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Bailouts Seminar, Winter, 2009 The Consumer Side of the Mortgage Industry Darius Horton Anush Yegyazarian Eunjoe Ahn Cleve Doty.

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Presentation on theme: "Bailouts Seminar, Winter, 2009 The Consumer Side of the Mortgage Industry Darius Horton Anush Yegyazarian Eunjoe Ahn Cleve Doty."— Presentation transcript:

1 Bailouts Seminar, Winter, 2009 The Consumer Side of the Mortgage Industry Darius Horton Anush Yegyazarian Eunjoe Ahn Cleve Doty

2 Adjustable Rate Mortgages (ARMs) n Start with a teaser rate, typically < 2%. n Once the initial interest rate period expires, reset to an index + fixed margin (for example, 2-3%) and adjust periodically, usually annually. u Common indexes include: w The rates on 1-year constant-maturity Treasury (CMT) securities: estimated 1-year yields of recently auctioned Treasury bills and notes. w The Cost of Funds Index (COFI): weighted average of interest rates paid out on deposits, loans, etc. by financial institutions in the 11 th District of the Federal Home Loan Bank (CA, NV, AZ). w The London Interbank Offered Rate (LIBOR): interest rate at which banks can borrow funds from other banks in the London interbank market. n Fully indexed rates are subject to both periodic and life-of-the- loan caps. 2May 3, 2015

3 ARM Index Rates 3May 3, 2015

4 Theme and Variations n Hybrid ARMs offer a fixed rate for the first 3, 5, 7 or 10 years, then switch to an adjustable rate. u An X/Y hybrid ARM is fixed for the first X years, then adjusts every Y years. u About 1.3 million subprime hybrid ARMs reset for the first time in 2008, and FDIC estimates that an additional 422K will reset in 2009. n Interest-only (IO) ARMs allow the borrower to pay only the interest for typically the first 3 to 10 years. n Option ARMs adjust every month. u Common payment options include interest-only, and a “minimum” payment that’s often less than the amount of interest due. u Option ARMs have a built-in recalculation period, usually every 5 years. At each “recast,” the new minimum payment will be a fully amortizing payment and any payment caps won’t apply. u Loans can also recalculate at any time if the amount of principal owed grows beyond a set limit, for example, 110% or 125% of the original mortgage amount. u Fitch Ratings estimates about $29 billion in option ARMs will recast in 2009, and an additional $67 billion will recast in 2010. Of this, about $53 billion is attributed to early recasts. n Some ARMs carry prepayment penalties if the borrower refinances or pays off the ARM early, usually within the first 3 to 5 years (for example, 1-3% of the original mortgage amount). 4May 3, 2015

5 Mortgage Loan Performance by Interest Rate Type as of Nov. 2008 5May 3, 2015

6 Alt-A Loans n Thought to be between prime and subprime in terms of risk. These borrowers typically have clean credit histories, but prefer not to provide full documentation for one reason or another. n The baseline: full doc. u Income verification: W-2, current pay stub, state/federal tax returns, Social Security, veteran’s benefits, etc. u Assets verification: bank account statements; savings bonds, stocks or investments and their market values; titles and deeds to property, etc. u Debt information: credit card bills, other loans, child support or alimony payments, etc. u Desired purchase information: for example, proof of current market value of property. n Stated Income Verified Assets (SIVA): stated income should be consistent with verified assets and employment. n Stated Income Stated Assets (SISA): lender will still verify employment. n No Ratio: borrower doesn’t need to meet any qualifying debt to income ratio. n No Income No Assets (NINA): borrower qualifies based on credit score and level of down payment; employment is verbally verified. n No Income No Job No Assets (NINJA): same as above, but no employment verification. 6May 3, 2015

7 Summing up… IncomeAssetsEmployment Full DocVerified SIVAStatedVerifiedVerbal verification SISAStated Verbal verification No RatioNot reportedVerifiedVerbal verification NINANot reported Verbal verification NINJANot reported 7May 3, 2015

