ANOTHER CHEF IN THE KITCHEN – N.Y. FED RESERVE TO WORK OUT KINK IN SECURITIZATION SYSTEM

In its desire to make corrections in the system with the hope of reinvigorating the secondary market for mortgage backed securities, it has been reported that the Federal Reserve Bank of New York is meeting with key players in the securitization market. This corresponds to the release of a paper last week authored by two members of the Federal Reserve of New York and two outside parties. The paper, titled “A Foreclosure Crisis”, simplistically highlights one of the current problems with the mortgage foreclosure process. While no specific remedies are discussed, the paper looks at the procedural requirements relating to the security interest (the mortgage) tied to the debt (the note) and the “chain of title” requirements when recording the mortgage.

The paper questions the state of the recording laws. The failure of these regulations to keep up with “modern financial practices and technological developments” is the crux of the paper. The authors also direct attention to the complexity of the securitization structures in order to meet the requirement of these more arcane regulations as well as the use of the Mortgage Electronic Registration System (MERS). As we all remember, the “MERS Issue” initially started the whole foreclosure problem, as plaintiffs’ lawyers tried that “razzle-dazzle” to confuse the judiciary as to the rights of servicers to foreclose on delinquent borrowers. The MERS issue also caught servicers not following the requirements of getting proper chain of title documents filed before instituting foreclosure actions.  

The paper heavily cites the congressional testimony of Mark Kaufman, Commissioner of the Maryland Office of Financial Regulation, before the House of Representative’s Committee on Oversight and Government Reform on March 8, 2011. In his testimony, Mr. Kaufman noted that the separation of the origination of a mortgage loan from its servicing “may have facilitated the flow of cheap capital, but [it] also fragmented roles, distorted market incentives, and severely complicated the task of modifying loans to avoid preventable foreclosures.”

Likewise, Mr. Kaufman’s testimony cited in the paper acknowledges that the economies of scale brought on by this securitization and the use of third party servicers drove the consolidation of the mortgage servicing business. This allowed the top five servicers to control almost 60% of the market today, nearly double that from 2000. Mr. Kaufman’s testimony also noted the importance of federal attention to this matter, since the largest servicers are federally supervised entities.

The paper concludes with the state of development for clarifying the current laws and current efforts to revise them. Two organizations, the Uniform Law Commission and the American Law Institute, through their joint Permanent Editorial Board of the UCC, issued a draft report explaining the application of the rules in both Articles 3 and Article 9 of the UCC to provide (i) guidance in identifying the person who is entitled to enforce the payment obligation of the maker of a mortgage note, and to whom the maker owes that obligation; and (ii) determining who owns the rights represented by the note and mortgage.

So, while the chain of title for the recording of mortgages may have gotten rusty from neglect and the individual links may have gotten bent from abuse, it appears that some people are now willing to take on the task of fixing the chain. For if this chain was to break, the 800 lb mortgage gorilla might truly get loose and cause more serious damage to the economy.

To read the paper ”A foreclosure Crisis” by Thomas Baxter, Stephanie Heller, Frederick Miller and Linda Rusch, go to http://www.newyorkfed.org/banking/consumerprotection/a_foreclosure_crisis.pdf

To read the testimony of Mark Kaufman, go to http://www.dllr.maryland.gov/finance/comm/speech-kaufman-03082011.doc.

DEAD CAT BOUNCE . . .AND BOUNCE . . .AND BOUNCE – DISTRESSED HOUSE SALES CONTINUE TO DEPRESS MARKET

In a report by Corelogics, the housing market’s statistical arm, year-over-year declines in housing prices are continuing. At heart to this decline is the ongoing depression of the housing market based on the discounting of homes sold as REO or otherwise from distress (short sales). This ties to the analysis by the National Association of Realtors (NAR) stating that up to 40 percent of existing-home sales in  March were REO and short sale properties. This is up from 39 percent in February and 35 percent in March 2010. This increase in the share of sales in the market is causing the median home price to continue to drop. NAR tags the discount of a distress home at about 20 percent.

This follows NAR’s chief economist, Lawrence Yun’s statement in April that “existing-home sales have risen in six of the past eight months, so we’re clearly on a recovery path." "With rising jobs and excellent affordability conditions, we project moderate improvements into 2012, but not every month will show a gain – primarily because some buyers are finding it too difficult to obtain a mortgage.

