Deutsche Bank Recognizes the Depth and Width of "A" Paper Crisis to Come

Summary
The depth of the "Alt A" mortgage crisis is coming home to roost. We are likely to see the depreciate creep (or flood as the case may be) is going to hit the areas that the subprime loans barely touched.
Analysis

Deutsche Bank (DE:DBK), while prompting new concern about the severity of the "A" paper mortgage crisis, is simply being forthright about the depth and width of the problem. Other lenders have been avoiding the truth as a means to avoid panic and to prevent further declines in their respective stock prices.

The "subprime crisis", while bad, was nothing compared to the potential crisis looming within the "A" paper and "Alt A" paper markets. I have been shouting from the mountaintops that the Option-ARM portfolios outstanding pose a substantial threat to our recovery. Negatively amortizing loans, combined with sharp declines in value, combined with lender hesitance to embrace loan mod options, combined with nominal loan mod options for this particular product, combined with the communal shamelessness of "walking away", are all conspiring to create the perfect storm for the real estate markets and banks.

Option-ARM's aside, as the article explains, we are seeing the creep of depreciation in more affluent communities and those where values were the highest at the peak of the market. The community mood is such that people are willingly walking from properties as a business decision, without the shame that that accompanied foreclosure in the past: "Why pay for a million dollar home that is worth $600,000.00?" Furthermore, "The value is not likely to come back for ten or more years!" In the communities that have been hardest hit, the latter point is even more valid than in the "Heartland". People in California, Florida, Las Vegas, etc., are certainly more nomadic than other regions of the country. These nomads are not willing to wait out the markets. The problem is that the population's, portfolios, and aggregated net worth of these nomadic areas is a substantial percentage of the country’s overall wealth. Thus, as the saying goes, "where California, et al, goes, so goes the country".

Of course, the unfortunate homeowner's who bought in the few years prior to the real estate run are going down with the ship.

The bankers who recognize the depth of the problem and openly address it will likely come out on top. Loss mitigation solutions, further consolidation of troubled banks, and real bleeding are necessary to get things back to equilibrium. I personally believe that is will be three years before we can foreclose, negotiate, or sell the inventory of houses that will be necessary for the market to start rising again.

Joe Chatham
President
Chatham Mortgage Partners Inc
805-496-3000 x1

Round II: Coming to a Neighborhood Near You

Summary:

While a very general description of the Pay Option ARM disaster that is looming, the Reuters article is dead-on in two conclusions: many more homes will be hitting the market over the course of the next two and one-half years and that the mortgage plague that started with the subprime crisis will be moving from the lower income strata to the middle and higher income areas.
Analysis

Iowa AG Tom Miller is correct in his assessment of the Pay Option ARM crisis. The crisis is not looming; it is here. As I have written and consulted on numerous occasions in the past, we have entered a period of re-cast hell. The Pay Option ARM, a loan that offers the borrower the flexibility of up to four payment options, was the product du jour for the years 2004, 2005, and 2006. While I think the Pay Option ARM is a terrific product for the right borrower, it has been abused. I have heard varying numbers regarding the dollar amount of outstanding Pay Option ARM's written in those three years, but I think it is safe to say, in total, there was about $500,000,000,000 lent under this program. According to Fitch Ratings, 80% od Option Arm borrowers pay the negatively amortizing payment option! So, this means that approximately $400,000,000,000 worth of loans will negatively amortize (turn upside-down) up to 125% of the original loan amounts, or BACK to $500,000,000,000! The problem is, of course, that the underlying value of the security backing these loans (residential real estate) has dropped anywhere from 25-50%! Most of these loans were written at 80% LTV. Thus, taking into account the negative amortization and depreciation, borrowers will owe 133% LTV, conservatively. I know quoting "The Clash" is not professional for my esteemed readers, but I can't find a more appropriate line: "Should I stay or should I go now? If I go there will be trouble. If I stay it will be double".

The typical recast allows the borrower to go to 125% OR five years, whichever occurs first. Given the low rates over the past five years, and given that most of the Pay Option ARM's are based on either Libor or MTA, most of the loans are triggering the recast feature at five year benchmark. Despite the knowledge of many of the borrowers that they will not be able to afford their recasted payment, they are sitting in their properties as long as possible taking advantage of the minimum payment option, tax benefits, and keeping a roof over their heads. The Pay Option ARM, it appears, offers a fifth feature: delayed accountability for both the borrowers and the lenders! The problem is that time is running out over the next two and one-half years; both borrowers and lenders must finally ante up.

