National Mortgage Servicing Standards?

Earlier this week, a group of 50 pundits, academics and other “experts” fired off a letter to the Fed, FDIC, SEC and any other Government Agency they could think of to make their case for following through on Dodd-Frank to push through a national standard for first-lien residential mortgage servicing (at least we assume they only meant first-lien residential mortgage servicing because there was no mention of autos, credit cards, commercial real estate, business loans, other personal loans, etc).

Now, we completely understand the foundation for this group taking up the cause at this time but please excuse us if a smidgen of sarcasm seeps into our reactions and comments here.  We “get it” that most folks didn’t know that the word “servicer” even existed before 2 or 3 years ago (they all thought that the bank (many may have believed the actual branch) where they borrowed the money “serviced” their loan).  On that basis, it’s not hard to understand that they have been working hard for the last 2 years cooking up a fix to the US mortgage industry.  Thank goodness that they took the time to write their letter.

As you might be able to tell by now, we fall decidedly on the side of the argument that suggests that everyone should take a timeout and go to their respective corners before we screw this market up even more.

We thought that best way to address the topic might be to provide commentary to several sections in the letter.  In doing so, we have provided a few comments in a few key sections.  While we could have commented in several other places, we don’t feel it’s necessary.  We think we make our points.

So here’s that letter and our comments:

Re: National Standards for Loan Servicing

 Dear Colleagues:  

We the undersigned write to you regarding the urgent need to develop national standards for originating, selling and servicing mortgage loans.  The private residential mortgage securitization market is frozen as to new issuance.  The housing market is suffering from a dearth of credit, which is causing a serious lack of confidence among potential homebuyers. [SM: Two pretty powerful statements about the state of the securitization market and the general availability of credit.  We would note here that not a single securitization investor (or a firm that issues securitized debt) has signed onto this letter.  If they had, certainly they would agree that there is a dearth of new issuance but not that it is due to a lack of cohesiveness in servicing standards; in fact it has nothing at all to do with that.  All investors care about is their ability to enforce the contracts (terms of their bonds) and that is their right to do so.  The dearth of issuance is not due to any lack of confidence in new homebuyers, it is due to a lack of confidence by institutional investors in the mortgage-backed markets and whether the terms of their bonds will be enforceable.  Quite honestly, they could care less if a servicer is abusing a homeowner via an overly aggressive foreclosure process.  Not trying to sound cruel but that’s not their concern particularly when you consider that the investor in question may be a local pension fund trying to make timely distributions to their retired members.  In an ugly twist of fate, those bond payments may actually be used to make a mortgage payment (imagine that!!).]

 Widely reported servicer fraud, whether in the foreclosure process or in the systematic assessment of illegal fees against homeowners, is also a serious problem.  It’s bad for investors, it’s bad for homeowners, and it’s ultimately bad for a sustainable residential mortgage securitization market and the U.S economy.  Fraud is also a symptom of the disease affecting our broader financial system, namely the lack of accountability in the loan servicing industry and the resulting impairment of the value of securities sold to investors.  [SM:  Now wait a  minute….. either there needs to be more laws and regulations to curtail abuses or there doesn’t.  We would agree that it would appear that at least some servicers have engaged in some illegal activities, at the expense of homeowners.  However, to say that it has already been determined that some of these activities are “illegal” would suggest that laws are already on the books (a view we would agree with; in fact there are plenty of laws) and that the problem is a lack of application or enforcement (a view we would also agree with).  This is not a case where more laws and regs are the answer.  Let’s start with an application of what’s already in place.  This is not a new position for us to take.  In fact we have been making this point to any and all who would listen for more than 3 years.  We have always believed that a more vigorous (in fact even just a moderate) regulatory regime back in 2000, 2002, and 2004 would have gone a long way to eliminate the systematic abuses in the mortgage industry.  However, it is always at times like this that the “rumbling herd” will call for more regs and more laws as the solution.  We obviously differ with this point of view.]

 To that end, new securitization standards should be adopted now.  The rules under the Dodd-Frank Act relating to disclosure and risk retention for securitization, which apply to all market participants, are the place to start.  We suggest, therefore, that the agencies concerned, led by FDIC and SEC, undertake a coordinated rule making effort now to start the process and then also report to Congress.  