8 Scope of the Problem n Alt-A loans represent 20% of the current mortgage market. About 3 million Alt-A loans totaling $1 trillion are outstanding, reports the Financial Times. n Mortgage Loan Performance by Borrower Type as of Nov. 2008: 8May 3, 2015

9 Comparing Subprime and Alt-A Loans (Jan. 2009) 9 StateTotal Housing Units (2007 Census) Number of Subprime /Alt-A Loans % Owner Occupied Number with prepay- ment penalty in force Number with a high LTV ratio at origin- ation Number with interest only Number with negative amort- ization % with FICO < 600 % with FICO > 660 CA 13,308,346 391,95 9 93.7%98,661115,076112,55635125.1%35.1% 666,38 6 80.6%141,70 2 103,26 3 232,84 6 201,87 1 0.8%84.1% FL 8,718,385 286,80 3 88.7%81,93481,28031,0307738.1%21.0% 231,38 4 60.6%45,63241,17350,47840,1381.6%77.3% IL 5,246,005 120,71 0 90.9%5,07744,3988,4532438.9%19.5% 63,58377.1%4,01418,71816,6877,3481.6%77.6% May 3, 2015

10 Comparing Subprime and Alt-A Loans, cont. 10 State% w/a pay- ment 90+ days past due % in fore- closure % origin- ated in 2007 % origin- ated in 2006 % origin- ated in or before 2005 % with no or low doc % ARM loans % of cash- out refin- ances % ARMs resett- ing in next 12 months % ARMs resett- ing in 12-23 months % ARMs resett- ing in 24+ months CA 14.9%12.6%16.2%41.5%42.3%44.6%68.3%59.0%15.8%3.5%4.7% 9.6%7.7%25.2%37.9%36.8%82.9%70.0%46.0%4.3%6.1%38.3% FL 11.7%25.7%18.1%45.1%36.8%41.4%64.6%57.7%18.0%3.4%2.8% 7.6%19.2%22.3%41.9%35.7%79.6%57.1%40.4%4.4%9.0%35.2% IL 12.0%15.2%16.3%37.3%46.3%34.9%73.0%55.0%17.4%5.7%2.6% 4.8%8.9%22.2%36.5%41.3%73.6%50.6%31.3%6.7%12.4%43.5% May 3, 2015

11 JUMBO Loans n Mortgages exceeding the conforming loan limits set by the Office of Federal Housing Enterprise Oversight, and thus not eligible to be purchased, guaranteed or securitized by Fannie or Freddie. n Conforming loans top out at $417K in most parts of the country. The stimulus package raised the limit from $625K to $729,750 in high-cost areas such as parts of CA, NY and HI. u The median home price in San Francisco and NYC is $600K. n About 4% of all borrowers have non-conforming loans, estimates First American CoreLogic. That %age rises in states like CA, at 17%, and NY, at 8%. n Since 2007, the interest rate difference between conforming and JUMBO loans has been about 1-2%. Before that, it averaged about 0.2%. n Last month, “about 2.57% of prime borrowers who took out jumbo loans last year were at least 60 days delinquent. They got to that level within 10 months, the fastest rate since at least 1992.” —Bloomberg 11May 3, 2015

12 12 Who regulates? n Mortgage lending in the United States is subject to a diverse patchwork of regulations. n Most regulations are found in state law, or the common law n Federal regulatory agencies operate on top of state law : u The Federal Reserve u The FDIC u The Office of Comptroller of the Currency u The Office of Thrift Supervision u The Federal Financial Institutions Examination Council

13 May 3, 201513 The Truth in Lending Act n Also known as Regulation Z n Its purpose is to “promote the informed use of consumer credit by requiring disclosure about its terms and costs.” n Requires disclosures about the loan’s APR, fees, points, term and pre-payment options. n Prohibits refinancing a mortgage within 1 year, unless “the refinancing is in the borrower’s interests.” n Prohibits lending without regard to the consumer’s ability to repay. n There is a presumption that the Act has been violated if the lender engages in a “pattern or practice” without verifying and documenting the borrower’s income.

