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.

B OF A CLAIMS INVESTORS LIMIT SERVICERS ABILITIES

In a statement released ahead of their official testimony before the Senate Banking Committee, Bank of America claimed that the bank is “constrained” in its role as a servicer. “Many investors limit Bank of America’s discretion to take certain actions” stated Barbara Desoer, President of Bank of America Home Loan. Bank of America “aim[s] to achieve an outcome that meets customer and investor interests, consistent with whatever contractual obligations we have to the investor,” Desoer said.

So, it appears that at least B of A, with its indigestion of Countrywide’s servicing portfolio, is claiming to be hog-tied by the Pooling and Servicing Agreements. What is interesting is that this was never a problem in the past. It is only now that there is this avalanche of bad loans that the issue of risk management and loss mitigation has now become a problem because of investors.

If you look at the standard language of a Pooling and Servicing Agreement, however, you can see that the servicer has fairly wide latitude in servicing a loan and working loss mitigation techniques. First and foremost is the REMIC provision that allows a servicer to modify either the rate or the term of the loan if the loan is in default “or in imminent danger of default” without jeopardizing the REMIC tax status. Next, Pooling Agreements usually have language to the effect that servicers are to service and administer the loans in accordance with “customary and usual standards of practice of prudent mortgage loan servicers.” Counter-balancing this provision is the subsequent provision in the Pooling and Servicing Agreements that state that servicers “shall not take any action that is inconsistent with or prejudices the interests of . . . the [Investor] in any Mortgage Loan . . .”

As far as foreclosing on a property, the Pooling and Servicing Agreements usually contain boiler-plate language similar to the following:

The Servicer shall use reasonable efforts to foreclose upon or otherwise comparably convert the ownership of properties securing such of the Mortgage Loans as come into and continue in default and as to which no satisfactory arrangements can be made for collection of delinquent payments. In connection with such foreclosure or other conversion, the Servicer shall follow such practices and procedures as it shall deem necessary or advisable and as shall be normal and usual in its general mortgage servicing activities; provided, however, that the Servicer shall not be required to expend its own funds in connection with any foreclosure or towards the restoration of any property unless it shall determine (i) that such restoration and/or foreclosure will increase the proceeds of liquidation of the Mortgage Loan after reimbursement to itself of such expenses and (ii) that such expenses will be recoverable to it through [such liquidation proceeds]

 Being as clear as mud and as directional as a compass on the North Pole, there are various other provisions in the Pooling and Servicing Agreements specific to that transaction or related to the specific servicer for that trust. But, generally speaking, the servicing provisions are usually pretty broad as to servicing functions, with any negotiated benefit going to the servicer, since investors were not part of the negotiations. So, how is a servicer constrained? Maybe it is whether or not such servicer needs to advance on a delinquent loan and wait for reimbursement for such advance? Depending on which tranche the investor is holding, it may or may not be a benefit to take a certain loss mitigation position. It all depends on where the investor is in the waterfall and realized loss allocation.

Well, I guess the servicer has to blame someone for the failure of the HAMP, HAFA and HARP. And clearly, the Investor has the most to gain on the sale of foreclosed properties at 40 to 50 cents on the dollar (after reimbursement for expenses and the like). At least at the end of “The Italian Job”, the ‘good bad guys’ got the ‘bad bad guy”. Its just getting harder to tell who are the good bad guys and the bad bad guys these days.

THE BOND INSURERS WEIGH IN ON REPURCHASES

From a September 13 Bloomberg article by Hugh Son, it appears that the Association of Financial Guaranty Insurers (made up of Ambac, Assured Guaranty and several of the other large insurers) fired a letter off to Bank of America’s Chief Executive Officer Brian T. Moynihan claiming that more than half of the soured home-equity credit lines and residential mortgages created from 2005 through 2007 that insurers examined should be bought back.

Clearly, the insurers feel that they should not be on the hook for these problem mortgages and the payments they have made or will have to make for the failure of the underlying MBS securities which they insured. And even more clearly is their attempt to jump on the bandwagon of “who’s to blame and who is to pay.”

With most of the mortgage companies gone (can’t really go after Ameriquest, New Century, Fremont, etc. . . .etc. . .etc), the only guy in the room with some cash is BofA, having to pay for their stepping into Angelo Mozilo’s shoes at Countrywide. What is interesting is that the repurchase number being thrown around is between $10 and $20 billion, which is only about 2.5% to 5% of Countrywide’s reported production of $400 billion for 2007. It appears that somewhere the numbers don’t seem right.

As was noted in the article, the battle for repurchases is tedious, with the legal fights having to be done literally hand-to-hand (loan by loan basis). To “back of the envelope this, on a $20 billion portfolio of repurchase loans with an average loan balance of say $200,000, we are talking about 100,000 loans. In court, the party demanding repurchase has to show why a specific loan has to be repurchased. It’s not that the loan is in default, but rather that the loan violated a specific representation or warranty set forth in the pooling and servicing agreement, usually at the time of origination of the loan. And each of the 100,000 loans has to be individually shown by the party requesting repurchase to have breached a specific representation. I have seen this in practice at Fremont. It’s as if the repurchase requesting party is trying to storm a castle, one arrow at a time. All BofA has to do is stand at the wall and wait for this war of attrition to fade away.

Generally, there were more than 50 representations and warranties relating to the mortgage loans in the pooling and servicing agreements, of which maybe a dozen or so could be substantive to a repurchase request. Therefore, the man-hours needed to develop the repurchase request for 100,000 loans would be difficult, at best. And who pays for the cost of developing the repurchase request? The pooling and servicing agreements generally provide for servicer and trustee reimbursement of costs, but it is unclear if other third parties would have an ability to recoup costs. That makes enforcement of repurchases somewhat challenging.

So, with BofA being one of the only players left, why not pile it on. “Buck Buck Number 9 coming in”

The Bloomberg article can be seen at http://www.bloomberg.com/news/2010-09-13/bofa-may-owe-20-billion-in-mortgage-buybacks-insurers-say.html.

FHA “QUICKY” REFINANCE PROGRAM STARTS TODAY

September 7, the day after Labor Day this year, and the mortgage market returns from a weekend of hotdogs and back-yard football games to a new “let’s hope this works” program of the FHA.

Back in August, HUD secretary Shaun Donovan talked about the launch of a new "FHA Short Refinance" program. Initially unveiled to the public on August 3 while speaking at the National Association of Real Estate Brokers Conference in Fort Worth, Texas, the plan outlined would provide a new form of refinancing option to underwater homeowners. Eligibility for the new loan would require that the homeowner (i) be underwater but still current on the mortgage and (ii) have a credit score of 500 or better. In addition, once refinanced and insured by the FHA, the new refinanced first lien loan must have a loan-to-value ratio of no more than 97.75% and the borrower’s combined loan-to-value ratio be no more than 115%. Since the new FHA mortgage can only be used to refinance the unpaid principal balance on the first lien, any second lien has to be written down to meet the CLTV requirement.

The biggest hurdle to the program, however, appears to be the requirement that the existing first-lien holder (the securitization trust in most cases) must agree to write down at least 10% of the unpaid principal balance, and it must bring the borrower's combined loan-to-value ratio on that first mortgage to no more than 115%. Servicers will have to look at the “imminent default” provision of the Pooling and Servicing Agreements to allow them to “write down” this principal without fear of investor litigation.

Questions abound as to the practicality of this program. How a borrower that is current, as required by the program, could be deemed to be in imminent default? Since the CLTV requirement is 115%, isn’t it possible that there may be situations that the first lien holder would have to take the 10% write down while the second would not be impacted? What is the value to be used for the LTV and CLTV calculations? Would the new appraisal/value also have to capture any advances that were previously made by the servicer on the loan in order to keep the calculation in balance? How is this write-down deemed allowable in the securitization structure, since it is not technically a “write-down” of the balance of the current loan, but rather a substitution of a new loan with an LTV of 97.75% and probably different terms? Don’t the Pooling and Servicing Agreements limit subsititutions?

The Treasury Department has committed $14 billion in TARP funds for this program. Together with the FHA insurance, these new refinanced loans will have a government guarantee for up to 97.75% of the new home value. It appears at this point, however, that this “quicky” program only applied to non-GSE loans, probably based upon some circular nature if it had. So, not only can the first lien loan to be refinanced not be an FHA loan, it appears that the Treasury has not cleared the GSEs to write-down underwater loans.

According to HUD, it appears that the TARP funds are a way for the servicers of these non-GSE securitization products to support write-downs and write-offs of mortgages and to provide coverage for a share of potential losses on these new loans. Therefore, this program is really a way that the government means to incentivize the servicers to make these refinancings.

So, it looks like we have another “Quick Snap Hail Mary” pass from the quarterbacks in Washington. And while this one looks like it will end up thrown out of bounds, with no receivers in site, it appears that the only “short(s)” in this refinance program are the ones the investors are going to take it in . . .

THE PLAY ON ALT-A SECURITIZATIONS – LET THE GAMES BEGIN (AGAIN)

In an article today in the Wall Street Journal by Prabha Natarajan, it looks like there is a renewed interest and demand for previously issued Alt-A securitization paper. While unclear, it appears these non-agency bonds include the sub-prime variety (there is some distinction between Alt-A and true sub-prime, which appears to have been lost in the recent financial hurricane).

