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Tuesday, February 24, 2015

Ocwen Wins this Weekend

Shortly after our blog posting went out on Friday evening, Ocwen (OCN) and Nationstar (NSM) and affiliated companies announced two agreements that sent all of their shares higher.




It will be interesting to see if some of them come back today: the reasoning for the bounce isn't immediately clear -- certainly for some of the Ocwen affiliates (AAMC, ASPS and RESI) who might reasonably be expected to miss out on future revenue opportunities as a result of the sale of HLSS.

Or is this just a win-win-win-win-win-win-win?



Ocwen selling MSRs to Nationstar ($9.8 billion of loans). 
Link: http://www.bloomberg.com/news/articles/2015-02-23/ocwen-to-sell-9-8-billion-servicing-portfolio-to-nationstar 

New Residential (NRZ) to buy HLSS: http://www.wsj.com/articles/new-residential-to-buy-home-loan-servicing-solutions-for-1-3-billion-1424692915?mod=yahoo_hs

Friday, February 20, 2015

Serving Up the Servicing Complaints

It's February 20th, and time to update our post from Feb. 20th last year, when we investigated state of the mortgage servicing arena.

Firstly the good news: overall, complaints for the year 2014 are down roughly 12% over 2013 levels.

Non-bank servicer Ocwen has been all the rage of late, and has risen to the most complained-about mortgage servicer out there in 2014.  Meanwhile many of the bank-servicers have decreased their servicing businesses and platforms -- often selling to non-bank servicers -- and with it their tally of complaints!

Notably, Ocwen has settled with the CFPB and related state AGs for alleged misdeeds between 2009 and 2012.  The settlement was to the tune of $2.1 bn, but much of this cost may well be absorbed by investors in RMBS trusts services by Ocwen.  Importantly, though, Ocwen's complaint count seems only to be rising, and is now roughly 70% higher than in was in 2012.

Also of interest, if you look in the list below at the five servicers whose complaints grew fastest between 2012 and 2013, all five of them continued to have complaint growth in 2014.  This unwelcome trends seems not to be abating.  For example, for Select Portfolio Servicing, Inc (SPS) complaints more than tripled from 2012 to 2013.  They're again up another 65% from 2013 to 2014.

For another take on this, see Tom Adams' interesting read in Naked Capitalism, entitled "Ocwen’s Servicing Meltdown Proves Failure of Obama’s Mortgage Settlements."


Tuesday, February 3, 2015

S&P Settles: Now How About that US Bond Rating?

In its settlement with the Department of Justice, S&P has backed off its assertion that the federal lawsuit was filed in retaliation for its 2011 downgrade of US Treasury debt. But the downgrade subjected S&P to a barrage of criticism both at the time and ever since, raising the question of whether the decision was appropriate. My view is that the downgrade was the correct credit decision in 2011, but that it is now time for S&P to restore the US to AAA status.

Since rating agencies earn minimal revenue from sovereign ratings, the downgrade was clearly not in the firm’s short term commercial interest. This speaks well for the sovereign group and senior management at the time: the analysts looked the numbers, decided that the US was no longer a triple-A credit and were allowed to implement and publicize their decision. While we often hear negative generalizations about rating agencies, it is worth noting that these firms are heavily siloed; the behavior of the structured finance group does not necessarily reflect on the work of the sovereign team.

Not only was the downgrade principled, but it was also justified. In 2011, the US debt-to-GDP ratio was skyrocketing, the country had an unsustainable fiscal outlook and it lacked the political will to deal with the imbalance between future revenues and swelling entitlements arising from baby boomer retirements. While the British and Italian governments were able to address population aging by raising taxes and delaying eligibility for social insurance programs, divided government in the US prevented a grand bargain from occurring here.

Further evidence that the US did not merit a top credit rating emerged in October 2013 when both parties engaged in brinkmanship over raising the debt ceiling. Had the debt ceiling not been raised, the Treasury would been forced to prioritize payments. While I believe that the Treasury would have prioritized debt service over other obligations, my confidence in this belief does not approach the 99.9%+ level normally associated with AAA ratings.