14 May 3, 201514 The Homeownership and Equity Protection Act n Passed in 1994, this amends the TILA for certain high-cost loans. n It applies to: u Any first lien with an interest rate 8 points (10 points for second liens) higher than a comparable treasury bill. u Or any mortgage with fees higher than $583 or 8% of the loan amount. n It prohibits: u Balloon payments for loans with less than 5 year terms. u Negative amortization u Most pre-payment penalties. u Disguising high-cost loans as home equity loans. n It does NOT prohibit steering borrowers into more expensive loans. n As high as 61% of sub-prime borrowers would have qualified for prime loans.

15 May 3, 201515 The Community Reinvestment Act n Passed in 1997, its purpose is to encourage banks to “meet the credit needs of the local communities” while maintaining “safe and sound operations.” n In practice, this amounts to a prohibition on “red lining.” u Banks would draw lines on the map around neighborhoods where they would not lend. u The Act requires banks to meet the needs of “low-and-moderate income neighborhoods.” u As well as the needs of women and minorities. n Only applies to deposit-taking institutions. n That means the CRA did not apply to many of the largest sub-prime mortgage originators, such as Countrywide and Ameriquest.

16 May 3, 201516 The Financial Benefits Worksheet n Designed to ensure compliance with the TILA’s prohibition on loans that are not in the borrower’s interests. n Add points for benefits such as: u Reducing monthly payment. u Reducing interest rate. u Cash out exceeds points and fees by more than 2 to 1. n Lose points for harms such as: u Points and fees exceed cash out. u Re-financing loan within 1 year. n Could not approve loan with a score below 3, but in practice, scores of 1 and 2 were quite common.

17 Mar. 5, 2009 Consumer-side Fraud 17 Appraisals n Governed by Federal and State law: u Financial Institution Rescue, Recovery, and Enforcement Act (FIRREA, 1989) w Title XI: Real Estate Appraisal Reform Amendments Created Appraisal Subcommittee, which set national appraiser standards matching those created by USPAP (an ad hoc group made up of appraisal professionals organizations) States still have a lot of leeway

18 Mar. 5, 2009Consumer-side Fraud18 n Certification and Licensing Required u States set the specifics w Training varies from 75 to 165 hours w Tests may be state-run or given through qualified organizations w Different categories of appraisers based on training and experience w Appraisers must renew their certification every two years w Guidelines require use of comparable property nearby to help set values, plus home inspection, written report

19 Mar. 5, 2009Consumer-side Fraud19 n Fraud Easy to Do, Hard to Catch u Skewed incentives w Lenders and mortgage brokers often required buyers and owners looking to refinance to use one of their appraisers w Appraisers paid per eval, need to keep lenders happy to keep business w In competitive market, consumers and lenders wanted high valuations u Fines for violations, but little oversight w Complaint required for investigation

20 u Appraisers lie about property or never visit u Lenders send e-mails and faxes explicitly telling appraisers to increase valuations Mar. 5, 2009Consumer-side Fraud20 Condo appraised at $275,000 for having extensive renovations, including Brazilian hardwood and granite countertops. Source: FBI 2007 Mortgage Fraud Report  Fraud Often Shameless

21 Mar. 5, 2009Consumer-side Fraud21 n Recent (Dubious) Reform: Home Valuation Code of Conduct, Effective May 1, 2009 u Required for business with Fannie and Freddie u Championed by Andrew Cuomo after NY investigations into WaMu, others u Sought to lessen lender influence over appraisers u Problem: Empowers intermediaries called Appraisal Management Cos. that have skewed incentives and little oversight

22 Mar. 5, 2009Consumer-side Fraud22 n Dubious Reform (continued) u Some of the same subprime players are now AMCs w NovaStar Financial, disciplined in 3 states, now an AMC called StreetLinks National Appraisal Service (BusinessWeek, Feb. 5, 2009) u Some banks run their own AMCs w Bank of America, Wells Fargo, for example, have their own AMCs (BW, Feb. 5, 2009)

23 The Consumer Side of the Sub-Prime Mortgage Market Fraudulent Practices

24 FBI Suspicious Activity Reports

25 FBI SARs n Up 31% from 2006 to 2007. (2008 numbers unavailable) n Reports from financial institutions only. n The FBI suspects that lax lending standards led to increased fraud. n Total annual estimated losses: $4 billion to $6 billion (estimated by The Prieston Group)