 As part of your duties under Section 941 of the Dodd-Frank Act, your agencies must develop new standards for the secondary market in mortgage loans.  These standards must promote a sustainable securitization market and, in particular, maintain additional “skin in the game” for sellers of loans so the excesses and abuses of the past are not repeated.  As part of this effort, you will be defining the criteria for the highest quality residential mortgages, those which do not need risk retention.  This new definition for what constitutes a qualified residential mortgage should be the gold standard in all areas of mortgage origination, securitization packaging and servicing, and disclosure.  [SM:  We absolutely love how these new buzzwords, such as “skin in the game”, work their way into industry parlance.  Lately, this particular phrase has us thinking about the Coors Lite TV commercial where former NFL Coach Jim Mora responds to a questioner with the phrase  “PLAYOFFS??……. PLAYOFFS????……. PLAYOFFS????????.  Don’t folks get it?  Don’t they understand just how much SKIN the average lender or issuer of securitized debt already has IN THE GAME?  All forcing them to hold 5% of the pools does is add cost to their structure.  It doesn’t add any discipline.  Accountability and risk take on many forms.  Just ask the big conduit issuers in the market in 2007, including Countrywide, Bear Stearns and others, if they didn’t already have too much skin in their game?  Oh that’s right, they aren’t around to ask!] 

Why is there such urgency?  Because of the ongoing litany of revelations pertaining to inadequate servicing, lost loan modification documents, and improper foreclosures which reveal significant problems in the mortgage servicing industry.  Problems of this magnitude are a threat not only to the economic recovery, but to the safety and soundness of all insured depository institutions.  Banks rely upon a functioning secondary market in home mortgages for liquidity management purposes.  The chaotic situation in the mortgage market today demands immediate action to ensure all parties are treated fairly and to restore the confidence needed to support a recovery in real estate markets and the entire U.S. economy.

 Servicing standards need not be overly complex, but they must address the misaligned incentives and ‘tranche warfare’ issues that have bedeviled mortgage servicing throughout this crisis.  We also believe it is of critical importance to eliminate existing discontinuities in servicing practices with regard to loans held in whole-loan form by banks, versus those in securitization vehicles.  Your agencies must address loan servicing as part of the lending process so that the new Dodd-Frank risk retention rules meet the goals set by Congress. [SM:  We are also just a little fatigued by this “securitization made me do it” argument.  Why can’t there be different servicing standards for loans that are securitized vs. those that are not?  We continue to see this overly liberal linkage of securitization to mortgage servicing standards and home borrower rights.  We believe, without reservation, that homeowners are protected by law from illegal servicing activities.  On the other hand, how a servicer handles a portfolio “after” and even in some cases “before” a servicer ensures that the homeowner regs are followed, should not be a concern of the homeowner.  Last we checked, we live in a “mostly” free market economy.  As such, investors and the banks that sell them securities should be able to negotiate terms which are most beneficial to the structure of their bond issue.  Let the appropriate authorities and regulators look after the homeowners and we assure you that investors will look after their rights.  At the end of the day, it is the issuer or bank that will have to negotiate with both.  That’s called running a business!]

To protect borrowers and investors alike, the standards generally should require lenders and servicers to:

 * Credit monthly loan payments promptly and correct any misapplication of such funds in a timely manner.

* Engage in loan modifications, including reductions in the payment amount and principal balance, consistent with state law, to address reasonably foreseeable default when a homeowner can make a reasonable payment and it is economically feasible to do so.  When existing or future loans are more than 90+ days delinquent, federal regulations should mandate that the credit be assigned to a special servicer.   [SM:  We can only guess that no one on this list of 50 experts has actually been through an asset management process.  We’d like to hear their ideas for the business model.  Most large issuers of mortgage-backed debt (certainly the large private conduits) prefer to service their own loans.  The “logic” is very sound…. who knows the loan better than the party that originated the loan or has serviced the loan in good times?  Sure, let’s turn the file over to a disinterested third-party when things get rough!  That wouldn’t be our vote.]

 * Prohibit the commingling of homeowners’ monthly mortgage payments with servicers assets except for the time necessary to clear the payments received, but generally not more than two (2) business days.  [SM:  We’re not sure we understand the rationale for this but, once again, we assume that they are referring to loans pledged to a securitization.  The bond trustees will surely like this measure but the income still has to go somewhere.  This is all about economics and not safety.]

* Be accountable for lost paperwork on loan modifications and/or for failing to suspend  the foreclosure process when a homeowner is actively engaged in the loan modification process.  [SM:  Is the group suggesting that the servicer is not currently accountable?] 

