Mortgage Security Holder Stands-Up – Could Cost BofA $80 Billion

Posted on December 2nd, 2008 in Daily Mortgage/Housing News - The Real Story, Mr Mortgage's Personal Opinions/Research

Just a few months after the Attorneys General of 15 states threw hundreds of thousands of  Countrywide/Bank of America mortgagees under the bus with a piddly $8.4 billion settlement, someone is striking back. And Greenwich has the size, background and relationships to actually get somewhere.

In all of the recent events surrounding bailouts and loan modifications, one very prominent party in this whole mess has been missing – the mortgage security (MBS) holders. Not any longer. With $7 trillion in securitized mortgages out there, this could be the very first of a major story unfolding over the next year. One in which the MBS holders finally stand up and banks, investment banks and mortgage lenders become ultimately responsible for the loans that they made and eat their own trash. Securitization contracts differ, but you would be surprised how many carried full recourse if the underlying structure on a loan was changed. A loan modification in many cases can qualify as a buyback event.

Securitization massively expanded home ownership in recent years by allowing investors to price the risk of less credit-worthy borrowers. But investors in some of the prime securities are angry about having to foot the bill for reworking the most risky mortgages. The chief risk manager for a mortgage investment company, who spoke on condition of anonymity, said that BofA isn’t paying for the modifications out of its own pocket, but “out of the bondholders’ money. That’s pretty egregious.

The legality of that structure—and the impact of any changes on bondholders—weren’t the top priorities of the attorneys general of California, Illinois, and at least five other states that last summer filed lawsuits accusing Countrywide of violating laws against predatory lending. Their complaints allege that Countrywide engaged in many deceptive sales practices, charged unlawful fees and interest rates, and made mortgage loans that Countrywide had no reasonable basis to think the borrowers could afford. All of that, the states claimed, was in violation of predatory lending laws.

Bank of America/Countrywide Slap on the Hand

The AG’s say their $8.4 billion ‘victory’ will help some 400k homeowners. When you do the math, the measly $21k per homeowner is barely enough to cover a few months back payments, penalties, modification fees and unpaid property taxes.  How the AG’s could settle for something this small claiming ‘victory’ is beyond me.  In CA where much of this ‘relief’ will go, the median home price is down from $484k in the summer of 2007 to $278k today. That is a lot of negative equity of which none was factored into this settlement.

I have been waiting for backlash over this Bank of America hand slap from either a mortgagee rights or securities owners group with all of the talk by the banks, regulators and lawmakers of a full court mortgage modification press and here it is.  This is the first of what could be many. Remember, 80%+ of all mortgage loans originated during the ‘fake years’ were sold and securitized making it very difficult for a bank, servicer or even the FDIC to modify the loan.

Wide-Scale Mortgage Modification Efforts Impotent

As of now wide-scale mortgage modification efforts are more talk than reality because of the securitization challenges, borrowers ability to qualify, prohibitive present house values and borrowers willingness to stay leveraged to a massively depreciating asset vs. renting. American Banker recently put out a story highlighting that this issue. Other reports show that the after-modification recidivism rate is well over 50%.  This is a lose/lose for MBS holders.

“For the most part, public discussion of modifications has focused on the ability and willingness of servicers and investors to make them. For several reasons, including the still undeveloped track record for modifications, less attention has been paid to the outcomes of those that have gotten done.

A handful of analysts and academics who have studied which types of loan modifications work have found that some of the most common changes — reducing or freezing the interest rate and allowing missed payments to be rolled into the balance — often fail to prevent the borrower from defaulting again. “

I have been one of the most outspoken mortgage modification supporters for over a year, but ONLY if done right. The problem is that none announced to date are structured properly with most relying on low teaser rates, 40-year terms or deferred interest and high debt-to-income ratios, which are the very things that got us here in the first place.

I am in firm belief that the only successful mortgage modification is one where the loan is re-underwritten / restructured using a market-rate 30-year fixed mortgage at 28/36% debt-to-income ratios.  To get there, a principal balance reduction will likely be necessary in most cases. But the process will allow home-owners to operate at leverage ratios that greatly reduce the chances of walking away due to negative-equity permanently solving the problem. Please see my most recent report on mortgage modifications:

Bank of America / Countrywide Could Pay $80 BILLION!

