Investors Putting Bad Loans Back To Lenders – This Is Only The Beginning.

Posted on May 28th, 2008 in Mr Mortgage's Personal Opinions/Research

A phenomenon not yet discussed in any great degree is the forced buybacks of defaulted loans by the original lender or investor due to early payment defaults, fraud and lender ‘negligence’. I have written about this many times and today the Wall Street Journal had a wonderful story out entitled ‘Investors Press Lenders on bad Loans’ from Ruth Simon and Jams R. Haggerty on page C-1 confirming this. Below is my summary. 
In the past, it was industry standard for a lender to ‘rep and warrant’ loans they sold to a particular investor for up to six months against default, commonly known as an ‘early payment default’ (EPD). Loans that defaulted at the first payment, known as ‘first payment defaults’ (FPD), and have always been a buyback. However, over the past couple of years, many mortgage investors/purchasers have pushed their lender clients into longer ‘EPD’ provisions, with many running up to a year. This, of course, significantly increases the percentage of defaulted loans for which the original lender/investor is liable. 
The auditing of defaulted loans looking for fraud or lender negligence is escalating at a feverish pace. This is being spearheaded in many cases by the mortgage and bond insurers, but even Fannie, Freddie, banks and the investment banks are picking up the pace. At this point in time considering the damage that has been done to the bond and mortgage insurers, they have nothing and everything to lose. Perhaps soon they will release detailed reports on the amount of fraud and negligence on the defaulted prime, ALT-A, subprime and home equity loans that they insure. When this news breaks it will shock the world. Everything thinks they have a handle on how pervasive outright fraud was. But nobody has a handle on ‘white-lie’ fraud and broader negligence, such as increasing income and/or asset levels on stated income/asset loans and making investor guideline exceptions on large percentages of their loans.

If any sign of fraud is found on a defaulted loan, in most cases the originating or selling lender/investor is liable. If the originating entity is no longer in business, as is the case with most middle market mortgage bankers and brokers, then the original ‘investor’ or loan purchaser carries the burden in many cases. Most likely, these are your big named banks and Wall Street banks. A few examples are Lehman’s Aurora Loan Services for Alt-A loans, Merrill’s First Franklin for subprime, Wells Fargo for non-conventional Jumbo intermediate-term ARM’s and Chase for Home Equity Lines/Loans.
Recent research reports have found that on limited documentation loans, income was inaccurate to the high-side in 90% of the cases studied.A recent report by the NY Fed showed that 83.2% of the ALT-A universe in CA and 73.1% nationally was limited income documentation. The same report found that limited documentation subprime loans accounted for 47.5% of the CA and 33.8% of the national universe. Home equity lines/loans were mostly limited documentation, including limited appraisal requirements. Pay option ARM limited doc numbers are tougher to find but being in the industry for years, my guess is that they mirror the ALT-A stats fairly closely.
Along with fraud, defaulted loans are being audited for ‘lender negligence’, which in most cases means that the loan underwriter did not follow the investor guidelines. Lender negligence is very vague and could mean that the loan underwriter missed something, were too liberal in the way they calculated income on tax returns, missed debt on a credit report, calculated income incorrectly, did not review the appraisal thoroughly enough or a variety of other things along these lines that are common when underwriting a mortgage loan.
Another type of lender negligence may lie in the lender granting ‘exceptions’. Exceptions are just what they sound like…an exception to the investor underwriting guidelines. Early on, ‘exceptions’ were a more formal deal that may have required manager or investor approval. But, in later years most underwriters made exceptions unilaterally. Many of these were based upon ‘compensating factors’ in the file such as higher than usual cash reserves or a lower than usual loan-to-value, both of which are considered to be strong points. However, exceptions were also made regularly based upon pressure from a client, broker, loan officer and even production manager.

The following story does a great job summarizing lender malpractice even at the investor level. The writer adds, “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.”

Ultimately, I believe that outright fraud, ‘white-lie’ fraud and lender negligence will be major deciding factors in the ownership of loans and the accompanying losses. Especially fraud and negligence surrounding income and assets used on limited documentation loan applications. An example of a practice that could lead to a fraud or negligent buyback decision was when the borrower left the income and asset portion of their hand-written loan application blank at the request of the loan officer. For years it was industry standard for the borrower not to include income and asset calculations because a) borrowers are terrible at calculating income and assets b) if they put an income/asset level on the application that was too low for the investors debt-to-income requirements a new hand-written application would have to be taken c) a large percentage of loan application were done over the phone or internet d) income and assets were the last item calculated because on limited documentation loans, the income and assets used were a function of what was needed to fit the guidelines of that particular investor. 