So what has changed and why am I suggesting an upgrade? First, after taking widespread blame for the debt ceiling debacle, Republicans have changed tactics. It is now extremely unlikely that they will trigger a similar confrontation when the debt ceiling has to be raised again. Since failure to raise the debt ceiling and failure to prioritize debt service are both low probability events, the chances of both occurring seem to be within the AAA risk band.

More relevant to S&P’s original downgrade decision, the nation’s fiscal long term outlook has changed since 2011. When I say this, I am not referring to the marked decline in headline deficit numbers. The fact that the annual deficit declined from $1.3 trillion in fiscal 2011 to a projected $468 billion in fiscal 2015 is not a surprise. Looking back at CBO’s ten year projection from 2011, the agency estimated a $551 billion deficit for the current fiscal year – pretty close to what we are actually seeing. While politicians from both parties may be congratulating themselves for this improvement, the downward deficit trend is exactly what one would expect from an improving economy. Rising tax revenues and lower unemployment insurance costs – not any major reform – are reducing the deficit. There was no grand bargain, nor is there likely to be one anytime soon.

But two developments since 2011 have greatly altered the country’s longer term outlook: reduced healthcare cost inflation and persistently lower interest rates. Between 2000 and 2007, annual healthcare expenditure growth averaged 8.5%. Since 2009, the rate of growth has averaged only 3.9% and health expenditures have stopped rising as a percentage of GDP. Back in 2011, the decline in health cost inflation could be dismissed as a temporary effect of the Great Recession – but now that it has persisted into the recovery, we apparently have a lower baseline rate. Since healthcare costs are such a large component of future federal spending, less cost escalation in this sector is a very important factor in the long term fiscal outlook. 

Last year CBO projected that in 2039 the US debt/GDP ratio would reach 106% under current law and 183% under a likely set of alternative policies. As healthcare disinflation persists these forecast levels are likely to fall. 

Lower interest rates should also slow the accumulation of debt. After years of recovery and many months after the end of quantitative easing, Treasury rates remain near record lows. Rather than assume that rates will return to pre-recession levels, it now seems more reasonable to assume that we have entered a new normal of ultra-low rates just as Japan did after 1990.

While discussion around government solvency often revolves around a nation’s debt-to-GDP ratio, a better measure is the ratio of interest expense to revenue – because it focuses on the government’s ability to maintain debt service. Just after World War II, Britain reached a debt-to-GDP ratio of 250% but did not default because it faced very low interest rates. If interest rates remain low in the US, the federal government can comfortably service the 183% debt load envisaged by CBO’s most pessimistic scenario.

In 1991, the nation’s interest/revenue ratio peaked at 18% - but there was no discussion of a default. Currently, the ratio is below 8%. My study of fiscal history suggests that a Western style government becomes vulnerable to default once this ratio reaches 30%. While the US can always avoid a default by printing money, it is possible that an independent Fed Chair would refuse to do so, out of fear that the resulting price inflation would have worse consequences than a Treasury default. 

Under the CBO’s most pessimistic scenario, the interest/revenue ratio reaches 46% in 2039, well into the danger zone. But this outcome assumes an average interest rate on federal debt of 4.85%. Right now this average is below 2% and falling as higher coupon bonds mature and are replaced by new low-rate issues. Even if the government’s average financing rate drifts up to 3%, its interest/revenue ratio will remain below the critical threshold.

S&P had good reason to downgrade the US in 2011. If health cost inflation and interest rates had returned to pre-recession historical norms, the case for the lower rating would still be strong. But now that we have entered a new normal of quiescent healthcare cost escalation and low interest rates, it appears that the US is due for an upgrade.