Greenwich Financial Services, a very large fund that has been a leader in the mortgage securitization arena is raising a stink – don’t they deserve a bailout too?  Why should the banks get bailed out from all of their bad decisions over the past decade and the mortgage securities holders that never signed up for buying a bunch of bad loans, get left holding the bag? They may not if Greenwich is successful.

In the proposed class action, or group lawsuit, the Greenwich, Connecticut-based fund demands a declaration that “Countrywide must purchase at par every mortgage loan that it sold to any of the 374 securitization trusts,” David Grais, a lawyer for the fund said today in an e-mailed statement. Grais said Countrywide could owe $80 billion to the trusts.

Countrywide plans not to absorb the $8.4 billion reduction in mortgage payments itself, even though it was Countrywide’s own conduct of which the attorneys general complained,” the fund said in the complaint filed today in New York State Supreme Court in Manhattan. Under the settlement, the mortgage lender would “pass most or all of that reduction on to the trusts that purchased mortgage loans from Countrywide,” the fund said in the complaint.

“We believe that the average unpaid principal balance of these loans is approximately $200,000. If so, and if the court grants the declaration we seek in this complaint, then Countrywide (and its parent Bank of America) would be liable to pay the trusts approximately $80 billion for the loans it modifies,” he said.

MBS Holders Have Been Left in the Lurch

The mortgage securities holders being left to fend for themselves over the past year and a half of the mortgage implosion is one of the reasons that the private label sector has never come back. If left going the way it presently is, the mortgage finance and housing sectors may stay depressed indefinitely.

While those loan adjustments may help to keep struggling borrowers in their homes today, Frey says those alterations run the risk of permanently damaging the secondary market for housing finance.

“I am an advocate for investors’ contractual rights,” says Frey, 50, in an interview. He has publicly argued since March that loan modifications (BusinessWeek, 11/26/08) are against contract law, and has threatened to sue banks—despite, he says, receiving pressure to back down from Washington. “Investors’ voices have been muted in this debate because they speak of an inconvenient truth: Current solutions sacrifice the long-term viability of this nation’s housing finance system for short-term political gain. No matter how noble the intent, it is not in the interest of the United States now, or in the future, to tell its citizens and the world at large that U.S. contract rights may be bent with the political winds.”

MBS Litigation Floodgates

If Greenwich has even reasonable success it will open the litigation floodgates. The end result could look like something that I have been noodling for a couple of years…that in the end the bank, investment bank, lender etc eats their own trash.

Frey says a more reasonable, albeit unpopular, solution would be for the government—that is, taxpayers—to ante up another $500 billion to buy all of the troubled loans from mortgage-backed securities pools in order to keep the public market for financing mortgages viable. (There have been roughly $7 trillion in mortgages financed by global public markets since 2002, according to ThomsonReuters. Of course, not all of those loans are troubled.)

While he’s so far the only member of the proposed class against the Charlotte (N.C.)-based BofA, Frey says he’s on a crusade on behalf of all large investors who bought Triple A-rated mortgage bonds, and not just those who bought bonds backed by Countrywide mortgages. The suit alleges that modifications favor bondholders who bought the riskiest pieces. Normally those investors should suffer losses first, but that’s not what’s happening in the current wave of workouts, according to the suit.

Stay tuned because this story is only getting started. -Best Mr Mortgage

Source: Business Week -Investor Sues to Block Mortgage Modifications

Source: Bloomberg – Countrywide Sued by Fund Over $8.4 Billion Loan Deal

More Mr Mortgage

18 Responses to “Mortgage Security Holder Stands-Up – Could Cost BofA $80 Billion”

  1. Question:

    Based on your modification proposal to lower borrowers’ debt ratios to 28/36, how will you prevent these same individuals from going out and buying a new SUV, taking an expensive vacations, etc. with the freed up cash flow from the modifications? I surmise that these people will shortly be back at unsustainable debts levels and looking for another taxpayer bailout.

  2. I wish these guys well! They are not against the modifications. They just want the responsible party to pay for them. I don’t think they’ll get away scot-free — they probably will have to bear some of the pain but I’m OK with that since they also bear some of the blame because, from what I’ve read, they were knowing and willing partners in some of the fraud.