The Journal story cites a lawsuit filed in Dec in LA Superior Court where units of the mortgage insurer, PMI Group, alleged that WMC Mortgage Corp breached it’s ‘reps and warrants’on a pool of subprime loans insured by PMI in 2007. Within eight months, the delinquency rate was at 30%. The suit also alleges that a detailed audit of 120 loans that PMI asked WMC to repurchase found evidence of ‘fraud, errors and misrepresentations’.
In my opinion, this story is only getting started and is where many of those currently taking this hit on defaulted loans will turn in placing blame for their losses. They would be stupid not to. -Best, Mr Mortgage


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Mr Mortgage Exposes the ALT-A Disaster Yet to Come

24 Responses to “Investors Putting Bad Loans Back To Lenders – This Is Only The Beginning.”

  1. Certainly this is exactly how stated income loans were originated, with the income line item the last to be filled in. It happened everywhere. My feeling is that this is the product of a bigger and more important issue, which is abuse of the income tax code by accountants and accounting firms, especially with regard to the self-employed. As an originator, quite a few of the ficticious tax returns I have seen in past years have been appalling, especially when I look at the percentages I have been shelling out to federal and the state of California tax collectors. Restauraunt owners and even well known Hollywood actor/producer/director-types showing woefully low income numbers on their federal and state returns. Why even go to work for $40k a year in West LA? Yet there they are. There has been a lot of shady stuff going on in the mortgge biz to be sure, just pointing out that it might be a product of an even larger issue…the fleecing of out national treasury as a by-product of poorly written and all too seldom enforced income tax laws. Keep up the good work.

  2. good thoughts Dave…to an even simpler degree, what about a CPA letter to verify self-emp status. That was quite common and fraudulent in many cases. Heck, what about rental agreements for that matter. haha.

  3. […] Read the rest of this great post here […]

  4. […] Original post here […]

  5. I certainly hope they continue all the way down the line to include Bankers, Brokers and Loan Officers that commited the offenses. Although they will probabaly never recoup anything, it would at least be nice if the fraudulent cuplrits could be tagged and booted out of the industry.

    This, of course, would require registration and background checks for ALL BANKERS, BROKERS and LO’s. Bunch of cluprits in this mess, and, from what I can tell, some of the biggest offenders are unscathed and continuing business as usual.

  6. MM85 – most are not in business anymore on the mortgage banking and brokerage side but on the bank side, they are. The bad retail loan officers at banks were no better than bad brokers.

  7. Please fix RSS feed

  8. I have heard many stories of bogus CPA letters from processers and other LO’s. Plenty of the “Office Depot” basic rental agreements as well. 2 years ago underwriters would fast track these files. The problem now is that they won’t touch anything , even when the letters, tax returns, and rental agreements are legit. Interesting news about Castle Point yesterday…I had a processer tell me a few years back that that type of crap was happening at Ameriquest. She told me they went so far as to have phony phone banks set up to verify phony employment. Not surprising that the lenders and investors have zero faith in any brokers these days. I am all for some serious changes and serious regulation in the mortgage business…I just feel that a lot could be solved by changes to the tax code. I have to bite my tongue a lot with clients that have been cheating the government for years. On the one hand, they are clients, and how I earn a living. On the other hand, when I see my own return and that my wife (who is w2) and I pay in about $80k a year plus $13k in property taxes annually on about $250k in income, it annoys the hell out of me to see returns of people with far bigger incomes and 3 million dollar mortgages that show $60k in gross adjusted income on their tax returns. The rental agreements are awesome, too. Schedule C’s that show losses, paired with $3k a month rental agreements.

  9. Ofcourse underwriters granted exceptions on loans. There wasn’t enough time to submit exception requests with all the volume. No doubt a high volume/low margin business is perfect environment for fraud.

    Now all of the fraud has simply moved to the GSE’s and FHA since they’re they only game in town. So instead of bogus stated income, we’re dealing with bogus tax returns. Oh Joy!

  10. I practice the thought “would I put my family in that loan” I keep it honest I sleep at night, however with all that is gone & going on with the blame game. I’m thinking its not worth being in the business anymore. This business is causing paranoia all the really good honest, ethical people will leave the business because it just isn’t worth the headaches. No one in any business can do a good job if the are paranoid it is very paralyzing you question every thing you do..

    Lender/broker/banker that push their sales people to meet goals are ridicules. that’s all they can think of.. Lender/broker/bankers that want the sales people with large producing volume history are not doing themselves justice isn’t it far more important to have quality than quality building a business on a positive reputation will eventually pay off with very high rewards..Treat all your employees as business partner rather than your grunts.

    Just my opinion

  11. […] Investors Put BadLoansBack to Lenders – This Is Only the Beginning. […]

  12. If PMI Group was dumb enough to insure WMC’s loans, they deserve the haircut (amputation) they got. WMC funded some of the riskiest loans…truly “sub-sub-sub-prime” loans. Stated Income + 640 FICO = $675,000 with NO MONEY DOWN, or 580 FICO + Full Doc. = $750,000 with NO MONEY DOWN. Furthermore, you could use deposits from 24 bank statements to qualify as Full Doc. Is it any wonder that these loans defaulted?


  13. […] Investors Put BadLoansBack to Lenders – This Is Only the Beginning. […]

  14. […] Investors Put BadLoansBack to Lenders – This Is Only the Beginning. […]

  15. Let me see if I understand this:

    The story says that on limited documentation loans “income was inaccurate to the high-side in 90% of the cases studied.”