Sunday, January 25, 2015

SEC Shines a Light on Inflated CMBS Ratings


On January 21, S&P settled a number of complaints with the Securities and Exchange Commission as well as two states’ attorneys general.  The issues primarily involved ratings of Commercial Mortgage Backed Securities (CMBS), although the rating agency also paid a relatively small fine for a self-reported lapse in its RMBS monitoring.
The settlements show that the SEC making use of the new regulatory powers it gained under Dodd-Frank and the earlier Credit Rating Agency Reform Act of 2006. While the complaints illustrate the fact that commercial considerations continue to affect credit ratings in the post-crisis era, regulators were able to identify and address (some of) them before another disaster occurred.
The CMBS market is much smaller than RMBS market was in its heyday, so a wave of unanticipated CMBS defaults may not have been enough to trigger another financial crisis on its own.  Nonetheless, it is nice to know that (some) misbehavior was caught early -- so we won’t have to find out.
Another difference between the contemporary CMBS market and the RMBS market of yore is greater competition. Six rating agencies currently vie for CMBS ratings mandates:  the “Big Three” plus DBRS, Kroll and Morningstar.  Neither Kroll nor Morningstar was around when bankers were shopping for higher RMBS ratings a decade ago.
After S&P temporarily suspended CMBS ratings in 2011, its market share position was quickly captured by Kroll. S&P’s subsequent misstep - distorting a Great Depression data set to justify lower AAA credit enhancements – was likely motivated by the fear of being permanently dislodged from the top three in a highly profitable asset class.
Ironically, the SEC enforcement actions, which include a one year suspension of conduit CMBS ratings, will cement S&P’s also-ran status. A takeaway here is one we have warned of many times previously: that more competition results in more ratings shopping by issuers and more pressure on rating agencies to dumb down their criteria - the type of concern that had motivated the Franken Amendment.

Competition in the Market for Single-Asset CMBS
S&P can still compete with the other players in rating single asset CMBS – a category that should worry any observer of the rating agency business. As the name suggests, single asset CMBS deals are collateralized by a mortgage on just one commercial property. The property can be an office building, a hotel or a shopping mall.
Typically investors in AAA structured finance paper have at least two protections:  seniority and diversification. With AAA securities at the top of the heap, collateral defaults usually have to destroy most or all of the value of more junior securities before the AAA holders are impacted. The second protection afforded to AAA structured finance investors is diversification:  the fact that the collateral pool contains a large number of loans whose risk attributes can be expected to offset one another.
Single asset CMBS deals kick this second protection away.  If the one loan backing the deal stops performing and has to be liquidated at a large discount, all investors lose – including those holding AAA paper.  The question in rating these deals is thus a fairly simple one:  what are the odds that the property will suffer a catastrophic loss in value?
According to the Moody’s idealized default probability table, the default probability on Aaa securities should be 0.0001% annually.  For an instrument rated Aa1, the annual default probability should be 0.0006%.  Differentiating between an event that has a 1 in 100,000 probability from one that has a 1 in 16,667 probability is difficult for any mere mortal – even one that happens to be employed by a credit rating agency.
But is it really credible to believe that any given shopping mall has just a 0.0001% chance of a catastrophic decline in value?  A brief review of recent history should refute this notion.
We have already seen one shopping mall devastated by a terrorist incident.  Although this tragedy happened in Nairobi, similar events are possible in the US which has already seen mass shooting incidents at Florida and New Jersey shopping centers.  But shopping malls can easily be laid low without an act of violence.  The closing of an anchor store or the opening of a competing mall can decimate traffic in short order.  And these aren’t theoretical possibilities as one can see by perusing the Dead Malls website.  This site lists over 100 US shopping malls that have closed or become largely vacant in recent years. Indeed, the rise of standalone big box stores like Walmart and the increased popularity of online commerce have placed enormous pressure on the entire shopping mall business.  Earlier this month, large tenants Macy’s and J.C. Penney both announced the pending closure of tens of stores around the country.
With such obvious risks, it’s hard to understand how a security collateralized only by a single shopping mall loan could be rated AAA.  Yet despite previous defaults on AAA shopping mall loans (see below) we continue to see AAA single shopping mall deals in the aftermath of the financial crisis.
Interestingly, the two pre-crisis shopping mall transactions with defaulted AAA securities weren’t single loan transactions – but they were overly dependent on individual loans that went bad.  Bear Stearns Commercial Mortgage Securities Trust 2007-PWR15 contained a loan to Las Vegas’ World Market Center II that accounted for 12.3% of the deal’s collateral pool. The default on this loan, in 2010, together with a large loss on the Aiken Mall in Aiken, SC have proved sufficient to trigger losses on the Aaa-rated AJ class.
CSFB Commercial Mortgage Pass-Through Certificates Series 2005-C2 included an exposure to the Tri-County Mall in Cincinnati that accounted for nearly 10% of its collateral pool. The liquidation of this mortgage at a deep discount eventually inflicted losses on AAA investors.
Despite these cautionary tales, we now have at least seven post-recession deals, with 100% exposure to a single shopping center, carrying AAA senior ratings.  These deals and their associated malls are as follows:
Deal
Mall
Location
AVMT 2013-AVM
Aventura Mall
Miami, FL
BBCMS 2013-TYSN
Tysons Galleria
McLean, VA
BBUBS 2012-SHOW
Fashion Show Mall
Las Vegas, NV
CGCMT 2013-SMP
Santa Monica Place
Santa Monica, CA
COMM 2013-GAM
Green Acres Shopping Center
Valley Stream, NY
MSC 2012-STAR
North Star Mall
San Antonio, TX
MSC 2013-ALTM
Altamonte Mall
Altamonte Springs, CA