As reported, in was stated by Jesse Litbvak, head of non-agency trading and Jefferies & Co in Stanford, CT (an MBS trading powerhouse?) that these trades are occurring because investors believe that the credit risk of continuing defaults are already priced into the bonds. That, together with the prospect of early redemption, as noted in the article by Matt Toms, head of U.S. public fixed income investment at ING Investment Management, means that the bonds have up-side potential.

Well, as we have seen from our recent past, that is anything but a sure thing. Of significance to this analysis of the value of the bonds is the redemption of the bonds before their maturity date. Currently, due to the refinance boom (or really, bubble), the bonds can be redeemed at their face value due to the early payment of the underlying mortgages. Where in the past, early redemption was something to be avoided (when the investor was paying 105 for the bond), now at the discount of 60-80, a redemption at face would be a good thing. And since in most securitizations, early payments are covered in the cash flow waterfall as a payment to the most senior bonds first, the AAA stand in line to get theirs before the rest.

Right now, with interest rates at historic lows, there has been an increasing portfolio of mortgages being paid off in the refinance market. However, this is still just a limited and decreasing pool of applicants. Beyond the fact that there are only a decreasing percentage of homeowners that will qualify for a refinancing over time, there is also the issue of whether the underlying mortgages are still tied to those ugly prepayment penalties that were the rage in the latter part of the Alt-A and sub-prime boom. And the only way to know that fact is to have loan level detail of the pool. So, while redemptions may be occurring today, do not expect this trend to continue strongly into the future.

The article discusses the fact that the play now is on the AAA bonds off the securitizations – yes those same AAA bonds that now everyone is questioning how the rating agencies reached that rating. More problematic will be the coming tsunami of realized losses on the securitization pools due to short sales and foreclosures that are then liquidated. With the failure of HAMP, HAFA, HALA and all the other programs to stem the tide, foreclosure still seems to be the outcome for a significant number of borrowers. Even Fannie is starting to put pressure on servicers to quicken the pace of foreclosures, as discussed in an article today entitled “Excessively Delaying Fannie Mae Foreclosures Will Now Cost Servicers” by Jacob Gaffney in HousingWire. And once the property is thereafter sold (at a loss to the unpaid principal balance of the loan plus costs and reimbursed advances), these “Realized Losses”, as defined in the securitization trust agreements, could press the losses beyond the mezzanine tranches and into the AAA bonds.

So, while the yields on these bonds may be double that of corporate paper and triple that of Treasurys, it looks like Wall Street is selling investors on stepping up to the tables and laying down money to roll the dice again. Let’s hope we don’t crap out (again).

FANNIE MAE - PUMPING UP THE VOLUME

And the beat goes on. Fannie Mae has reported issuing $42.7 billion in MBS in July, showing an increase of 6.4% from June production. In comparison, Fannie’s kissing cousin, Freddie Mac, is showing a month-to-month decline.


While Fannie does not break out purchases of refinanced loans in its monthly reports, its monthly report shows MBS issuance slowly rising from May, clearly based on the recent surge in refinancing applications. As reported by the Mortgage Bankers Association, by the end of July, refinancing applications hit a 13-month high. Since these applications would then show up in MBS issuances in August and September GSE reports, we can assume that more good news is around the corner as this trend continues for the short term.

And where is this product going? Well, the ice cold grip of the MBS investor may be starting to thaw. MBS, especially those paying higher rates of interest than comparable Treasurys (currently at about 150 basis points over), are being looked at by the MBS investor needing to invest cash and take advantage of the higher yields. Given the cleaner underwriting standards for the underlying product, together with prepayment speeds reportedly being somewhat flat, investors may be willing to put more than a toe in the market pool. And though roughly 25% of all outstanding mortgages are reported to be under water with a national delinquency rate of just under 10%, it appears from industry figures that mortgagors are continuing to pay their loans even though they are under water. This is in spite of the fact that these borrowers may not be able to refinance because they have no equity, or cannot qualify for a modification.

So, it appears that the two porch dogs that people have been liking to kick these days appear to be doing what they are suppose to do. Which is to watch out for the old homestead.

THE SEC's ATTEMPT AT SHOOTING THE MESSENGER

On April 7, the SEC opened up for comment its proposed rules that would fundamentally revise the regulatory regime for asset-backed securities. As stated by Chairman Shapiro in her announcement of the rules, "[t]he proposed rules are intended to better protect investors in the securitization market by giving them more detailed information about pooled assets, more time to make their investment decisions, and the benefits of better alignment of the interests of issuers and investors through a retention or "skin in the game" requirement." Query, wasn't that what Reg AB was suppose to handle, especially for transparency and information. And what ever happened to Static Pool data. Is anyone still filing (I can tell you that Litton isn't on many of its sub-prime deals).


Ms. Shapiro goes on to state that "as we know all too well, securitization . . . played a central role in the financial crisis." That is like trying to blame Enzo Ferrari for your car not starting after you put dog-sh_t in your gas tank. Securitization structures may have facilitated the capitalization of bad mortgage loans, but it was the loans, and not the securitization structure, that was the culprit of the financial meltdown.