An interesting note is NAR’s finding that investors accounted for 21 percent of first quarter transactions, up from 18 percent a year ago. When balanced with the fact that first time home buyer percentage slipped 10 percent to 32 percent, the economics of the price slide take over. In its press release on April 20, the NAR also stated that the share of all-cash purchases rose to 35 percent in March, having grown from 33 percent in February and 27 percent in March 2010. So, it looks like investors are starting to get back in deeper as prices continue to slide.

What does that mean to the securitizations. Well, less money is still less money. So, securitization investors will continue to take the hair cuts on cashflow as sale prices for these properties continue to slide. Add to this the costs that servicers will now pass through as foreclosure practices are changed following the Consent Orders and soon to be decided Attorneys General actions, and the “flow” will start looking like a trickle.

On the upside, at least for servicers if investor appetite continues to grow, is the speed at which trusts can sell the REO property or get the short sale done. This should help the servicers recover their advances and costs faster. Given that carry costs on funds expended usually cannot be charged to the securitization trust, any increase in the speed for the return of capital helps the servicer. Whether or not this “velocity to sale” balances the expected slow-down in the foreclosure process due to the implementation of new policies and procedures, however, is yet to be seen.

Another benefit to servicers is through the continued depression of sale prices for these distressed sales. As sale prices continue to slide, servicers will then have more statistical ammunition when it comes to the determination of “non-recoverability”. Or stated another way, less money on the sale means less money being advanced prior to foreclosure.  

So, like those reality TV shows about people buying abandoned storage units, keen eyed (or just plain lucky) buyers can find gems. The storage company gets a least some of it money back. We just try not to think about the family that lost its stuff. That doesn’t make good TV.

THE PERSON WHO WOULDN’T BE KING – REPUBLICANS TO SHOOT DOWN ANY CFPB APPOINTEES

In classic “Hill” style, 44 Republican Senators issued their writ to President Obama, stating that changes to the director position of the Consumer Financial Protection Bureau (CFPB) need to be made before they will confirm any nominee for the position. At the heart of the Republicans’ position is the establishment of a board, rather than the appointment of an individual, to preside over the CFPB. In what may be the most powerful regulatory body to have been established in the past century, Congress is looking to make sure that power is not centered in the hands of a single individual.

The CFPB was established under the new Dodd-Frank Act to regulate any person or business that provides “a financial product or service”. This bureau would then have ultimate regulatory, supervisory, investigative and enforcement powers over the entire financial products industry, including the decimated mortgage industry. And the director of this bureau would have ultimate power over pretty much the entire financial landscape, including Wall Street.

Adding to the requirement that the CFPB be ruled by a board of directors and not a single individual, Republicans are also pushing for the bureau to be subject to the appropriations process. Rather than submitting financial reports twice a year to justify its prior year’s budget, the Senators want to see the CFPB be subject to the same purse string issues as the SEC. Regrettably, we have seen how that has played out in the past. 

So, Senate Republicans are looking to do a little horse trading for board positions. Add to this the requirement that the CFPB be kept on a tight leash for money. It looks like opening day for the CFPB may be delayed from its July 21 start date. Let’s hope it is not a complete failure to launch . . . or worse.  

“IT’S NOT SOMETHING THAT’S TOTALLY UNEXPECTED” – MOODY’S DOWNGRADES BofA SERVICING

In the continuing question of why anyone would want to manage the servicing of mortgage loans in this day and age, Moody’s took the step they had initially warned about in October of last year by downgrading the servicing rating of Bank of America on its prime, subprime and second lien mortgage loans as well as for its special servicer rating.
 

The rating, referred to as SQ or Servicer Quality ratings, has a high score of SQ1 and a bottom of SQ5. BofA’s servicer rating had been at the high category of SQ1. The recent downgrade puts BofA at SQ2. Moody’s SQ review covers at least nine areas of servicing functions, including management, staff experience/training/compensation, loan administration, arrears management, loss mitigation, IT systems/reporting, general quality and guidelines and financial stability. The weighting of these factors depends on whether the rating is for the Servicer as primary, special or master servicer. In the case of BofA, it was as primary servicer.