Recasts are now being triggered from 2004. The article states that $389,000,000,000 worth of loans was written in 2004 and 2005. While I cannot find the source to show the average loan size, let's divide that number a reasonable average home loan of about $260,000, or 1,496,000 homes, and we have a lot of homeowners facing some huge payment jumps between now and the end of 2010. While I have heard varying numbers regarding the default rate on these loans (it is a bit too early to have accurate info), but let's be real conservative and estimate that 25 percent default, or 374,000 foreclosures/short-sales added to an already bulging inventory (9-15 months, depending on the area). I have heard some claim default rates as high as 40%. Do I hear the sound of prices dropping more?!

Up until now, the lenders have not had to acknowledge these bad loans. In the past, lenders have taken advantage of accounting rules that allow them to claim the fully amortizing payments instead of the minimum payments. Only now, will they have to start showing the loans that are starting to default. It will be ugly. Perhaps acknowledgement of the problems will come in the form of active and real loss mitigation efforts: reducing loan amounts, extended terms, lower rates, etc.

I will not bore you with the reasons these loans were mostly given to middle and upper income borrowers except to say that underwriting did, in fact, require decent credit scores and, given the low payments this program afforded, these loans tended to be loaned on higher-valued properties. Thus, we will see the creep of defaulted loans from the economically challenged areas to the more affluent areas, resulting in lower prices, more foreclosures, lower prices, more foreclosures, etc., etc.

In my past writing and musings I have used different figures, but the figures are only starting to roll in. My doomsdaying is a work in progress and will be amended as I gather new info. Please keep in mind, I am not ordinarily bearish; it only hurts my business if I am correct. Indeed, I hope I am wrong. I can assure the readers, however, that I have remained relatively conservative.

Joe Chatham
President
Chatham Mortgage Partners Inc.
805-496-3000 x1

It is all in the "W"

Summary:

KB (NYSE:KBH), a lower cost builder, is benefitting from the perception that we have hit the bottom. We have not. Thus, the peak of the inside of the "W" is about to wane.

Analysis:

KB is benefitting form a few things; namely, KB is a builder of less expensive and/or "starter homes". Thus, they benefit tremendously from the tax incentives that the Obama Administration created, the easing lending standards/rates for FHA loans and the increased lending limits for conforming loans, the perception of diminishing inventory of lower priced homes, and the de facto overall reduction of new building. All of these factors have postured KB and their business model to benefit from the inside/upward slope of the "W" recovery...if in fact we are in a recovery? I would not pull out the hammers and construction crews yet!
There is the "Alt A" mortgage crisis about to hit and the resulting inventory surge is going to create huge challenges to home builders and the overall economy. The inside/downward slope of the "W" is about to hit. Of course, no one knows how many foreclosures will be coming to market in the next three years, but we are finally hearing writers and analysts acknowledge that the "Alt A" crisis exists, and with it the very real proposition that home prices will still decline further. Declining values will equal more problems for all builders, including KB. We will simply have too many homes on the market to leave room for new
construction.

Joe Chatham
President
Chatham Mortgage Partners Inc.
805-496-3000 x1

Hello,

I would like to gather up mortgage holders and attorneys who are interested in filing a Class Action Suit against Aurora/Lehman brothers. I would like to put up some kind of sign up sheet on the internet of people that are interested, and see what we can do.

Aurora/Lehman Brothers is suing me for foreclosure in southwest florida, where I put $50k down on a $250k house which is now worth about $89k. It has lost it's value because of their actions and I think they are liable for that. They have damaged me extensively, and many many people throughout this country and it's time for them to be held responsible for their actions.

This company and many other investment banking companies took individual's fees for mortgages, upped the supposed "median price in America" for housing (to $250k in 2005), gave loans to any bum on the street who could sign their name, and created the financial disaster that so many people in Florida, Arizona and California are facing, as well as most of the Country, and foreign countries. And now, they want $200k from me for a house which they have destroyed the value on, in a town where they have destroyed the job market and renters cannot pay anywhere near the carrying costs for the houses they had appraised and approved for these high prices. They failed in their fiduciary responsibilities, are being investigated by the FBI for fraud, and after having destroyed me financially, are further trying to get me to pay them $200k for a house they don't even have a Note for.