    Borrowers generally paid a premium price for limited documentation loans instead of full doc.

    If a borrower could document income, why would they pay a premium for limited doc?

    The obvious question is: Why did 10% of the borrowers pay a premium for limited documentation when they could have had a cheaper loan by simply providing pay stubs, W-2s, or tax returns?

    Why would anyone be surprised that income was overstated on these loans? It seems that the people writing the guidelines were simply saying that for a pricing premium they would allow the borrower to overstate the income. In fact, that’s exactly how the loans were presented by AEs to brokers. The big lie is that the people writing the loan guidelines, buying the loans, and insuring the loans didn’t know what was going on.

  16. Who really knows what is going on ? Clowns. Clowns and clowns. You are soo lucky in the USA to have all those stupid and really dumb foreigners in love with your country. Don’t forget it.

    Your country will be saved by those stupid and dumb Russianss, Chineese, Japaneese, Libaneese, and ah yes those stupid Canadians anamoured with pieces of corporate american garbage.

    So AIG needs much much more money ? Good! Who else ?
    Go and get the stupid jerks from Libya and Singapore. Nothing better than a stupid sucker from Saudi Arabia or Kazahkstan. The choice of foreign suckers is infinite.

  17. Thanks, Mr. M. I went to FL for memorial weekend, still a lot of people traveling. However, I did feel the pinch when I saw the gas price is over $3.90 all over the States. Best.

  18. Everybody needs to quit gasping for air at these numbers. Everybody from the broker on the street to the ultimate owner of the loans was a part of what happened. Even FNMA and FHLMC had stated loans and they all benefited.

    Now the light is turned on for what it really is and they all act indignant, how could these scum bags have done this? I was doing loans, with holes in my shoes back before the stated loan was invented. Think of that, before stated loans came into being?

    Well, let me tell you that if you sat down and invented a loan product and called it stated you could figure out the entire problem.

    Everybody just needs a big bag of “shut the hell up” and take their medicine!

  19. The blame NEVER seems to get pushed up high enough.

    After 9/11, the economy was at stall speed at best.
    So the Fed cut rates to stimulate spending. Which, given incomes that weren’t growing, meant it wanted to stimulate borrowing. The Fed didn’t know precisely WHERE the cheap, borrowed money would go, but AG certainly advocated the use of ARM-based home loans. So this was planned to a large degree, at the highest levels.

    Most of the folks who signed on to this fraud, had essentially received explicit or implicit encouragement to do so. That doesn’t exonerate anyone of course.

    But lets put the ultimate blame where it belongs, at the hands of the Soviet monetary planners that override the functioning of the most important market in our economy. The Fed created the boom, just as they more recently created the oil and foodstuffs pricing ‘booms.’ They will point OVER THERE and say oh my, “look at that inflation.” That’s awful, and we now be vigilantly keeping that under close watch .. maybe even do something about it! But it was the Fed (and their overseas pals) that CREATED these problems in the first place. Just like the housing boom .. & bust.

    Lets get to the ROOT of the problem. Indeed, the Fed is the root of many other major economic problems this country faces today, as they ENABLE our Federal government to borrow recklessly, affording Congress the ability to spend like drunken sailors.

    If this country is to recover, we need to get to the ultimate root of its problems. Not trying here to dismiss ANY of the concerns noted above, but to take the scrutiny to its logical limits.


  20. Forget about those “white lies” about income. I have been seeing a large number of buy backs request for loans origingated 2 – 4 years ago due to I have been seeing a large number of buy back request for borrowers that opened numerous mortgages at the time the loan for my company was originated. These other mortgages were never diclosed to us and in many cases there were not even additional inquiries on the credit report. But once they start going belly up, all these loans become buy backs to the lender due to non-disclosure of these additional mortgages. Even when the new mortgages are all opened after 1st one was closed. The majority of these loans were full doc loans verifying all income and assets. But the borrowers went over board with buying properties and once 1 goes bad the house of cards come tumbling down. Then all the lenders get the buy back requests.

  21. Trying to eliminate economic cycles creates exactly the contrary effect. It creates the opposite. The dynamic is always the same. To stop the bust each time, you need more and more and more credit and more and more bubbles. The next step is hyperinflation.

  22. […] MR Mortgage – Investors Putting Bad Loans Back To Lenders – This Is Only The Beginning.- […]

  23. I started almost a year ago doing contract review work for Fannie Mae appraisals. Not as concerned about values as they were to the technical approaches, and factual data contained in the reports. In fact, about 80% of the appraisals were just fine re a supported value. However, there were many factual data errors. My understanding is that almost all of these loans were performing, but were deemed high risk. Most were approaching the one or two year mark when the reps and warrants from the originator would expire or be reduced. The entire loan package was being audited. Those that did not meet guidelines were being sent back to the lender even before a possible default. I have to wonder how many of these loans are held on the originator’s books (mostly banks).

  24. Hello,

    I would like to do a loan modification thru Aurora Loan Servicing, but I do not know if they go off of the gross income or the net income. I need help with this. I would like to get my modificaiton approved. I currently in a 30-year interest only program.

    Please help

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