 

And BofA is not out of the woods yet. Moody’s has stated that BofA remains under review for further downgrade due to their foreclosure process.  Given the complete disarray of the loss mitigation systems, as well as claims that the staff of the servicing shops are overwhelmed and inadequately trained, it is not surprising that BofA expected this downgrade.

                                               

However, as one of the largest servicing portfolios with 13.3 million loans under management (excluding REOs), this little speed bump will not slow down the massive servicing structure. With new management recently put into place, as well as compliance with the recent Consent Order signed by BofA with the OCC and the Federal Reserve, things may start looking up for the servicing group. Whether or not they can make money at this side of the business is another question.  The trick is cost containment while the portfolio continues to be stressed by delinquencies, short sales, foreclosures and  aggressive plaintiff litigants who want homes for free. Infrastructure building, with clear policies and procedures, training and auditing is the only way to clear this up.

               

AND THE PAIN KEEPS ON COMING – WELLS and JPMORGAN REDUCE VALUE OF MSRs

In another acknowledgement that servicing residential mortgage loans isn’t all that it is cracked up to be, Wells Fargo announced that it is reducing the value of its mortgage servicing rights (MSRs) by $214 million in the first quarter based upon higher projected costs for loss-mitigation and foreclosure. Following the Consent Order that the major servicers, including Wells, signed last week with their federal regulator (either the OCC or the OTS together with the Federal Reserve) JPMorgan also acknowledgement that the cost of the Consent Order it signed will haircut its MSR valuation by $1.2 billion in the first quarter. Interestingly, Citigroup announced at the beginning of this week that the Consent Order it signed with the OCC will only cost the bank between $25 million and $30 million annually. Maybe they got a better deal?

Whatever the costs associated with the new regulatory requirements to be instituted, it is clear that there aren’t going to be blue skies ahead for the servicers. Beyond the Consent Orders, there is still the brewing of the 50 (now 49, since Oklahoma broke from the pack) Attorneys General action against the servicers, as well as the FDIC’s new insurance/risk balancing act. Defaults are not slowing down,  REO assets are stockpiling, and the governments newest attempt to move REO inventory by allowing IRA moneys to be used to purchase foreclosure homes is not a very strong solution to the problem. And as the pack leader, Goldman’s announcement that it is looking to sell its mortgage servicing company, Litton Loan Servicing, indicates that there isn’t any meat left on this bone.

So, what is a servicer to do? Well, back in the day, the servicer was part of the origination platform. Because of that, the economics of the servicing were different, since the originator would then retain the residual pieces of the deal. With “gain-on-sale” and the use of “creative accounting” on the prepayment assumptions, servicing looked like a winner, since money out of one pocket (the servicer)  came back into the other pocket (at least for accounting purposes) on the residual certificate. Once the connection between origination and servicing was broken, and residuals were sold into NIM structures, the plight of the servicer was sealed. Now, it is a matter of marginalizing costs, meaning the cheaper the better. This is why HAMP didn’t work (modifications are really just re-underwriting the loan, which has a significant cost) and why there is a need to foreclose (cost containment and reimbursement of advances).

The entire industry has to be reworked, as well as re-adjusting the fees paid to make it economically feasible for servicers to manage the cash-flow from a less “squeezed” position. But, unfortunately, the servicers are operating under agreements (the Pooling and Servicing Agreement) that never contemplated this level of stress. And investors will never allow the servicers to change the terms, for it will only be a detriment to the investors. So, the deals are going to have to run out before the servicing shops will be able to find some relief. That, or servicers  will have to “game” the system (robo-signing, “rocket-docket” and the like) to maintain profitability.

So, let the games begin (or continue). But now it appears that the referees are at least trying to keep the playing field level (until, like Washington and state regulators have done in the past, elections are over, people get bored/tired with hearing about the problems  and certain men with certain bags of money appear and the rules get forgotten).

THE COST OF DOING (SERVICING) BUSINESS – LITTON ON THE ROPES

From a report today in HousingWire, Goldman Sachs acknowledged a $220M expense in the first quarter of 2011 relating mostly to its operations of its mortgage servicing arm, Litton Loan Services. Such a huge wallop to earnings means that the attempt by Goldman to manage cash-flow of securitization structures through the servicing of the loans has not played out as well as expected. Remember, Goldman got into servicing back in 2007 when it purchased Litton from C-BASS.