Thank you for reading, and let me know if you have any suggestions or would like to list this on your blog as a place for people to add their names.

Liz M.

I am happy to post this with the caveat that TotalMortgageAdvice.com neither endorses nor supports this lawsuit. We are completely neutral.

Fed Wants To Limit Compensation On Difficult Loans

Albeit, sub-prime and Alt-A lending appear to be dead for the time being, both product pools are extremely valuable for the mortgage borrowing community. Yes, there have been abuses, but that does not mean we effectively "throw the baby out with the bathwater". This proposal by Bernanke and Co. simply insures the demise of the sub-prime lending industry. Thus, eliminating a huge pool of potential borrowers and destroying a sector that, until recently, was an extremely important part of lending, "sub-prime". We need sub-prime lending, ironically, to help get us out of this mess.

Yes, abuses have taken place in sub-prime lending over the past several years. The fact is, however, that sub-prime lending (to encapsulate all sub-prime and Alt-A loans) has been a successful part of the lending world going back decades. Remember HFC (NSE:HFC/PB), Beneficial, Norwest, Associates, Avco, etc.? All the aforesaid were vital companies serving borrowers' needs. The key differences in the "old" style of sub-prime lending and the style which helped get us into this mess, are that the old-style maintained higher underwriting standards and priced according to risk.

Obviously, underwriting standards need to be raised. I remember when HFC was considered insane for going to 85% CLTV! Assuming we can re-establish sound sub-prime underwriting standards, we need to price accordingly.

This brings us to risk-based pricing. Higher borrowing costs for sub-par borrowers will achieve two things: 1) It will limit borrowers to those who are willing to pay the price for their inferior credit circumstance(s), and 2) the higher costs and rates to the borrowers will help the offset losses for the lenders due to higher charge-off. Some may argue that this will stifle lending. What lending? Nobody is lending in the sub-prime arena these days anyway. Perhaps we can attract lenders back by allowing them to make profits based on risk?

So how does this relate to Mr. Bernanke, et al? If we limit the compensation for lending to higher risk borrowers, you will simply see loan professionals walk away from that business altogether. The work it takes to get a sub-prime borrower approved is FAR more than the work to get an "A" paper borrower approved, historically speaking. If I were to spend three months working a difficult file, I want to be paid for it. Borrowers understand this as does anyone who charges for their labors.

We need to get back to good underwriting, appropriate pricing, and compensation that make sense. I am not arguing that abuses were committed. I am arguing that we cannot eliminate, by regulation, policies, or compensation structures, the much-needed area of lending called sub-prime. To limit compensation to that of "A" paper compensation is just another nail in the coffin.

Joseph Chatham

I hate to say I told you so, but....

The following relates to the article above:

The Reuter's article reinforces what I have been saying for the past several years. More importantly, it reinforces what I have been saying (and writing) for the past several months; we have a ways to go before the real estate market bottoms-out! Despite all the glowing news from the realtors, mortgage bankers, etc., we need to be leery of the sources and look at the facts. We have a HUGE backlog of REO, a large portfolio of upside down neg am loans which are yet to recast (and offer little in the way of loan mod potential), homeowners who are resigned to the fact that their values will not come back any time soon, tax policy which encourages abandonment, lenders who are unwilling to negotiate, poor policies from a well-intentioned government, and cheap postage to mail keys back to the lenders. The list goes on and on. We will likely see the bottom of the trough at around 45% to 50% of the peak. Not to be too political, but we need to let this bleed and recover rather than use inneffective anesthesia on a wound that is festering: it lessens the pain, but does nothing for the infection.

