Compass Point To Hold Call Addressing Mortgage Repurchase Risks

Posted on August 26, 2010 by Isaac Gradman

Compass Point Research & Trading, a registered broker/dealer and one of the leading financial research firms investigating Alt-A and subprime mortgage backed securities (MBS), will be hosting a conference call to discuss mortgage repurchase risks.  The call will be held on Tuesday, August 31, 2010 at 1:00 P.M. Eastern and will be open to the public by using the following call-in number: 1-866-812-6491.  Jason Stewart, the Managing Director of Compass Point, will moderate the call and I have been invited to be the featured guest.  The plan is to have some prepared remarks, and then open up the floor to questions.   I would welcome the participation of any of my readers.

Compass Point issued a report on August 17, 2010 that did a great job of attempting to quantify the potential liability that banks are facing from private-label mortgage repurchase obligations.  The report cites to the Subprime Shakeout and discusses the potential impact of the FHLB lawsuits (prior articles here and here), the investor syndicate, the FHFA subpoenas, the mortgage insurance lawsuits against Countrywide in New York State Court, the Greenwich Financial lawsuit against Countrywide, and the recent involvement of the New York Fed in enforcing repurchase obligations.  The report recognizes that the real issue is access to loan files and that the investor syndicate may have amassed enough voting rights to compel servicers to turn these files over in a large number of trusts.  In short, Compass Point seems to have a firm understanding of the key issues and developments with respect to mortgage repurchase liability.

What’s the bottom line?  While Compass Point’s report provides best and worst case scenarios, it also takes a position as to the ultimate liability that the largest banks will face in connection with their origination of subprime and Alt-A mortgages during the 2005-2007 timeframe.  While these loss estimates may be conservative (they assume investors will only attempt to put back roughly 50% of loans, whereas from my experience, this number could be more like 75-80%), they are nonetheless significant: liability for Alt-A and subprime originations combined is estimated at $35.2 billion for Bank of America (based on the acquisition of Countrywide and Merrill Lynch) and $23.9 billion for JP Morgan (based on the acquisition of Bear Stearns).  The report goes on to note that there are serious questions over whether banks have adequately reserved for these losses, echoing the letter sent to JP Morgan this year by the SEC.

I am very much looking forward to this call on Tuesday, and hope that many of you will join.

Posted in BofA, Compass Point, Federal Home Loan Banks, Federal Reserve, FHFA, JPMorgan, liabilities, loan files, loss estimates, private label MBS, repurchase, research, reserve reporting | 4 Comments

New York Fed Throws Weight Behind Mortgage Buy Backs

Posted on August 5, 2010 by Isaac Gradman

As reported in Bloomberg, the Federal Bank of New York has announced that it is involved in “multiple efforts” to exercise its rights with respect to its holdings in faulty mortgages an other assets acquired through the bailouts of Bear Stearns and AIG.  The Fed holds nearly $70 billion in assets such as mortgage backed securities and collateralized debt obligations that were placed in holding companies established during the rescue of Bear and AIG in 2008.  BlackRock, which has led the charge among investors to force banks to absorb losses, is purportedly advising the Fed on its rights with respect to its holdings.  The Fed joins Fannie Mae and Freddie Mac among the federal regulators that have recently turned their attention to putting back defective loans to the banks that originated them, which in the Fed’s case includes Countrywide/BofA, Goldman Sachs, UBS and defunct lender New Century Financial.

Just last month, the Federal Housing Finance Agency, which oversees Freddie and Fannie, issued 64 subpoenas to loan servicers and securitization trustees seeking loan files underlying the securities bought by the GSEs. The GSEs reportedly held nearly $255 billion of mortgage related securities as of the end of May 2010.

As discussed in prior posts, loan originators generally sold loans into securitizations with extensive representations and warranties regarding underwriting methodology and compliance with strict guidelines designed to ensure the loan value and the borrower’s ability to pay were supported.  Where loan files underlying the mortgages in securitization reveal that those guidelines or underwriting methodologies were not followed, lenders have contractual obligations to repurchase the loans or substitute the loans with comparable performing mortgages. According to the Bloomberg article, violations of these reps and warranties cost the Big Four U.S. lenders about $5 billion last year, but that number is expected to skyrocket as more regulators and private investors jump on the put-back bandwagon.  These prospective losses have attracted the attention of the SEC, which issued a demand to JP Morgan in January for more disclosure on its repurchase liabilities.