In the game of servicing, it is all about cost containment. Generally, servicers are allowed to make 25bps on each loan it services for the securitization trust, where a majority of the loans are actually owned. From this fee, servicers are expected to send statements, follow-up on lagging payments and manage the loss mitigation (modifications, short sales, deed-in-lieu, etc.), foreclosure and subsequent REO acquisition and sale. In certain situations, that fee can be extending to include up to 50 bps for “special servicing.”  But in either case, the ability to make money in the servicing game is solely based upon keeping the costs associated with these services to the securitization trust at a minimum. This is why the servicing shops ran into the problem with robo-signing, sewer service and pushing for the “rocket-docket” in Florida.

Now, the servicing shops are facing new, costly, regulatory compliance requirements. The OCC and OTS, with the backing of the Federal Reserve, have gotten the major mortgage servicers to executed Consent Orders this past week, requiring that they clean up their foreclosure practices. This will add another layer of cost to an already thinly stretched bottom line to servicers.  Fortunately for Goldman and Litton, they were not part of this regulatory round-up. However, there is still the 50 state Attorneys General action that has still yet to be flushed out, which will probably cover Litton’s practices.

Add to this the ever looming requirement that servicers advance delinquent payments of interest and principal to securitization investors and you can see why Goldman is looking to pull its chute and bail from the mortgage servicing business.

What is interesting to see is the players expressing interest in the Litton servicing portfolio. Ocwen Financial, which recently just digested HomEq Servicing, has expressed interest. Homeq was originally the servicing platform for The Money Store and started its independent life following the acquisition of The Money Store by First Union/Wachoiva. Wachovia subsequently sold HomEq to Barclays, which then sold it to Ocwen. The other player presumably expressing interest in the platform or its servicing rights is Carrington Mortgage Services, which is made up of mostly ex-Fremont Investment & Loan servicing employees, especially in senior management.

So, with Goldman looking to say “adieu” to residential mortgage servicing, clearly it is time to rethink what  is the benefit to collecting payments in an industry overwhelmed with problems. Because, as the preeminent negotiators on Wall Street, Goldman always does what is best for Goldman. All that otherwise can be said is  “Caveat Emptor”!

AND THE FEDERAL GOVERNMENT STEPS UP TO THE PLATE WITH THE BIG BAT FOR SERVICERS

The Office of Comptroller of the Currency and the Federal Reserve got the largest of residential mortgage servicer to sign “Stipulation and Consent to Issuance of a Consent Order” today, forcing the servicers to take a look at their prior practices that allowed for robo-signing and improper foreclosure practices and to make changes to those processes in pretty quick order.

Of those servicers hit with the Order include Bank of America, JPMorgan Chase, Wells Fargo, Citigroup, Ally Financial, HSBC North America Holdings, PNC Financial Services, U.S. Bancorp, MetLife  and SunTrust Banks.

The Order appears to basically address the “robo-signing” issues that have plagued the servicing industry since last year. Claims by the OCC were that the servicers:

·         Filed affidavits in state and federal court in which the affiant represented that the assertions in the affidavit were made based on personal knowledge or based on a review by the affiant of the relevant books and records, when, in many cases, they were not based on such personal knowledge or review of the relevant books and records ;

·         Filed numerous affidavits or other mortgage-related documents that were not properly notarized, specifically that were not signed or affirmed in the presence of a notary;

·         Litigated foreclosure and bankruptcy proceedings and initiated non-judicial foreclosure proceedings without always ensuring that the promissory note and mortgage document were properly endorsed or assigned and, if necessary, in the possession of the appropriate party at the appropriate time;

·         Failed to devote sufficient financial, staffing and managerial resources to ensure proper administration of its foreclosure processes;

·         Failed to devote to its foreclosure processes adequate oversight, internal controls, policies, and procedures, compliance risk management, internal audit, third party management, and training; and

·         Failed sufficiently to oversee outside counsel and other third-party providers handling foreclosure-related services.

In light of these findings, servicers are now being required to:

·         Develop Oversight Committees within 5 days to monitor and coordinate compliance with the Order;

·         Provide the Board of Directors of the Servicer with a Compliance Tracking Report within 90 days (and every 30 days thereafter), showing the progress in complying with the Order, for which the Board will then, within 10 days, have to enter such report and their findings into the corporate records.