If readers are aware of others, please pass them along.

Thursday, December 4, 2014

High Frequency Hiccups

This week has been an interesting one in the world of HFT worries...

Citigroup, somewhat surprisingly, announced the closure of its premier alternative trading system, or ATS, called LavaFlow.  LavaFlow had been the subject of regulatory scrutiny, leading up to a small settlement with the SEC back in July.

Citigroup maintains at least two other ATSs or ECNs, much smaller in size than LavaFlow.  LavaFlow, despite some negative press associated with the July settlement, had gained significant traction recently -- see the table of weekly flow, below -- which makes its closure all the more intriguing.


Citigroup reportedly explained that "Following a recent review of the LavaFlow ECN, we have decided that our capital, resources and efforts would be better redeployed to other areas within Citi’s Equities Division, ..."

Citi had previously spent heavily to get into the game.  We dug up a couple of their multi-million dollar purchases from 2007 and before that, including the $680mm purchase of Automated Trading Desk LLC.  The newly shut down LavaFlow likely took over the reins from Lava Trading, a division bought from Knight Capital back in July 2004, purportedly to "catapult [Citigroup] to a leading position in the electronic-execution arena."

Barclay's dark pool, the subject of one of our earlier posts, continues to grow, although it remains a fair share away from its lofty heights of early June.

Meanwhile the SEC is purportedly nearing the end of a lengthy investigation into the way BATS Global's Direct Edge Holdings LLC exchanges handled customer orders.  Among the concerns are whether all parties were allowed access to the same information about how the order types worked (or would be executed) and the order of execution among various open orders -- and whether they were indeed executed as they were advertised to be executed.  

We'll blog more on this issue in the coming months, as order types are an area of significant regulatory investigation, in addition to the focus on how or where brokers choose to execute their trades, as we covered previously.

Thursday, November 20, 2014

California Municipal Default Probabilities and a Reply to Lumesis

Earlier this month, we published default probability scores for 490 California cities and counties using a municipal scoring model I developed during previous research. The scores and a description of the model can be found on the California Policy Center’s website. The methodology – which relies solely on financial statement data – is further justified in this academic paper.

The accompanying CPC study identified thirteen cities that had heightened risk of default or bankruptcy. The median city in the universe had a one year default probability of 0.11%, while cities in this highly distressed category had default probabilities of 0.74% and up.

Our findings were reported in the Los Angeles Times and produced rebuttals from two of the cities on the distressed list – Compton and San Fernando.