So what are the proposals? Well, first on the information side, the SEC proposes requiring ABS issuers to file with the Commission standardized information about the specific loans in the pool at the time that the asset is securitized and on an ongoing basis. Additionally, these issuers would be required to file on the SEC Web site a computer program of the cash flow provisions, or "waterfall" in the securitization structure. And lastly, the SEC want to give investors a 5 day look-see.

Well, I guess the SEC thinks that investors of ABS securities are "Mom and Pop" investors, without the where-with-all to have these technical abilities. And what are the "standardized" information that is not already required in the Prospectus Supplement that will give investors better knowledge of the loan level issues. Maybe an information point should be which loans, and what percentage of the pool, were written outside the underwriting guidelines. You know, the loans that did not meet the nice disclosure contained in the Prospectus Supplement.

Next, the SEC proposes to rid itself of the references to the ABS' credit rating as an eligibility requirement for shelf registration, replacing this instead with four new eligibility criteria: (1) the chief executive officer of the ABS depositor would need to certify that the assets have characteristics that provide a reasonable basis to believe that they will produce cash flows as described in the prospectus (2) the ABS sponsor would be required to retain a five percent "skin in the game" interest; (3) the ABS issuer also would be required to provide a mechanism whereby the investors could confirm that the assets comply with the issuer's representations and warranties; and (4) the ABS issuer would have to agree to file Exchange Act reports with the Commission on an ongoing basis.

Boy, I don't know where to start. So, instead of having an independent agency confirm their position on an ABS offering (I guess the government wants to get the rating agencies out of the business), we have an executive of the issuer certify that the cash flow works. Well, based upon what assumptions? That only 3% of the pool default? That the CPR is a certain %? This would turn out to be a worthless certification based upon assumptions. And don't we already get this somewhat covered in Reg AB and SOX certifications?

So, "skin-in-the -game". But didn't we always have that, in the fact that the originator kepts the residual piece (although NIM pieces changed that). And what 5%. -the top peice or the bottom piece that they could book on their balance sheet at some number based on market-to-market accounting rules as applicable on that day(Ms. Shapiro obviously does not remember the late 1990's securitization melt-down)

Representations and Warranties enforcement. Hum, isn't that the job of the Trustee and Servicer. I can tell you from personal experience that those "dead-head" Trustees are not doing anything to enforce rep and warranty issues. And the Servicers are part of the problem, since they are usually owned by the originator/sponsor of the ABS securities. And how are you going to have investor enforement of the reps and warranties? They would still have to go through the "dead-heads" who would then just turn into "bobble-heads".

Like with Reg AB, the SEC is making the required "Hill Noise" to make it look like they know what they are doing and are here to "protect" the investing public. What it will turn out to be is another failed attempt by bureaucrats pretending to fix a system they do not understand, rather than attacking the players that control the industry.

Moody's Fires A Warning Shot at the Fed.

From the March 15, 2010 article in the New York Times by David Jolly[http://www.nytimes.com/2010/03/16/business/global/16rating.html?hp]  Moody's was reported as saying that "Major Western economies have moved “substantially” closer to losing their top-notch credit ratings, with the United States and Britain under the most pressure . . ." Even better is their comment that “their ‘distance-to-downgrade’ has in all cases substantially diminished.”

For those that can read between the lines, Moody's statement of “Preserving debt affordability (the ratio of interest payments to government revenue) at levels consistent with Aaa ratings will invariably require fiscal adjustments of a magnitude that, in some cases, will test social cohesion” looks like a veiled threat against Congress, given that the Obama administration is looking to increase federal debt to 64% of G.D.P. Looks to me that they are saying we are going to have a significant tax increase to cover federal debt service.

As reported, U.S. debt currently remains affordable, as the debt affordability ratio fell to 8.7 percent in the current year, after peaking at 10 percent two years ago. If that trend were to reverse, which it would based on the desire to increase federal debt, the Moody’s analysts said, “there would at some point be downward pressure on the Aaa rating of the federal government.”

And what exactly is the testing of "social cohesion." Is Moody's worried about the outbreak of anarchy if the U.S. Governmnet raises taxes and cuts more social services (the fiscal adjustments) to cover its debt service to avoid a downgrade? I think they are.

I guess if the government wants to keep their ratings up (and limit the cost of raising more capital in the world market) Congress should not investigate how Moody's (or S&P) concocted AAA ratings for sub-prime mortgage securitization structures where the loans underlying the securities were comprised of such strong products like 2/28 interest only teaser rates, negative amortization and "pick-a-payment" loans. Clearly, Moody's thought that those securities were well worth their AAA rating. I wonder about the debt affordability factor that Moody's used in their analysis of those structures.