* Create incentivized compensation structures tied to effectiveness in managing the long-run performance risk of the assets in a securitization. [SM:  We assume that they mean incentives for the issuer/servicer.  These incentives are already in place.  They are called bond ratings and interest rates (cost of funding).  Do people actually think that investors haven’t thought about this stuff for the past 25 years?]

 * Mitigate losses on residential mortgages by taking appropriate action to maximize  the net present value of the mortgages for the benefit of all investors in a securitization rather than the benefit of any particular class of investors.  [SM:  See last comment above] 

* Make servicer advances to a securitization vehicle a required reporting item.  Prohibit the servicer from advancing delinquent payments of principal and interest by mortgagors for more than three (3) payment periods unless financing or reimbursement facilities to fund or reimburse the primary servicers are available. [SM:  Let’s leave the bond structuring to the pros, shall we?  If they agree to something different, so be it.]

* Disclose any ownership interest of the servicer or any affiliate of the servicer in other whole loans secured by the same real property that secures a loan included in a given pool of mortgages used in a securitization.  

 * Eliminate the regulatory incentives that motivate banks to keep troubled portfolio loans in “limbo,” without permanent modification or remediation, merely because the bank is successful in obtaining a marginal payment that avoids classifying a loan as non-accrual.

* Establish a pre-defined process to address any subordinate lien owned by the servicer or any affiliate of the servicer, if the first mortgage is seriously delinquent (i.e., 90 days or more past due) to eliminate any potential conflicts of interest.

* Attest annually in writing under penalty of a fine or legal action that a bank or non-bank servicers’ foreclosure process complies with applicable laws.  

During a December 1, 2010 hearing, Federal Reserve Board Governor Daniel Tarullo acknowledged that “it seems reasonable at least to consider whether a national set of standards for mortgage servicers may be warranted.”  We agree with Governor Tarullo.  The time to act is now.  

Recent discussion among regulators as to the need for new legislation to address the servicing issue are misplaced, in our view.  We cannot wait for uncertain future legislation to accomplish something that is clearly appropriate under the Section 941 risk retention rules of Dodd-Frank and current law, namely a national standard for loan servicing.     

 The agencies currently involved in developing the standards for residential mortgages have an opportunity to address this critical issue now.  The responsible servicing standards described above would be applicable to all issuers of securitizations and will prevent the problems we are seeing today in the secondary market for mortgage loans. [SM:  By now, we think you know where we stand……..]

Yours sincerely,


Obama Administration looks to scale back GSE guarantees

Recent reports are describing a desire by the US Treasury and other Government Agencies to try to revive the mortgage-backed market by scaling back the levels of guaranteed debt issued by Fannie Mae and Freddie Mac.

The “theory” behind the so-called Plan B is that the over availability of government guaranteed debt is crowding out any resurgence/recovery of the private mortgage-backed market.

This line of reasoning is not new, as the private market for years had complained about the tilted advantage that the GSE’s had in the market place.  However, we don’t think a scaling back of the government guarantees , whether discreet or implied, is the answer to today’s problem.

Let’s not forget, despite all the complaints coming from the private market for many years, that side of the market did remarkably well, competing side-by-side with Fannie and Freddie for the attention of investors.  The private  market didn’t shrink.  On the contrary, it grew by 20% or more in many years through 2006.  Certainly, we won’t argue with the fact that the GSE’s have a huge advantage in the market but there are probably many good arguments on both sides of the question of whether this a good thing or a bad thing.

No, we believe that there is a much more sinister culprit at work in today’s private market.  However, the good news is that the Treasury, FDIC and SEC should realize that they have the power to fix this problem as well.  We believe the real problem is the continuing confusion among the private MBS investor community for how to judge current and future policies around critical “investor resolution” issues like Safe Harbor.

It’s hard enough for investors to analyze a private market MBS investment without trying to predict if their rights to the cash flows from the underlying loans won’t be superseded by another creditor class (i.e. the FDIC).  How can anyone expect new private market activity to pick up when currently outstanding securities are stuck in Safe Harbor Limbo?

While we do understand that the private market makes a strong case for evening the playing field with the GSE’s, simply cutting back on government guarantees will not bring many private market investors back to the field.  All this will do is slice up a smaller pie (i.e. market) between the GSE’s and the private MBS market.  We much prefer a strategy that looks to make that pie bigger by giving private investors the confidence to return to the market.  Creating a strong set of Safe Harbor polices is the best way to accomplish that.  Restoring the ability of issuers to move MBS programs off balance sheet would be another strong step.