We also received a rebuttal from an unexpected source: a municipal bond analytics provider named Lumesis. In a November 10th commentary, they compared our county default probabilities to their Geo Scores, which measure relative economic health. Finding little correlation between the two sets of results, Lumesis concluded that our model “needs improvement”.

But this conclusion begs a fundamental question: are municipal bond investors better served by socioeconomic metrics like those provided by Lumesis or by metrics that rely upon financial statement data? Even our colleagues at Lumesis appear to recognize that economic health is not conclusive, noting the “ability of bad management to create a mediocre credit from a strong economy.”

Fortunately, we have some empirical evidence at hand to assess the relative strength of fiscal and economic predictors. Back in December 1994, Orange County California filed for bankruptcy. Thanks to the magic of the MSRB’s EMMA system, I was able to locate the County’s 1993 and 1994 financial statements –as appendices to old offering documents.

For the reader’s convenience, I have posted the statements here and here. Next I input relevant numbers from the statements into my fiscal scoring tool which you can see here and in the screenshot below.


The result was a default probability of 0.85%, well above the current median and comparable to the worst performing entities in the current universe. As of June 30, 1994, the County had a negative general fund balance and had experienced declining year-on-year governmental fund revenues – two harbingers of trouble we have seen in other default and bankruptcy cases.

Would the Geo score have singled out Orange County in this way? Perhaps Lumesis can run the numbers for us and report back. Short of that, I note that according to 1990 Census figures, Orange County had the 5th highest per capita income among California’s 58 counties. So it would seem that a methodology based solely on economic health (like the Geo score) would have missed this particular calamity.

Monday, November 17, 2014

Broker Order Routing, in a High Frequency Trading World

The brokers/dealers have had their fair share of scrutiny among the recent revelations in the high-frequency trading (HFT) saga.

Among the questions being asked are whether Brokers are routing orders to whichever venues pay them most handsomely for the flow ... and potentially not to whichever venue provides best execution for their clientele.

We previously covered the discount brokerage world in which TD Ameritrade is being sued
(see for example Gerald J. Klein, on behalf of himself and all similarly situated v. TD Ameritrade et al, 14-cv-05738) for their order routing decisions.

You may recall that shortly after New York's AG filed a complaint against Broker Barclays in June 2014 for issues relating to its dark pool, Broker Barclays saw a precipitous decline (of roughly 66%) in trading within its own dark pool.   Some of that has returned, but while the tide has turned and the "true" nature of trading activity in some of the dark pools has been revealed, others like Wells Fargo have had to shut their dark pools: each venue requires a certain amount of trading activity to be relevant, or advantageous.

Brokers' Routing Decisions - Where to Send the Trades

Today we're covering a little of what we've found in the brokerage world itself: the changing nature of Brokers' routing orders to their own dark pools. We're spent some time digging through order broker routing information in their quarterly Rule 606 reports, and found some interesting changes in the regularity with which some of the large brokers are routing "non-directed" orders -- orders for which the client hasn't specified a specific execution venue.

The data are sparse, and the time periods short, but it seems like Credit Suisse (which has the largest dark pool) is generally substantially increasing its order routing to its internal dark pool, while Goldies and Broker Barclays are generally decreasing their self-routing decisions.


Monday, November 10, 2014

Minimum Authorized Denominations: A Truly MAD Restriction Now Enforced by the SEC

Last week, the SEC sanctioned thirteen brokerage firms for selling individual investors Puerto Rico General Obligation bonds in denominations less than $100,000.  The action is part of a wider SEC effort to protect municipal bond investors, which has also included pressuring issuers to post their continuing disclosures on EMMA and censuring issuers that have improperly reported their pension obligations.

While the SEC’s efforts to enforce transparency are welcome, the enforcement of minimum denominations is, in my view, counterproductive. Before I explain why, I should begin with the necessary disclosure:  I am an owner of Puerto Rico General Obligations, so I clearly have a financial interest in taking the view I am advocating.  However, it is not a very large financial interest – probably not large enough to justify the time spent writing this piece.