Indeed, the holdings of the New York Fed and the GSEs in mortgage related securities constitute only a fraction of the $1.5 trillion private label bond market, and just over half of the pool represented by the Investor Syndicate, first introduced here and here.  The Syndicate fired its first warning shot across the bows of securitization trustees and servicers last month, and is expected to begin identifying specific breaches and enforcing its rights to documents and repurchases this month.  Various estimates from loan auditors have placed the percentage of deficient loans in 2005 to 2007 vintage private label securitizations anywhere from 40 to 90 percent (MBIA alleges in its complaint against Countrywide and BofA in Los Angeles County Court that it found deficiencies in 91% of the loans it reviewed in a particular sample).  If you do the math, that’s a massive amount of potential liability for the surviving subprime-era lenders.

The recent flurry of activity by federal regulators provides perfect political cover for the Syndicate and should grease the wheels of document production and lender cooperation.  It’s one thing to resist the efforts of a private consortium representing over one-third of the private label bond market.   It’s another to refuse compliance with the federal government.

In short, the concerted resistance to turning over loan files and servicing loans in accordance with bondholder wishes displayed by banks over the last year should begin to erode as banks realize that they can stall no longer.  Investors have clear rights to the documents underlying their investments, and to mortgage buy-backs where those documents reveal loan quality was deficient.  The problem up to now has been enforcing those rights.

Because the inherent strategy of a mortgage securitization was to spread out mortgage risk among a large pool of investors, no one private investor had the authority (or the incentive) to take action against the banks and force repurchases.  Generally, at least 25% of the asset class is required to petition the Trustee, and 50% is required to have a credible threat of firing the Trustee if it does not respond to entreaties for action.  Moreover, any benefit of a mortgage put-back would be dispersed among the entire pool of securities, or even several pools of securities, so the benefit to any one investor would be diffuse and freerider problems would abound.

Now that investors have organized, and have sufficient numbers and the proper incentives to take action, and now that federal regulators have joined the fray, I see the banks changing their strategy from one of postponing and delaying losses, to one of trying to resolve their repurchase liabilities through settlement.  Whether that’s a global settlement or a number of individual deals remains to be seen, but what is certain is that the major banks face a slew of lawsuits and a hefty repurchase tab if they don’t acknowledge their repurchase risk and take a seat at the negotiating table.

Posted in AIG, Bear Stearns, BlackRock, CDOs, Fannie Mae, Federal Reserve, Freddie Mac, freeriders, global settlement, incentives, Investor Syndicate, loan files, MBS, rep and warranty, repurchase, SEC | 1 Comment

Investor Syndicate Fires Warning Shot Across Trustee Bows

Posted on July 24, 2010 by Isaac Gradman

As first reported by Reuters on Wednesday, and as further detailed by Bloomberg today, the Investor Syndicate has finally begun to emerge from the shadows and give securitization trustees a hint at what’s coming.  According to Talcott Franklin, the Dallas attorney who is spearheading the Syndicate, the group sent letters to some of the major trustees of mortgage-backed securitizations, detailing the holdings of the group and urging trustees to help them enforce servicing breaches and pursue buybacks of improperly-originated loans.  The letters have not yet been made available, as the group appears to be continuing to closely guard the identity of the investors involved.

Franklin would only say that the members of the Syndicate are investors representing over $500 billion in mortgage-backed securities (MBS) holdings, which would account for over one-third of the $1.5 trillion private-label MBS market.  Franklin was formerly with the lobbying group of the Washington, D.C.-based law firm, Patton Boggs, that was involved in bondholders’ lobbying efforts over the Servicer Safe Harbor, but reportedly left the firm this year to head up the Investor Syndicate.

As discussed in prior posts (here and here), the Syndicate’s initial goal was to amass enough representation in a material number of securitizations to meet the 25% or 50% ownership thresholds imposed by the trust agreements, thereby acquiring the right to petition the trustees of those deals to take action.  From Franklin’s statements, it appears that this first step has been accomplished, as he has represented that the Syndicate owns bonds giving them 25% of “voting rights” in over 2,300 deals, 50% in more than 900 deals, and 66% of the bonds in more than 450 deals.

Assuming this is true, the letters sent on behalf of the Syndicate this week should be viewed as merely an opening salvo.  It is only a matter of time before the Syndicate begins issuing communications to trustees identifying specific instances of servicer misconduct or defects in the underwriting with respect to particular loans.  These instances of misconduct, also known as “defaults,” will change the responsibilities and incentives of the parties dramatically.  Once trustees are made aware of specific defaults by bondholders owning the requisite percentage of voting rights, the trustees become essentially fiduciaries of the bondholders, and acquire obligations to take steps to remedy those defaults.  Should they fail to do so, they may be fired or sued.