26 FBI SARs - Reported Losses

27 Fraud Investigations

28 n FBI mortgage fraud investigations at the end of FY 2007: u a 47% increase from FY 2006 and a 176% increase from FY 2003. n 56% of 2007 investigations involved dollar losses of more than $1M. n L.A. led the nation for mortgage fraud SARs (more than 2x as much as the next worst city, Miami)

29 Fraud Schemes n Illegal property flipping n Builder-bailout schemes n Seller assistance scams n Short-sale schemes n Foreclosure rescue scams (the new fad) n Mortgage fraud ponzi schemes n Other lending practices at financial firms

30 Illegal Property Flipping Fraudulent appraisal + straw buyer combine to rip off a bank.

31 Builder-bailout Schemes n Builders fraudulently unload property in a distressed market. n Example: builder has difficulty selling property, so he offers incentives that are not on the loan paperwork. He inflates the value of a $200,000 home to $240,000. The bank gives a mortgage for $200,000, thinking that the lender paid the builder $40,000, creating home equity. n The builder then “forgives” the home owner’s $40,000 down payment and keeps any profits. n The lender has no equity in the home, so it must pay foreclosure expenses.

32 Seller Assistance Scams n Perpetrators find an anxious seller and offer to find a buyer. n Perpetrator finds out how much seller will take. n Perpetrator finds appraiser to inflate home’s value, and negotiates a sale (with mortgage) to a buyer recruited by perpetrator. n Seller receives asking price for home, and perpetrator receives “servicing fee” = difference between seller’s WTA and inflated value. n When the mortgage defaults, the lender is stuck with home that can’t be sold at inflated value.

33 Fraudulent Short Sale n Perpetrator recruits a straw buyer to purchase a property. n Straw buyer secures mortgage for 100% of home’s value. Straw buyer may refinance and obtain $30,000 for repairs. n Perpetrator pockets the $30,000. n Mortgage goes into default. n Straw buyer informs lender of default, and recommends perpetrator as a potential buyer in a short sale. n Perpetrator purchases home before foreclosure in a short sale. n Perpetrator sells property at actual value for a profit, or artificially inflates the value to create an illegal property flip.

34 Foreclosure Rescue Scams n Perpetrators contact individuals in danger of foreclosure, promising help. n Perpetrators secure deed through promise of help and sometimes a series of forged deeds. n Perpetrators strip home of equity or sell the home, pocketing profit.

35 Mortgage Fraud Ponzi Schemes Claims to have originated $810M in fraudulent MBS. Involved in $100M ponzi scheme at Loomis Wealth Solutions. “Apprehended At Border With $70,000 In Cowboy Boots, $1M In Swiss Bank Certificates” (see links) Meet Christopher Warren, age 27. Confessed to large-scale mortgage fraud before fleeing the country.

36 Ameriquest n Nation’s largest subprime lender. n Supported many political campaigns; Deval Patrick was on its board. n Ameriquest customers filed more complaints with the Federal Trade Commission from 2000 through 2004 than did those of two of its biggest competitors combined, the agency said – 466 compared with 101 for Full Spectrum Lending (Countrywide’s sub-prime unit) and 51 for New Century Financial Corp.

37 Ameriquest n Ameriquest employees “forged documents, hyped customers’ creditworthiness and “juiced” mortgages with hidden rates and fees.” n Settlement: $325 million nationwide, $21M in Texas.

38 Ameriquest n In court documents and interviews, 32 former employees across the country say they witnessed or participated in improper practices, including: “deceiving borrowers about the terms of their loans, forging documents, falsifying appraisals and fabricating borrowers’ income to qualify them for loans they couldn't afford.” n “Whatever you had to do to close a loan, that’s what was done,” said Brien Hanley, a former loan agent at the company’s Leawood, Kan., branch. “If you had to state somebody’s income at $8,000 a month and they were a day-care provider, who's to say it wasn’t?”

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