Scaling Back Your Securitization Business

With the end of 2010 fast approaching and the ink on hiring and expense budgets drying quickly, we thought it might be a good time to take a “reality check” on what managers of businesses engaged in structured finance should expect for 2011.

A Shrunken Market

No one should delude themselves as to just how much the securitization markets have shrunk since their zenith in 2006.  Here are some sobering statistics:

* Total U.S. ABS issuance for the last 3 years (2008, 2009 and 2010) has averaged approximately $140 Billion.  That’s a full 80% off issuance levels in 2006 (the peak year for this market)

* Total U.S. Non-Agency RMBS issuance for the past 3 years (2008, 2009 and 2010) has averaged $30 Billion.  That’s just 3% of the non-agency RMBS issued in 2006.

* Total Euro-market ABS issuance is down 50% from 2009 and is just 40% of the levels issued in 2006.  However, recent trends in the Euro market seem to be more positive.

In summary, the new issuance activity for the two major securitization markets is probably no more than 20% of what it was in 2006.  That is a sobering statistic for all the bankers, law firms, accounting firms, bond trustees, rating agencies and technology providers that have carved businesses and product lines out of this industry over the past 20 years.

For the past year, many of these organizations have been occupying their staffs and resources dealing with defaults, re-rating exercises, litigation, etc and, while all hope to recover their costs or, in some cases, profit quite handsomely from the disruption, the bottom line is that it will be some time before we see anything close to the market activity levels for new structured finance issuance to which we had become accustom.

This is not huge news to most companies and businesses operating in this specialized market.  However, we do think that firms should consider whether, after three years of steady contraction, there is any reason to think that 2011 and possibly 2012 will be any different from the historical averages for the last 3 years?

Budgeting for 2011

We would like to focus on the operating platforms that service the market.  These would include the asset managers, trustees, servicers, technology and administrative services companies, etc.  In most cases, these organizations spend significant amounts of time and energy building up staff, processes and technologies to support their products and services.  Under normal market conditions, a typical expense base for one of these providers might be broken down as follows:

– 70% Staffing  (including salaries, incentive pay, benefits, real estate)

-20% Technology (including hardware, software, network)

-5% Business Development (including sales, marketing)

-5% Other (including legal, accounting, etc.)

As we look out to the coming year and companies make final adjustments to their operating budgets, we suspect that each of these expense categories is being heavily scrutinized.   However, to add some sobering thoughts to this analysis, let’s for a minute look at the revenue side of the equation.  

Let’s assume that a provider had a 5% market share for new business in 2006 and, as such, generated some $100mm in revenue off this market share.  Not even considering the runoff from their historic business that we are sure has occurred over the past 3 years and even assuming that they have doubled their relative market share, due to industry consolidation over the past 3 years, the best new business performance that they might expect in a “flat” 2011 might be something in the range of $40mm. 

If 2011 does, in fact, look a lot like the past 3 years, then the absolute best that these providers can expect is to tread water.  It is much more likely, however, that their historical revenue base will continue to fall at between 10% and 15%, at minimum.

So what is a company engaged in securitization services to do for 2011? 

We would make a few suggestions:

1- Look Beyond the Transitional Effects:  While wide cross-sections of staff and other resources may be devoted to sorting through defaults, litigations,etc, make no mistake in understanding that these are temporary situations.  Give serious thought to outsourcing clerical and administrative activities associated with these events as the best method for keeping your expenses as low as possible.

2-Downsize your Business Development Efforts:  Unless you are a relatively new enterprise and particularly if you are an established player in the market, we would recommend a signficant downsizing of your sales and marketing operations in 2011.  Keep only the best and only what you really need.  Reallocate resources that you have retained to chase new clients, new markets, and emerging products.  Simply a smaller version of the what you already have is not the answer.

3- Renegotiate with your Vendors:  Despite the possible ripple effect that might be felt throughout the industry, it is extremely important that each firm become more efficient in its own right.  This should include a re-visitation to each vendor contract to determine if the terms are suitable for the “new normal”.  This doesn’t necessarily have to be a reduction in price only as it might include product/service upgrades, alternate volume thresholds, deferred payment schedules, etc.  Every firm should attempt to find the set of solutions that works best for them.  In a perfect world, each company adopting such a strategy will ultimately improve efficiency across the entire securitization market which will lower funding costs and advance the return to higher issuance levels.