·         Build appropriate Compliance Programs within 60 days to ensure that all servicing and foreclosure actions company with all applicable legal requirements. This Compliance Program will then need to be implemented within 120 days.

·         Provide the Regional Director of the OCC within 60 days

o   an acceptable plan (the “Action Plan”) to achieve full compliance with the Order.

§  to include effective mortgage servicing, foreclosure and loss mitigation actions, as well as associated risk management, compliance, quality control, audit, training and staffing.

o   policies and procedures for outsourcing foreclosure and related functions, with implementation with 120 days;

o   a plan to ensure appropriate controls and oversight with respect to MERS and its rules;

o   a management information system for foreclosure and loss mitigation;

o   an acceptable plan, along with a timeline, for ensuring effective coordination of communications with borrowers, both oral and written, related to Loss Mitigation or loan modification and foreclosure activities;

·         Provide within 45 days for an OCC approved independent consultant to conduct reviews of foreclosure actions

o   The OCC shall review the terms and methodology to be used by the independent consultant.  

What does all this mean? Well, in the first place, the cost to service loans will now become much more expensive, as these policies and procedures will require significant more man-hours. Anytime you build more policies and procedures with specific reporting requirements, costs go up. At 25 bps, servicers are going to be squeezed, at least in the short term, until efficiencies can be found to comply with these new requirements. This will be similar to the implementation for SOX, except that the servicers have limited revenue generation, which is now going to be scrutinized by the government.

Secondly, this can turn out to be another boon-doggle for the plaintiffs’ bar, like the first round of MERS litigation. Until the courts get their heads around what is going on, slick plaintiff’s attorneys will use these new requirements to forestall the foreclosure of their delinquent borrower clients even more. Which also mean higher costs to servicers and slower repayment of servicing advances as servicers are dragged into slower foreclosures.

Lastly, investors will be left waiting for their money even longer, if they get any at all, as the time to foreclosure and resell the home, as well as the cost of foreclosure (which may now include the policies and procedure costs), will be passed along into the securitization trusts. More government intervention always means less money to the investor.

So, while there was clearly a need to fix the broken foreclosure process following the over-greased skids that were in place, the OCC’s efforts to right the ship may have sent the boat over the other way. Let us hope that if that is the case, like in the last “Pirates of the Caribbean” movie, turning the ship upside-down actually gets us out of this “Davy Jones’ locker” of mortgage servicing. But then again, that was Hollywood and Disney.

THE HARDEST HIT FUND – TAXPAYER CASH FOR PRINCIPAL WRITE-DOWNS

In its efforts to stop the proverbial plane from nose-diving into the ocean, the Obama administration back in February of last year put forth the Hardest Hit Fund (“HHF”), a $1.5 billion taxpayer backed initiative to allow state housing authorities to come up with “innovative measures” to help homeowners in the most hardest hit states. First in line were California, Florida, Arizona, Michigan and Nevada.

 Now it appears that Wells Fargo is looking to help out Arizona underwater homeowners by using some of the HHF money to provide for principal reductions. In an announcement that it is in talks with the Arizona Department of Housing to join a program of principal reduction, Wells Fargo now joins the ranks of Bank of America in providing principal reductions to delinquent homeowners in Arizona.

This is good news for investors! Simply put, if it is structured in a way that allows the HHF money to off-set the principal reduction, the investor is made whole for the write-down. HOWEVER, if the servicer looks to capture some of that money for expenses and deferred costs, the investors will be getting less than their full reimbursement. It is up to the state housing authorities to hold the line for investors, and not the servicers.



At stake as well is the reimbursement for advances that the servicers most probably will attempt to recoup from the HHF moneys. Now, while the servicers should be entitled to any reimbursement of advances that are specifically tied to principal advances, it is questionable if reimbursement of interest advances should be permitted. The counter-argument, however, is that any interest advances not reimbursed would then most likely be added to principal (either as a straight addition or as a deferred balloon payment) and would then constitute principal as well. Either way, the servicer would be left out in the cold for a while as it attempts to get back its advances.

 So, as the property values in Arizona remain as stagnant as the hot summer air in the desert, let’s hope that this program provides a bit of cooling to the burn that homeowners have been suffering. And although this may be more of a spray of water than a jump into a pool, for those of us that have been in Scottsdale in August know, even the mist makes a difference when you are otherwise baking in that Arizona sun.