To those invested in the Big Four banks, which originated and now service huge percentages of the loans underlying these private-label securities, this next step will be the equivalent of yelling “fire” in a crowded movie theater.  Up to now, banks have been able to drag their collective feet in recognizing losses associated with the profligate lending practices of 2005-2007.  When banks originated mortgages and sold them into securitizations, they made representations and warranties regarding the quality of the underwriting and the guidelines they followed.  Should the Investor Syndicate be able to acquire the servicing and loan files associated with these mortgages and find breaches in those reps and warranties (as Freddie and Fannie are trying to do now through their subpoena powers), banks will be inundated with repurchase requests.  And as the media and government officials have only recently begun to recognize, banks have consistently under-reserved for the losses they will likely face from investor buyback obligations.

Further, in their role as servicers, these same banks have been slow to foreclose on hopelessly delinquent borrowers, as they were rife with conflicts of interest based on their second lien holdings.  Servicers have instead been content to rack up late fees while investors remained unorganized and the normally passive securitization trustees had no incentive to act.  Without active trustee enforcement of servicing obligations, the banks have also been able to modify loans as they pleased, irrespective of whether such workouts were in the best interests of bondholders, because trustees would not enforce servicer obligations to obtain the approval of the investors (see articles on the Greenwich Financial lawsuit against Countrywide for more background on this issue).  However, once trustees are compelled to go after these servicing breaches (or are fired and replaced by friendly trustees if they don’t), the banks will be liable for additional losses caused by their failure to service loans in accordance with bondholder wishes.

All this is to say that the financial landscape will change drastically in the coming month as the Investor Syndicate moves forward with its plans.  To drop a shameless Counting Crows reference, the MBS world may look very different in “August and Everything After.”

Posted in fiduciary duties, firing servicers, Investor Syndicate, irresponsible lending, private label MBS, repurchase, reserve reporting, securitization, servicer defaults, Servicer Safe Harbor, Trustees | 13 Comments

Loan File Issue Brought to Forefront By FHFA Subpoena

Posted on July 14, 2010 by Isaac Gradman

The battle being waged by bondholders over access to the loan files underlying their investments was brought into the national spotlight earlier this week, when the Federal Housing Finance Agency (FHFA), the regulator in charge of overseeing Fannie Mae and Freddie Mac, issued 64 subpoenas seeking documents related to the mortgage-backed securities (MBS) in which Freddie and Fannie had invested.  The FHFA has been in charge of overseeing Freddie and Fannie since they were placed into conservatorship in 2008.

Freddie and Fannie are two of the largest investors in privately issued bonds–those secured by subprime and Alt-A loans that were often originated by the mortgage arms of Wall St. firms and then packaged and sold by those same firms to investors–and held nearly $255 billion of these securities as of the end of May.  The FHFA said Monday that it is seeking to determine whether issuers of these so-called “private label” MBS misled Freddie and Fannie into making the investments, which have performed abysmally so far, and are expected to result in another $46 billion in unrealized losses to the Government Sponsored Entities (GSE).

Though the FHFA has not disclosed the targets of its subpoenas, the top issuers of private label MBS include familiar names such as Countrywide and Merrill Lynch (now part of BofA), Bear Stearns and Washington Mutual (now part of JP Morgan Chase), Deutsche Bank and Morgan Stanley.  David Reilly of the Wall Street Journal has written an article urging banks to come forward and disclose whether they have received subpoenas from the FHFA, but I’m not holding my breath.

The FHFA issued a press release on Monday regarding the subpoenas (available here).  The statement I found most interesting in the release discusses that, before and after conservatorship, the GSEs had been attempting to acquire loan files to assess their rights and determine whether there were misrepresentations and/or breaches of representations and warranties by the issuers of the private label MBS, but that, “difficulty in obtaining the loan documents has presented a challenge to the [GSEs’] efforts.  FHFA has therefore issued these subpoenas for various loan files and transaction documents pertaining to loans securing the [private label MBS] to trustees and servicers controlling or holding that documentation.”

The FHFA’s Acting Director, Edward DeMarco, is then quoted as saying ““FHFA is taking this action consistent with our responsibilities as Conservator of each Enterprise.  By obtaining these documents we can assess whether contractual violations or other breaches have taken place leading to losses for the Enterprises and thus taxpayers. If so, we will then make decisions regarding appropriate actions.”  Sounds like these subpoenas are just the precursor to additional legal action.