You see, I own an “odd lot” of Puerto Rico GOs.  In fact, my purchase of $25,000 face value Puerto Rico bonds was legal in January 2014 when I made it, and would still be legal today. The $100,000 Minimum Authorized Denomination (MAD) restriction only applies to bonds issued in 2014 (and probably thereafter).  An individual investor can still purchase smaller amounts of PR GOs that were issued prior to 2014.  Many of these bonds mature in the 2030s, thus presenting risk characteristics very similar to the March 2014 MAD bonds, which mature in July 2035.

The reason for this discontinuity is that the SEC is enforcing a restriction in the Commonwealth’s bond resolution that authorized the issuance of the 2014 securities.  That resolution includes the following:

The Bonds … shall be issuable … in the minimum denomination of $100,000, with integral multiples of $5,000 in excess thereof; provided, however, that upon receipt by the Registrar from the Secretary of written evidence from any of Fitch Ratings, Moody’s Investors Service, or Standard & Poor’s Rating Services that the Bonds have been rated “BBB-,” “Baa3,” or “BBB-,” or higher, respectively, then the minimum authorized denomination of the Bonds shall be reduced to $5,000.

Prior to 2014, Puerto Rico carried investment grade ratings from the big three credit rating agencies, so earlier resolutions apparently did not need to incorporate the $100,000 denomination floor. Thus, investors can and do continue to trade these securities in smaller pieces as anyone can see on EMMA.

Buying older PR bonds is not the only way for an individual investor to evade the new MAD requirement. Since many municipal bond funds own PR GOs, one can gain exposure to this asset by purchasing shares in any one of these funds. Not only can the investment be less than $100,000 in most cases, but the exposure to PR will only be a small fraction of the fund’s overall exposure.
But why should investors have to pay mutual fund overheads to add Puerto Rico exposure to their portfolios?  It should be possible to simply buy a small amount of PR bonds directly as part of a diverse municipal bond portfolio or multiple asset class portfolio.

The MAD restriction begins to foreclose that option to all but the wealthiest investors. Imagine, for example, an accredited investor with $5 million in investable funds.  Let’s say that, after reading all of Puerto Rico’s voluminous disclosures, she decides to take some risk on Puerto Rico, but to limit this risk to 1% of her portfolio.  If worst comes to worst, and Puerto Rico repudiates its bonds, she will still have $4.95 million – enough to survive. But, since 1% of $5,000,000 is only $50,000, that investment choice is not available for the 2014 and future bonds.

Many hedge funds and other institutional investors thought Puerto Rico’s March 2014 bonds to be a sensible investment, concluding that the 8.7% yield more than compensated them for the Commonwealth’s heightened risk. That issue was five times oversubscribed, with hedge funds being major participants.  The question is why anyone else who shares this view must be compelled to pay a hedge fund “two and 20” to express this conviction.

Besides being discriminatory and easily circumvented, the MAD restriction is just bad public policy. Investors can buy small denominations of penny stocks which frequently become worthless, so why single out PR General Obligations as something from which the “little guy” must be protected? It furthers the false narrative that municipal bonds are an especially risky asset class, when, in fact, quite the opposite is true.  No US city, county, state or territory filed for bankruptcy in the last year.  How does that compare to the corporate sector?

Municipal bonds were recently proscribed by regulators from the list of high quality liquid assets that banks could hold.  The major justification for excluding munis was their lack of liquidity. Regulatory actions that scare investors away from municipal bonds and impose floors on trade sizes simply reinforce the lack of liquidity in the market.  This, at a time when we hear that Republicans and Democrats agree on the need for greater infrastructure investment – investment that could be partially financed by municipal bonds.

Finally, the MAD restriction uses credit rating agency assessments to determine whether the bonds are “junk” and thus subject to the denomination floor. Using bond ratings to distinguish between investment grade and non-investment grade securities goes against the spirit of Dodd Frank, which sought to cleanse regulations of their reliance on credit ratings. This aspect of Dodd Frank is one of the few parts of the controversial law that seems to have elicited bipartisan support.