  3. Hi Craig – no credit available. It is perfect time for this. Borrowers have gone into save mode no doubt. A year ago you may have been correct but I think the combination of the two make it less of a threat.

  4. Mr. Mortgage,

    If you believe that mortgage modifications via principle reductions are the only way out, an opinion I don’t share, who do you believe should and ultimately will bear the cost of those modifications. As Frey noted…

    “While those loan adjustments may help to keep struggling borrowers in their homes today, Frey says those alterations run the risk of permanently damaging the secondary market for housing finance.”

    ,making the investors pay could backfire. Who will lend to the American housing market if they know their contracts can be torn up when the going gets tough? Also, do you have any numbers as to how much mortgage forgiveness would be required in total to fix this for good. I would imagine we are talking big big numbers here and that determining how much and to whom is a very complex matter. The situation is so fluid it will be very difficult determine the right balance as the economy and incomes are in a huge state of flux.

  5. MM:

    The sh!t is starting to roll down the hill, no? After the initial ‘Shock & Awe’ of it all (the past year or so), now we get to the fun part – the details… In other words, time to lawyer-up, here comes the finger-pointing.

    - ‘Look, it’s them that caused this mess…’

    - ‘Well, you and your irresponsible lending habits caused it…’

    - ‘Well, didn’t you read your mortgage contract before you signed it…?’

    - ‘G-damned Wall-Street greed caused it…’

    - ‘Haliburton!!!…’

    Tell you this much, frugality will rule this holiday season, but I ain’t scrimpin’ on the booze…

    Peace -

    C.C.

  6. The suit alleges that modifications favor bondholders who bought the riskiest pieces. Normally those investors should suffer losses first, but that’s not what’s happening in the current wave of workouts, according to the suit.

    Once Again, until the powers (i believe morons and crooks) realize that until you face the realization that the HOMEOWNERS who are paying their mortgages and the Bondholders who hold the LEAST risky, are part of any modification solution, the whole ponzi scheme cannot be fixed, because those will become your NEW PROBLEM in 2009-10

  7. Loan servicers will eventually wake up. They were better off getting the bankruptcy laws changed that allowed judges to modify loans. Most Pooling and Servicing agreements protect servicers from orders by court directly to the loan to modify.

    I would expect that this type of litigation will be the next big frontier of litigation. These security holders are going to force buy backs at 100 cents on the dollar.

    This is why we are not getting loan modifications at any real serious level, the risk of litigation is quite high between the servicers and holders of the securities. Damn is this going to be a fun several years.

  8. There is little incentive for lenders to give principal reductions to borrowers. This is as it should be.

    If the loan is not in distress, the lender shouldn’t even think about proactively modifying the loan.

    If the borrower is in default, the lender should foreclose and sell the house at the best possible price as required by their contracts with the MBS holders.

    Principal reduction is effectively equivalent to foreclosing on the home and then allowing the homeowner to repurchase the home at the market price (sweet!).

    But there is a big problem with this from the standpoint of the MBS holders. The borrower has proven to be a poor credit risk (by defaulting). Recidivism is high in such cases and must be factored into the “risk premium” attributed to the borrower. Unless the borrower is willing to accept a reduction to level that is substantially HIGHER than the market price (to account for the risk of a second default), the MBS holders are better served by foreclosing and getting the best possible price from the open market. This is true even when accounting for the additional costs associated with the foreclosure (legal fees, agent fees, etc).

    To summerize: principal reduction only makes sense when the balance is set at level that is significantly higher than the market price plus foreclosure associated fees. And of course that poisons the deal for the borrowers. Not enough candy!

    In the end, the only “solution” to the problem is the one that is unfolding:

    1. Prices drop. Much wailing and gnashing of teeth ensues.
    2. Foreclosures happen. More lamentations. Trillions of dollars of phoney wealth evaporates.
    3. Prices continue dropping until houses become good deals again (i.e., price/rent ratios revert to long term averages).
    4. Buyers return to the market. Sales volume increases.
    5. Prices start to rise again.
    6. Homeowners, with the historical perspective of houseflies, start bragging about their investment genius again.
    7. Lather. Rinse. Repeat.

