August 19, 2008

Mathematically Challenged

Those who have been around this mess for a number of years are used to hearing the same questions from newly-impacted borrowers, and another frequent one is “If the bank is losing so much money on foreclosing, why won’t they let us work something out?”

The fact that the borrower still thinks they’re dealing with a “bank” that made their loan is revealing; in fact, it you were actually dealing with a bank or credit union that retained its own loans they may very well be willing to work something out.

But in the real world of securitization and subprime and alt-A lending, the party who you have to deal with is the servicer, and the servicer is a captive to the pool trustee under something called a “Pooling and Servicing Agreement” (PSA). That PSA dictates the terms and conditions under which a servicer is supposed to manage defaults and foreclosures, and it is all but impossible to find the PSA that allegedly governs a borrowers loan until the name of the trust is uncovered in a lawsuit and the SEC filing for the trust can be found.

Maybe this diagram will help:

Note that the "servicer" can be as many as four separate entities, but a single servicer can perform all four functions - all of which are defined and legally contracted to in the PSA.

Bond investors generally don’t pay a lot of attention to the PSA if it appears to be one of the standard so-called “boilerplate” versions that go into the securities offering. They pay more attention to the ratings of the servicer until something goes wrong and they start looking into how the pool is supposed to be serviced. The servicer can be (and in some cases today is being) sued for not handling the loans they way they’re supposed to be in terms of default management. Most trustees have the right to change servicers if the terms and conditions of the PSA aren’t being met. If they get into the details of some of the more toxic loans, the trustee may even push back against the originating lender and force them to purchase the loan back out of the pool.

Of course, in most subprime loans, PMI (Private Mortgage Insurance) is in place as a "risk enhancement" to improve the pool's marketability, thus the insurer also has an interest in the loan.

As you can see, there are multiple players, all with their own interests to protect and all with their own version of the numbers involved.

If we use the numbers recently provided in testimony before Congress, the average loss in a foreclosure is in the neighborhood of $50,000. We're pretty confident that is wildly exaggerated, but the more exaggerated it is the more it makes our point:

Why are they in such a rush to lose money?

In the formal statement of David G. Kittle, Chairman-Elect of the Mortgage Bankers Association, he rails on and on about the enormous costs of foreclosure and how “MBA members are devoting significant time and resources to finding ways to help borrowers keep their homes.”

Again, why then the rush to lose money by foreclosing?

The only legitimate defense has to be the terms and conditions of the PSA - but that also requires the parties to say they aren't willing to modify it. And if that decision is resulting in $50,000 losses per foreclosure, either that number is simply a myth or these entities are truly mathematically challenged and their stockholders should be asking more questions about who is making business decisions.

We have some suggestions; if the industry really wants to avoid losing $50,000 per foreclosure, they're going to have to start acting as if they really stand to lose that much. Someone trying to avoid a $50,000 loss would not:

(1) Send payments back to borrowers for any reason or put payments into suspense accounts.
(2) Let a modification opportunity wait until the loan was in serious default, thus trashing a borrowers credit score to preclude refinancing.
(3) Add absurd fees and charges for forbearance or reinstatement.
(4) Give borrowers the run-around and not have a single point of contact for an at-risk borrower.
(5) Continue to tack on fees and charges while "processing" the modification.
(6) Refuse to respond to RESPA QWR letters.
(7) Ignore requests from agents and refi lenders for payoffs.
(8) Keep blaming a third (or even fourth) party for the lack of a decision.
(9) Have ill-informed personnel handling something that could result in a loss of $50,000.

Now, if the real losses were much smaller (or in some cases weren't losses at all), a servicer would do all of the above (and more) to ensure the loan went into foreclosure.

It's all about the math.

Craig and Dave

No comments: