A Tale of Two Mortgages: What Have We Learned?

These are two stories of people I know. They represent the extremes of how the mortgage industry is unwinding the mess it created.

(I)

A couple in Florida wake up one morning in January 2009 and decide to get divorced. They own a home with a $235,000 mortgage from First Franklin (“FF”). It was a LIAR loan. They have no money and no interest in the house. They call FF. A day later someone shows up, looks the place over and asks, “You ready to vacate the premises?” They say, “Yes”. The guy says, “We will take it from here on”.

The next day there is a For Sale sign up. The pricing is aggressive. In two weeks an all cash buyer at yet a lower price emerges. The sale price is $160,000. With expenses this comes to just $150,000 to pay back the debt. The short sale deal closes in less than a month. The borrowers walk away with a modest blemish on their credit. Story over.

First Franklin was a sub-prime loan originator that was acquired by Merrill Lynch from National City Corp in 2005. They paid $1.3 bil for it back then. As it turned out it was a good sale for NCC and a very bad buy for MER.

One can safely assume that MER securitized the original loan from the Fl. couple and it is part of that ‘toxic asset pool’ we keep hearing about. The value in the market for these assets ranges from just a few pennies for some tranches to 50% of par for others. Broadly valuing this stuff at 30% is generous. In this example if one looks through the MBS to the actual loan there is an arbitrage. The settlement resulted in a return to the MBS holder of 64% of par after expenses. If this were the case with all the other mortgages in the MBS package it would result in a 100%+ return from the 30% market/book value.

The market is solving the problem here. My guess is that the Merrill Lynch legacy securities that cost Bank of America a bundle in the 4th Q (and the spat with Bernanke and Paulson) are now turning out to be worth more than what they had them booked at. That makes BAC very motivated. That is why this problem loan was made to disappear in less than one month.

(II)

Outside of NYC a man owns a home with a mortgage from Indymac Bank (“IM”) This fellow is middle aged and is a small business/real-estate sales guy. He had a fairly predictable income until 2008. Then he had next to none. His story. (Sorry for the details)

-July 2008
He sees the writing on the wall and puts the house on the market hoping for an offer. He remains current on the mortgage.

-September 2008
There is no action on the house. He is going broke and informs IM that he can no longer pay the mortgage.

-November 2008
IM offers to modify his loan. He responds, “Thanks but no thanks, I have no income to pay the modified number either. I am trying to sell the house instead”.

-November 2008
An all cash buyer emerges with an offer of $302,000. The sale price net of commissions results in cash to IM of $284,000. The outstanding loan principal balance is $292,000 so the loss to IM is just $8,000.

-December 2008
Sale contracts signed on the house.

-January 2009
IM requires detailed information from both the seller and buyer. This information is gathered and returned to IM.

-January 2009
A letter is written to IM urging that they accelerate their effort.

-February 2009
IM requests a new document. An Affidavit from both seller and buyer that they are not in anyway related. This document is executed and returned to IM. On a phone call IM promises a closing with a short sale in less than four weeks.

-March 2009
IM advises the owner that the minimum they are willing to accept in a short sale is now $290,000 net to them (they now want to resolve the arrears). This represents a shortfall of $6,000. The owner says, “I have no money”. IM says, “We will have to get back”. They never do.

-April 2009
The buyer walks. The house goes back on the market.

-April 2009
IM sends the borrower a computer generated form letter. The letter states that he is about to lose his home. There is no reference to the mountain of prior documents and all the failed steps that have been taken.

-May 2009
There are no buyers for the house. The owner sends the keys and a letter to IM. His attitude is that he tried and failed to fix this problem. It did not get fixed because of the endless delays from IM. His view is that it is an IM problem now.

-June 2009
The house is empty and uncared for. There is a For Sale sign in the front yard; the weeds obscure it. No one comes. The taxes are accruing. The insurance has run out. It is now nine months since IM first received notice that the borrower was unable to pay.

Indymac Bank was taken over by the FDIC in July of 2008. It continues to be in receivership. Sheila Bair who runs the FDIC has been very outspoken on the need to restructure mortgages and solve problem loans. It is clear that in this situation her Agency has done a terrible job.

I present one situation where a market-based solution is applied. While it is not a ‘happy’ resolution for the original lenders, it is now in the past. Where it belongs. The other is an example of a government solution that does not work. There is no resolution in sight for that saga.

There are approximately $12 trillion of residential mortgages outstanding. More than half that amount is owned/guaranteed by the various Federal Mortgage Agencies. Extrapolate from this that the government similarly owns half of the problem loans. It implies that the restructuring process in the mortgage market will take a very long time.

With the benefit of hindsight it is easy to say that the government's involvement in the mortgage market should never have been 60% of the total. With the benefit of that same hindsight, it is very easy to conclude that the government’s role in the mortgage market should be dramatically reduced in the future.

It is currently 85% of the new mortgage market.

Comments

[D_Virginia:]

Sure: yay market, boo government. I got it.

But the first scenario isn't actually how those situations usually play out with large lenders.

In reality, most people are forced to sign a promisory note in association with the short sale, saying they'll pay the bank the difference -- and this is only /after/ they stop making payments for 3+ months in order to get their lender to even talk to them about a short sale.

Basically, in most states and in most situations, the banks can and will pursue the borrowers to the ends of the earth to get their money, nothing short of bankruptcy will let them walk away with nearly six figures of forgiven debt.

Also, between the missed payments and short sale and still-outstanding debt with no appreciating asset, it's a pretty significant black mark on the credit, not just a "modest blemish".

I'm not saying the government's doing a good job (perish the thought), but the market ain't doing so hot either...

Jun 15 08:07 AM

[nobull:]

Isnt it all so easy for the borrower? Cant pay? Walk away. You lose, its on the bank. You gain, its yours. Wish I had that kind of deal with my stock purchases. And if thats not enough, slime like Sheila Bair want to bail them out with our money. Disgusting!

Jun 15 09:12 AM

[Bruce Krasting:]

Virginia - I am sure you are right. The FL. story shocked me. That is why I wrote about it. This was a subprime loan from the start. It was a cash out refi on silly terms. So it was lumped in with all the other junk mortgages. I think that is why it got resolved so quickly.

This small example raises an interesting question. Does the outcome of one's mortgage woes depend on who their lender is?

In my example the conclusion is yes. If that were to be broadly true, then there is some big inequities. It is likely that those inequities will have to be addressed. We can't send one person to debtor prison and give the other a free ride.

bk

Jun 15 09:39 AM

[Looch:]

Bruce
In your first example I would assume that there was credit enhancement -private mortgage insurance- and the recovery would have been over 70% and possibly even more if there was another layer of coverage calle pool insurance. However, the MI company would have to approve the short sale inoredr to waive its deficiency rights against the borrower which exist in FLA.

Yes, with the entire mortgage insurance industry puckering up with constrained underwriting guidelines the FHA -GNMA- is now becoming the latest radioactive waste heap. The government does not have the risk management discipline, technology and resources to operate effectively. And now that the FHA loan limits have been permenantly raised the private market is being further squeezed out. (FHA doing 85% of high LTV loans)




On Jun 15 09:39 AM Bruce Krasting wrote:

> Virginia - I am sure you are right. The FL. story shocked me. That
> is why I wrote about it. This was a subprime loan from the start.
> It was a cash out refi on silly terms. So it was lumped in with all
> the other junk mortgages. I think that is why it got resolved so
> quickly.
>
> This small example raises an interesting question. Does the outcome
> of one's mortgage woes depend on who their lender is?
>
> In my example the conclusion is yes. If that were to be broadly true,
> then there is some big inequities. It is likely that those inequities
> will have to be addressed. We can't send one person to debtor prison
> and give the other a free ride.
>
> bk

Jun 15 10:35 AM

[Bruce Krasting:]

looch - No credit enhancement on that loan. the lender ate the 36% loss.

Jun 15 02:40 PM