While it is gratifying that the SEC is trying to protect municipal bond investors, we need to be sure that the rules being enforced actually contribute to investor welfare. Puerto Rico’s MAD requirement is a restriction that is easily circumvented, that penalizes individual investors, that reduces municipal bond market liquidity and that reinforces the credit rating oligopoly.  For these reasons, it fails the test of being a rule worthy of commanding enforcement resources.

Friday, October 24, 2014

San Francisco Mortgage Eminent Domain Plan - A Look at the Target Properties

On October 28, San Francisco Supervisors will consider forming a Homeownership Stabilization Authority with the city of Richmond. The Authority would have the ability to condemn residential mortgages as a way of keeping financially distressed owners in their homes. The focus would be on underwater properties with mortgages held in private loan securitizations; federally owned or guaranteed mortgages would be excluded.

I was surprised to learn that San Francisco has a problem with underwater mortgages. According to Zillow, the median home price in the City by the Bay peaked at $822,000 in 2007, bottomed out at $667,000 in late 2011, and has now reached $979,000 - 19% above the pre-recession high.

The Board of Supervisors' resolution states that San Francisco has approximately 300 underwater mortgages in private loan securitizations and that these are concentrated in "historically Black, Latino and Asian working class communities." 

Supporting documentation in the Supervisor's agenda packet includes a memo from ACCE Action stating that 279 San Francisco mortgages have LTV (loan-to-value) ratios of 107% or more. The memo breaks these mortgages down by zip code - with the highest concentrations in 94112 and 94124.

These two zip codes are in less affluent sections of the city where real estate prices have not performed as well as they have in the "hottest" neighborhoods.  That said, property in these zip codes is not seriously depressed by historical standards. In 94124 - which has seen the worst price performance - Zillow shows a median home value of $609,000 compared to a pre-recession peak of $635,000. Further, Zillow forecasts that within a year, the median will reach $636,000 - roughly equaling its previous peak. In 94112, Zillow only reports selling prices per square foot, and these have fully recovered from the recession.

Looking Beneath the Cover - Examining the Data

To learn more about San Francisco's underwater mortgages, I filed a public records request with the Mayor's Office of Housing and Community Development.  They provided the 279 mortgages in an Excel file along with other lists and correspondence.  There is a lot of material to work through, but I thought I would share some initial findings.

First, unlike in the case of Richmond, there are no property addresses, so it will not be possible to map the properties unless and until the list is matched against a public records database. CoreLogic and some other companies perform this sort of matching, but normally charge substantial fees for doing so.

Still, the file does contain information that should raise some eyebrows. For example, 47 of the 279 properties have current estimated values in excess of $1 million. Many of these are 2-4 unit properties, but there are 18 condominiums and single family houses in the million dollar-plus category. One home has an estimated value of $8.65 million after being originally appraised at $12 million.

Perhaps the biggest surprise is the number of loans that have been modified. According to the Board's resolution, homeowners whose loans were sold into private label securitizations "are unable to access many of the foreclosure prevention programs available to other struggling homeowners". Yet the data tell a different story:  129 of the 279 mortgages have had some kind of modification, such as principal reduction, interest rate reduction or additional time allowed for repayment. In many cases, multiple features of the mortgage were modified.

The resolution also notes that the vast majority of private label securitizations have "predatory" features. The features identified as predatory include negative amortization, interest only, balloon payments and adjustable rates. While I agree that negative amortization loans can be objectionable, I don't consider all these attributes to be necessarily predatory. Like many financial professionals, I have taken out ARMs on multiple occasions, and I never felt exploited. Indeed, since base interest rates are sharply lower than they were in 2007, it is likely that most ARM borrowers are paying little more than the original interest rates they incurred at origination. Of the 279 underwater San Francisco mortgages, 203 bear current interest rates of 4% or less - hardly predatory. Half of the universe consists of ARMs and another 49 are fixed rate.