The fact that servicers and trustees have been stonewalling even these powerful agencies on loan files should come as no surprise based on the legal battles private investors have had to wage thus far to force banks to produce these documents.  And yet, I’m still amazed by the bald intransigence displayed by these financial institutions.  After all, they generally have clear contractual obligations requiring them to give investors access to the files (which describe the very assets backing the securities), not to mention the implicit discovery rights these private institutions would have should the dispute wind up in court, as it has in MBIA v. Countrywide and scores of other investor suits.

At this point, it should be clear to everyone–servicers and investors alike–that the loan files will have to be produced eventually, so the only purpose I can fathom for the banks’ obduracy is delay.  The loan files should, as I’ve said in the past, reveal the depths of mortgage originator depravity, demonstrating convincingly that the loans never should have been issued in the first place.  This, in turn, will force banks to immediately reserve for potential losses associated with buying back these defective mortgages.  Perhaps banks are hoping that they can ward off this inevitability long enough to spread their losses out over several years, thereby weathering the storm caused (in part) by their irresponsible lending practices.  But certainly the FHFA’s announcement will make that more difficult, as the FHFA’s inherent authority to subpoena these documents (stemming from the Housing and Economic Recovery Act of 2008) should compel disclosure without the need for litigation, and potentially provide sufficient evidence of repurchase obligations to compel the banks to reserve right away.  For more on this issue, see the fascinating recent guest post by Manal Mehta on The Subprime Shakeout regarding the SEC’s investigation into banks’ processes for allocating loss reserves.

Meanwhile, the investor lawsuits continue to rain down on banks, with suits by the Charles Schwab Corp. against Merrill Lynch and UBS, by the Oregon Public Employee Retirement Fund against Countrywide, and by Cambridge Place Investment Management against Goldman Sachs, Citigroup and dozens of other banks and brokerages being announced this week.  If the congealing investor syndicate was looking for political cover before staging a full frontal attack on banks, this should provide ample protection. Much more to follow on these and other developments in the coming days…

Posted in Alt-A, Countrywide, Fannie Mae, FHFA, Freddie Mac, Investor Syndicate, irresponsible lending, loan files, MBIA, private label MBS, repurchase, reserve reporting, subpoenas, subprime, Wall St. | 1 Comment

When Fed Bailed Out A.I.G., Banks Were Given Immunity

Posted on June 30, 2010 by Isaac Gradman

The story just keeps getting worse as more details about Credit Default Swaps (CDS) emerge daily.  CDS were essentially side bets on the performance of other mortgage derivatives, such as mortgage backed securities (MBS) and collateralized debt obligations (CDO).

From Michael Lewis’ The Big Short and other commentary, it was already well documented that A.I.G. was the counterparty on much of the CDS issued by Wall St., being one of the few large companies willing to take the long side of the bet on mortgage default risk.  Those selling mortgage default risk to A.I.G. had several risks to consider: 1) that mortgages would perform better than expected, 2) that mortgages would underperform but the counterparty on the trades (e.g., A.I.G.) would become insolvent and not be able to make good on the trades, and 3) that the counterparty would sue the bank issuing the CDS or underlying mortgage securities for fraud and misrepresentation in the creation of the instruments.

Up to now, Lewis and others, including the New York Times, had focused primarily on the second risk above in pointing out that the Fed’s bailout of A.I.G. had the primary effect of ensuring the solvency of the trading partner of big banks, so that they could collect on their bets against the mortgage market.  However, there is now a spotlight on the third risk above, after the House Committee on Oversight and Government Reform released 250,000 pages of largely undisclosed documents showing that A.I.G. was forced to agree to waive its rights to sue several banks – including Goldman Sachs, Societe Generale, Deutsche Bank and Merrill Lynch – over irregularities in the mortgage securities it insured.  This fact is only made more appalling by the fact that many of the primary decisionmakers at the New York Fed (which oversees A.I.G. and presided over the bailout) were alumni of the banks that would benefit from this forfeiture, and some even still held stock in those financial institutions.

Sources indicate that this waiver prevents A.I.G. from suing to recover claims it paid on $62 billion worth of mortgage securities that it insured.

For more information, read the article published yesterday in the New York Times, entitled “In U.S. Bailout of A.I.G., Forgiveness for Big Banks.” It pretty much says it all, and if you are not shocked and outraged by what you read, you may want to have your pulse checked.

[Thanks to Manal Mehta for being the first to bring this story to my attention – IMG]
Posted in bailout, Uncategorized | Leave a comment