Joe Chatham

Loan Modification, Aurora Loan Services, and Fear

Dear MortgageMaster,

I am wondering if I am also at the start of a bad experience with Aurora Loan Services. Let me start by saying that at this point I have never been late with my mortgage payment of $740.36. But after being laid off and subsequently taking a buyout from the auto industry, my family’s income has significantly dropped. For this reason I asked Aurora Loan Services if I was eligible for a modification under the Obama Plan. They assured me I was and took my info over the phone, coming up with a new payment amount of $736.54. The payment has not dropped much, but my new payment would include escrow for taxes and ins that my old payment does not. They mailed me the modification papers around May 24, including the trial payment plan details, financial affidavit, etc. with a due-back date of June 16. No problem. I filled everything out, copied all my financials, sealed it up, and sent it out June 1, 2009 in the preaddressed/postage paid envelope they provided. I might mention that while on the phone with the initial representative I consented to have each of the 3 trial payments automatically come out of my checking account on the first of the month in which it is due (with the first due July 1, 2009). On June 16, I called Aurora to make sure my paperwork had made it by the deadline and was told it was not in the system yet, but they were “bogged down with lots of them, try again next week-they should be there). The next week I called Aurora, still no sign of my paperwork and I’m told to call in a week once again. June 30 I called back, concerned that my first trial payment is coming out but they have no paperwork for a modification plan. I’m told “don’t worry about it. Send the paperwork that I have, (which is not all of it) via fax.” At about this time I’m starting to get a bad feeling. I have one set important financial information floating around ALS, a trial plan payment coming out, and no proof of any modification plan in my hand because I sent both copies back as instructed. Not a good place to be at. My unease leads me to the BBB to see if Aurora has any bad listings due to the mod program-nothing much specific there. I do a search on Aurora Loan Services and come back with a nightmare of bad experiences people have had. Now I feel sick. I watch my bank account for when the trial payment comes out, which it did, for the $736.54. Then I log onto my mortgage account and the first thing I see is my July 1, 2009 payment is still due in the amount of $740.36. So I look at where my payment was posted and instead of principal/interest/escrow the money was posted under “other”. What the heck is that! And the system says I’m not paid for July! I’m not waiting for 3 months of the system saying my mortgage is behind and possibly starting foreclosure proceedings. I guess my only choice is to make the July regular payment and try to get the other funds released to me and the “mod program” stopped. Do I have a legitimate concern? Could I be blindsided by Aurora if I leave things the way they are? Or am I just overreacting to the horror stories I read online?


Thanks for any input,
Melissa K

Melissa,
Your experience unfortunately is not unique these days and it's not just Aurora. Secondly, you are not being paranoid or overreacting. The bigger loan servicers, in particular B of A/ Countrywide, can be particularly onerous to deal with. Aurora is not much different. Bottom line advice to you or any other person trying to do their own loan modification would be to keep extremely good records of what you have sent (always keep copies), who you are talking with, dates and time, extensions or direct lines if available, list of promises made and whom to call when you haven't received what you've been promised. Most importantly is follow up. Our firm has had some success by calling back sooner than later and also more frequently, in particular once we have some contact person in an organization that has been responsive. If your property is in jeopardy of foreclosure/sale, it is all the more important to follow up sooner rather than later and find out whom to contact at the company facilitating the sale. We recently negotiated a forbearance deal and only when we got the fax from the servicer saying the sale had been postponed did we actually feel like we had some success. To get there required multiple phone calls and faxes and lots of good record keeping.
With respect to your individual situation, do your self a favor and do a print screen of any withdrawals that have been made from your bank account and also do print screens of your account at Aurora. This will possibly be your only hard copy for purposes of backing up your story. If you are not getting any response, be prepared to spend a lot of time on hold. Continue to make the payments that you promised to make as this will most certainly show compliance from your end and you will point to this when you call them. Again, make a print screen of the withdrawal and also print screen to show how payment was applied.
It also helps to keep in mind whom you are dealing with on the other end of the phone. Often times that person has been on the job for only a very short period of time and won't know a whole lot. If you feel like your are simply educating that person by repeating your information again and again, don't hesitate to ask for a supervisor, or in some cases being polite telling them you've got a screaming kid and you'll have to call back. While not the most pleasant thing to do you are rolling the dice that you'll get someone else who is more experienced when you call back. Also, demeanor is really important on the phone. It might sound like a cliche, but you really do attract more flies with honey than you do with vinegar - i.e. be nice to the person - chances are really good that they have been screamed at for the last 5 phone calls and called every name in the book.
I wish you luck. A loan modification can be akin to a marathon in that it is often a very long process.
Regards,
Gregory T. Royston, Esq.
South Bay Law Group, P.C.3848 Carson Street, Suite 204Torrance, California 90503
www.sbaylaw.com
Office 310-780-8275
Cell 310-977-1062Fax 310-943-1472