may not be reflected in documents covering past income.

This, of course, is confusing a lender's rules on calculation of qualifying income with a lender's practice of verifying it. If a lender's guideline is that applicants are qualified at the average of the last two years' income--and sometimes this is a rule--you are using "SIL" to lie your way around the guidelines if, when asked to state your average income for the last two years, you state your income from last month.

Every lender can make an exception to the two-year average rule-of-thumb for determining "qualifying income." If you just stopped being Nurse Sue and became Assistant Professor of Nursing Sue, and you spent the last two years renting while you were building up your credentials for that career move, waiting to buy until it made more financial sense for you, and you can give me the W-2s, rental history, and employment agreement with Nursing U to prove it, I won't just make you a loan, I'll cut your cake and give you a big warm hug because you're my kind of borrower.

If you've been behind the counter at Taco Bell for the last two years, but just recently got put on the payroll at your brother-in-law's new vitamin supplement marketing startup company, and now you'd like to do a cash-out refi to make a little investment with? You will be "qualified" on your average Taco Bell income for the last two years. I'm the underwriter. I make the rules. You do not get to "underwrite yourself" by deciding that my rule on qualifying income is "unfair" to you and therefore you can get around them by "going stated."

If a married couple pool their incomes and one has a much lower credit score than the other, the full-doc rule is that the lower score is the one used. Stated income allows the partner with the higher score to claim all the income, which appears reasonable in most situations, especially in community-property states, where husband and wife share legal right to each other's incomes.

It appears reasonable to use stated income to lie your way around the lender's rules on credit history? Really?

Since the dawn of time, Prudence has married Spendy. The idea is usually that Prudence is going to "reform" Spendy. The love of a good spouse and all that. Fine. I'm an underwriter, not your mother. You can marry whoever you want to.

The problem is that, since the day after the dawn of time, divorce lawyers have been admitted to the bar, because it does tend to turn out that Prudence and Spendy argue a lot. Sometimes it's over whether they should make the mortgage payment or take the cruise to Aruba. The mortgage payment does not always win.

If you want me to consider you an "economic unit" for the purposes of granting you a loan, then I will do so. But that means that I can consider your creditworthiness in terms of the total unit. If I count Spendy's income, I count Spendy's FICO. Claiming that all the income is Prudence's in order to get around this is fraudulent misrepresentation designed to induce a lender to make a loan that it would not otherwise grant.

Got one of those situations where one spouse has excellent credit and one is just recovering from a past bout of misfortune? Fine. Give me the documents showing the layoff, the illness, the resumption of payments, the well-managed current debt situation, and we'll talk. Tell me it was all a misunderstanding, while refusing to give me paystubs? I don't think so.

Full documentation rules are backward-looking; forecasts of future changes in income are not accepted, no matter how well grounded they may be. This means, for example, that the low-paid medical resident who, barring a catastrophe, will triple her salary in three months can declare only her current salary with full documentation. Using an SIL, however, the resident can declare her future income.

Look, I love medical residents. My own life has literally been saved by a medical resident. I have never met a finer group of people than medical residents.

A medical school graduate without a job is an unemployed person with decent prospects. I don't lend on prospects. A resident with a residency agreement that will start in September may or may not have any business buying a house right now, but that's OK. I will look at your credit and your debt and your property just like I would anyone else's, and you can get the same deal Nurse Sue got if you qualify.

I have run into very few medical resident loans in which the medical resident wouldn't cough up that residency agreement. I have met one or two 22-year-old Business Administration Majors with the ink still wet on their BS degrees who want me to qualify them for a loan assuming they'll be a Senior Vice President in five years, because that's The Plan.

It doesn't seem to have occurred to The Professor that, at some level, we qualify everybody based on reasonable assumptions about the future. Unless I see something in your file that indicates otherwise, I'll assume you won't get fired tomorrow. I will set my DTI guidelines in such a way that can allow first-time homebuyers, who may be at the beginning, not the peak, of their earning years, to "grow into the loan" a little bit. But I still have to make sure you can carry the loan from payment one. We have just experienced an "Early Payment Default" crisis of unprecedented magnitude, and somebody is telling me I should stop worrying about whether a borrower can make the payment in the here and now. It's like dropping acid without the amusement value.

Does The Professor consider this problem? Why, yes:

The valid rap on SILs is that some borrowers, without any realistic basis for expecting a rise in income, lie about their current income and take loans they cannot afford. This irrational behavior of some borrowers may be encouraged by rational behavior on the part of rapacious loan officers or brokers, who get paid only if a loan closes and have no interest in what happens afterwards.

Because borrowers with high credit scores are much less likely to be irrational in their financial affairs, lenders place a lot more weight on credit scores of SIL borrowers than of full-doc borrowers. SILs will not be available to borrowers with very low credit scores, and if they are available, the price difference between good credit and poor credit is much larger on SILs than on full-doc loans.

This is from the guy who just suggested that borrowers use stated income to get around my FICO rules.

This is after we just had S&P admit that high-FICO SILs are going down just like low-FICO SILs. This is after we just discovered that apparently "the price difference" wasn't nearly enough to cover the losses on this stuff. This is after we discovered that FICOs can be manipulated. This is after we discovered that the RE market doesn't care what your FICO is.

Look. Coming up with all this documentation I'm asking for in these odd situations is time-consuming. This is a mortgage loan. It is the largest debt most people ever contemplate. It has, as we have seen lately, not just profound personal repercussions, but social and political and macro-economic ones, as well. It should be time-consuming, and it should be more expensive, in terms of transaction costs, than getting a $200 Barnes and Noble Master Card at the counter so you can get 10% off your copy of Elvis, Jesus, and Coca-Cola. It does not have to be draconian, just sensible.

Stated income is never sensible. Guidelines that take into account differences in qualifying income or ratios for young people, first-time homebuyers, people with sporadic income, people with lots of cash assets, etc., have always existed and will (if we get through the crunch that stated caused, that is) continue to exist. But those guidelines put the onus on the lender to make an occasionally difficult decision and justify it to the investors, the insurers, the regulators, and the public.

This "stated" thing just pushes the "responsibility" for foolishness back onto the borrower, who cannot pay the cost of his foolishness. That is the situation we are now in. You all can get as morally-disapproving of these borrowers as you like. These borrowers cannot pay the cost of their mistakes. That was the whole problem. It is still the whole problem.

Now we're all paying for it one way or another. And someone calling himself an expert on the mortgage business wants to continue to allow borrowers to underwite their own loans, and lenders to continue to pretend we don't know what this is all about.

The only sane policy is to require verification of any income used in qualifying. That does not mean that Congress writes the rules that define "qualifying" in all cases. Let lenders be "lenders." But let's quit letting borrowers be "lenders except for the fact that it isn't their money."