4- Make Acquisitions or Find a Partner:  In the case of larger organizations that have invested significant time and effort to train staff, build technologies and to master processes, we would recommend the development of a defined program aimed at identifying and executing acquisition opportunities to offset low market activity.  Such a strategy should not be taken lightly ( it takes work and commitment) but it has proven, time and again, to be one of the most effective methods for surviving business downturns.  For smaller enterprises, we would recommend the serious consideration of combining your business with a competitor or a related product or service provider.  The benefits that come from scale (efficiency) and revenue diversification cannot be minimized.

Live to Fight Another Day

In summary, all the evidence appears to be in for the state of the securitization industry.  While we continue to be staunch believers in the eventual return of this market to perhaps even rival the heady days of 2006, we should not kid ourselves into thinking that we are out of the woods yet. 

Most providers of products and services to the securitization industry operate within larger companies, ones that service a number of different markets and industries.  It is significantly important that the senior managers, in each segment of the securitization services industry, recognize that the commitment of their respective organizations to their product line is not immortal.  Clearly, the industry as a whole benefits from having more people engaged in developing new products and in enhancing services to support these programs.  It is the responsibility of  “industry management”, across structured finance, to act decisively and to look for answers from outside their organizations, if they cannot find them within.

Europe private securitisation market gets a jump on the U.S.

Institutional Investor recently ran a nice little article about the recovery of the private securitisation markets in Europe; one that is apparently out-pacing the recovery of its U.S. counterpart.

The author points to the lack of competition in Europe from government agencies, like the GSE’s in the U.S. (e.g. Fannie Mae and Freddie Mac) as a primary reason for the more than 550% increase in new mortgage-backed issuance in the Euro-market over the first 9 months of 2010 compared to the same period in 2009. 

Granted, the US$50 Billion in new RMBS issuance is a far cry from 2006, when some $300 Billion was brought to market but we’ll take it, particularly given the paltry US$9 Billion that was issued in 2009.  The article describes activity in several markets and several asset classes.  All good signs, for sure.

However, the real “news” here is the fact that the investors with the largest appetite for these euro-securities seem to be U.S. Banks.  Yes, we said U.S. Banks looking for yield in an asset class that they understand!

Does this tell you anything?

Could it be that the lack of pace in the U.S. securitisation market’s recovery has more to do with a lack of confidence and certainty in new regulations such as Safe Harbor, Skin-in-the-Game and Fair Value Accounting than it does about competition from the GSE’s?

Are the FDIC, SEC and FASB listening?

Did BoA drop the ball in Countrywide case?

News out this week that Bank of America is attempting to distance itself (very quickly) from the recent testimony of two of its own in a case involving a foreclosure litigation.  Kemp v. Countrywide has drawn the attention of the securitization industry, primarily due to the testimony of a BoA manager and their outside counsel about how Countrywide went about transferring (or not transferring) important mortgage documents, including the mortgage note, to the bond trustee and the trust.

We won’t comment about whether these two witnesses had enough “knowledge” to be informed (as BoA has suggested) as to the general practices of Countrywide and the bond trustee (The Bank of New York Mellon) but, based on what we know of industry practices, it is almost certain that, if there was a problem with the processing and handling of the Kemp loan or even the entire process that BoA was utilizing to process new RMBS programs, there certainly wasn’t a conspiracy theory to be hatched, as some of the histrionics detailed in such places as Naked Capitalism would have you believe.

Foreclosure happens for lots of reasons; most legitimate and some not.  The Courts are there to be sure that disputes are settled fairly.  You have to split the baby here.  If the mortgage was not properly conveyed to the trust, then it is the bondholder that suffers.  If the homeowner defaults on his loan, he may face foreclosure.  If BoA in the middle got it wrong, even on both sides, they will be the one that suffers.  Let’s not make this discussion into more than it is.

Certainly, the bond trustees are reviewing and tracking tens of thousands of mortgages and thousands of other mortgages change hands between banks and finance companies all the time.  Is the paperwork spot-on all the time.  Of course not.  That is one of the primary reasons that the mortgage industry initiated MERS, to help alleviate the problems associated with arcane and outdated UCC requirements and other unwieldy laws and regulations.

The mortgage industry and the selling and trading of mortgage portfolios was not invented in 2005.  It has been a thriving industry for more than 25 years.  Securitization did not invent this secondary market.  It did help it to grow and it did open the market to new investors.

Courts will decide what they will decide on individual cases, but let’s not lose sight of the fact that everyone clearly understands what the intent of these transactions was; starting with the borrower who was happy to get the loan, all the way through to the bond investor who believes he has the right to enforce his ownership of the asset for which he paid.