  9. savetheflippers… I dont necessarily disagree with you. Industry is claiming that they are going to “help” homeowners and modify their loans. If the alternative is not to, that should be accepted by society as a fact. Foreclosures will spin out of control and the loss to those investors will extremely high. Fact is, they want their cake and eat it too. They dont want foreclosures and they dont want to lose money. A homeowner has no incentive to stay in a home that they owe 100k more than it is worth… so security holders have no incentive to assist them. The difference between these two? The loss is borne by the investors in the securities and the homeowner merely takes a ding in his credit for a few years that will recover. I think that the investor will lose less money by working with the homeowner than foreclosing. But, if the message is no help… consumers walk… the hit is only for a few years and credit is so tight anyway you will most likely not even notice it.

  10. STF,

    You argue against modifications in your above post by saying:

    “Principal reduction is effectively equivalent to foreclosing on the home and then allowing the homeowner to repurchase the home at the market price (sweet!).”

    Your comment equating a principal reduction to a distressed homeowner essentially short selling their house to themselves is accurate. But if the lender is going to lose less via this process than foreclosure (which they almost certainly would), why foreclose? It seems like a foreclosure in this case would be like the lender cutting of their nose to spite their face. I don’t get your reasoning. Some say modifications are not fair to everyone unless everyone gets one, but what does fairness have to do with it? People buy identical new cars at the same dealership on the same day from the same salesman and get them for different prices. Is this fair? Not really, but it is a natural result of a negotiation in which both parties are trying to get their own best deals. This just happens to be a very unique time in our history where the homeowner actually has some negotiating power with the lender. Whether they got this power by being financially irresponsible or not is irrelavent.

    “…the MBS holders are better served by foreclosing and getting the best possible price from the open market. This is true even when accounting for the additional costs associated with the foreclosure (legal fees, agent fees, etc).”

    How is this possibly true? Even if the homeowner only makes one payment after a modification it would be a better deal for the investors. The market price will not change much in one month. The costs associated with the foreclosure will not change much if at all. Perhaps if the modification reset the clock in regards to missed payments (ie. the homeowner would now have to miss several payments again in order to restart the foreclosure process) this would not be the most cost effective option for the investor. But I highly doubt that a modification which reduced the principal to “fair market value” would be defaulted on in the near future. I believe that most people who are interested in and pursuing a modification are actually wanting to stay in their home long term.

    I really don’t think any of this matters though, in the end the lawyers will get all of the money and everyone will take it in the shorts. John Grisham will certainly have a book based on it, Law and Order will do an episode on it, maybe Jack Bauer will even chase down Angelo Mozilo next season. Either way, it will be legal armageddon. Good luck to us all…

  11. Partyboy:

    Imagine you’re the guy in charge of loss mitigation. Your job is to recover the max number of pennies for every dollar of the loan. If you think this way, then it all becomes easy:

    Borrower stressed but not in default? Great, let them keep paying as long as they can. Maybe they’ll stay current.

    Borrower in default due to events that could reasonably be cured in the near future (job loss, etc) but otherwise a good risk? Offer some short term forbearance.

    Borrower in default, underwater, and swirling down the toilet? Take the estimated amount you will recover from foreclosure (say fair market value less 10%) and weigh that against what you think the borrower could handle in a workout with principal writedown, FACTORING IN THE LIKELYHOOD OF RECIDIVISM. If you think you can get more through foreclosure, then foreclose.

    You say:

    “Even if the homeowner only makes one payment after a modification it would be a better deal for the investors”

    But that is simply not true. After you’ve gone through the expense of the loan workout and written up the new loan, if the borrower defaults again after making only one payment then you’ve been stiffed again. You lose. Back in line for the 90 day foreclosure moritorium, etc, etc, etc.

    A bird in hand is better than two on the line. Especially when the line is proven credit risk.

  12. [...] Excellent Article by Mr. Mortgage: Mortgage Security Holder Stands up to Bofa [...]

  13. MLE:

    “I think that the investor will lose less money by working with the homeowner than foreclosing”

    In some cases that is certainly true. And it those cases, it makes sense for the lender to do the workout.

    But in many cases it is not true. Often the homeowner can’t afford the loan even if the principal is written down to, say, fair market value less 10 percent. It such cases the lender should foreclosure. But even if the homeowner could make the payments on FMV-10%, why would the lender take the risk of them defaulting again when they could get FMV-10% through foreclosure? It only makes sense @ FMV or even FMV+5%. I, as an investor, would want that premium to compensate for the risk I’m taking (that the homeowner would default again). And the problem with doing the writedown to, say, FMV+5% is that the borrower is FAR more likely to default again if they remain underwater. Thus the risk premium needs to be even higher!
    Maybe a variation of a Keynesian beauty contest? http://en.wikipedia.org/wiki/Keynesian_beauty_contest

    Of course all bets are off when the Government makes it public policy to never allow a bank to fail (Lehman notwithstanding). Who the hell knows what will happen?

  14. [...] This stuff is catnip for bloggers like Oxdown Gazette, Loan Sharks, StockMarket-Implode, and Mr. Mortgage. [...]

  15. STF,

    I will have to agree with you that making one payment would not make the process worthwhile. That was an overstatement on my part.

    I do think that your FMV – 10% is a bit optimistic though. Anyone who is behind in their payments is very likely not making property tax payments either. These are attached to the property and not the homeowner so this is an additional cost to the bank. Many walkers are trashing the homes on the way out the door as well. Add in the cost of marketing and realtor commisions and I think you are well over 10% in foreclosure costs.

    That being said, the recidivism factor is a tough one to quantify. You can look at someone who is in default and assume that they are a bad credit risk but I don’t necessarily agree. If I was $25k in CC debt and underwater in my home, I would consider the option of stopping mortgage payments and taking that money to pay down the CC debt. Perhaps I can then get the missed mortgage payments put on the back of the mortgage and continue my life debt free (except for the house). IF not, I rent for a few years…debt free. That doesn’t necessarily make me a bad credit risk, just someone who is making decisions which will help my long term financial situation. Does this thought process lead to a higher chance of recidivism? Perhaps, but I think that it is a more direct result of allowing homeowners to buy with no skin in the game. That will always lead to a higher chance of default as their home becomes an investment bought purely on margin with virtually no financial risk.

    In response to what I would do if in charge of a loss mitigation dept…I think that I would offer a stepped principal reduction over the course of the loan combined with a fixed rate and possible rate reduction. For example, if I was willing to lower the principal by $60k on a 30-year fixed, at the end of each year of payments I would reduce the principal by $5k. This would last 12 years and would speed up the process of reaching the “break even” point for the owner, give him additional incentive to perform on the loan, and would allow me to write down my losses over the course of 12 years instead of in one year. Just an idea…

  16. Partyboy:

    I think if workouts were such a cost saver, banks would be all over them. As it is, they only seem to consider the idea when heavily incentivized. Those incentives are coming fast and furious, both as carrots (Hope for Homeowners, TARP patricipation, etc) and sticks (Jerry Brown Countrywide settlement, Barney Frank threats, etc.)

    Left to their own devices, banks would act rationally and try to recover the max they can on behalf of their investors. If they don’t, they get sued by the investors.

    I do think that banks need to get better at efficiently foreclosing and liquidating REOs. They will, I’m sure.

  17. The whole world is relying on timely payments. If they didn’t know it then they know it now, that their investment package relied on property values rising. Apparently, the Treasury will guarantee some foreign investments (GSEs and associated) but the originators and first few tiers of investors before the leverage continued outside the Country will get stuck holding the bag.

    So normally, when you talk about who should take the loss, it’s whomever took the risk, enter fraud, greed and deception all with leverage and everyone is broke except those the Treasury decides to pacify (foreigners and maybe bank CEOs). Taxpayers foot any payouts.

    Lawsuits will begin to expose the true numbers involved in all the connected investments, this is why Washington is begging that the suits not be filed.

    Homeowner losing his home seems mild in comparison.

  18. [...] This stuff is catnip for bloggers like Oxdown Gazette, Loan Sharks, StockMarket-Implode, and Mr. Mortgage. [...]

Leave a Reply

XHTML: You can use these tags: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>