Finally, it is worth noting that the vast majority of the underwater homes have multiple liens. In 244 of the 279 cases, the Combined LTV Ratio is different from the LTV Ratio, suggesting the presence of second and third mortgages. If one of the other liens is federally backed, the Authority may be challenged to liquidate the private mortgage while leaving the government mortgage intact. 

Undoubtedly, some San Francisco homeowners were sold predatory mortgage products by unscrupulous financial institutions. In some cases, these individuals may still be underwater because their homes were aggressively appraised or they live in neighborhoods with less robust price appreciation.

That said, we have yet to see a pool of mortgages that reliably falls into these categories. If the City cannot identify a set of mortgages that is fit for condemnation, the joint powers authority might benefit some undeserving homeowners - like the one with the $8.65 million house mentioned earlier. Further, if only a few dozen mortgages really do need to be liquidated, it is likely the City can find more cost effective means of doing so than through the use of eminent domain.

Wednesday, October 22, 2014

Ocwen Letter Spooks the Market

Ocwen just can't seem to get a break.

After a rough first 9 months to the year -- stock was down 53.5% YTD as of Monday's close -- the release of NY State Fin. Dept. Superintendent Benjamin Lawsky's letter to Ocwen's general counsel sent the stock tumbling again. 

Our last coverage was back in February, after Ocwen had agreed to a settlement fee, with the CFPB, of $2.2 billion, for its missteps from 2009-2012.  We showed the potential for this litigation expense to grow, as there were even more complaints in 2013 against Ocwen than in 2012.

The stock is now down 24.8% from Monday's close: Lawsky's letter included some powerful language, some of which could have repercussions to Ocwen beyond the immediate scope of the letter.


Lawsky's previous letter to Ocwen, dated April 2014, brought to the fore what Lawsky's office saw to be a "particularly troubling issue" - "the relationship between Ocwen and Altisource Portfolio’s subsidiary, Hubzu, which Ocwen uses as its principal online auction site for the sale of its borrowers’ homes facing foreclosure, as well as investor-owned properties following foreclosure." 
Hubzu appears to be charging auction fees on Ocwen-serviced properties that are up to three times the fees charged to non-Ocwen customers. In other words, when Ocwen selects its affiliate Hubzu to host foreclosure or short sale auctions on behalf of mortgage investors and borrowers, the Hubzu auction fee is 4.5%; when Hubzu is competing for auction business on the open market, its fee is as low as 1.5%. These higher fees, of course, ultimately get passed on to the investors and struggling borrowers who are typically trying to mitigate their losses and are not involved in the selection of Hubzu as the host site.
In August, Moody's downgraded Ocwen's primary servicer and special servicer ratings - and left both assessments on watch for further downgrade.  The shareholder class action complaints started to trickle in in August, and by September 2014 a handful of shareholder complaints had been filed.  (See for example NORBERT TUSEO, Individually and on Behalf of All Others Similarly Situated v. OCWEN FINANCIAL CORPORATION, RONALD M. FARIS, JOHN V. BRITTI and WILLIAM C. ERBEY)

The recent information about Ocwen's potentially backdating thousands of foreclosure documents is relevant not just insofar as it affects the nature of all current shareholder litigation, but insofar as Ocwen is being sued by mortgage borrowers, directly, and by mortgage market players and investors.  Crucially, Ocwen's servicing performance can be critical to the performance of RMBS securities.

For example, at least five third-party complaints have recently been filed by Nomura Credit & Capital, Inc. against, among other co-defendants, Ocwen as the servicer of the RMBS trusts. The complaints argue that Ocwen's underperformance has harmed the plaintiff, or that the breaches ought alternatively to relieve Nomura of certain of its duties to the trust.  The following excerpt comes from Nomura Credit & Capital, Inc. v Wells Fargo Bank, N.A., and Ocwen Loan Servicing, LLC, filed 8/11/14.


This public embarrassment can make it more difficult for Ocwen to defend itself in the existing and future litigation as it will inevitable have suffered a deterioration in reputation capital.  Last but not least, it will likely further hinder any near-term hopes Ocwen may have had of buying additional mortgage servicing rights (MSRs), and expanding its business.