Friday, May 13, 2005

Subprime Loans Become Legal Liabilities

The lax lending standards are starting to show up in the courts, as a mortgage insurer is sueing a subprime lender. " PMI Mortgage Insurance alleges that it was misled by NovaStar when PMI set the terms on insurance for 6,300 loan made from 2000 to 2002. The loans in question, known as 'stated income loans,' require borrowers to truthfully state their income without providing documentation."

"(In) a March 9 deposition by NovaStar President Lance Anderson..said if the income 'seems reasonable, then we're comfortable not verifying it and not using it in our underwriting decision.' However, under further questioning he said that stated income is 'not a material part of the underwriting decision.'"

"PMI's suit cited testimony of Rachel Jones, NovaStar's director of corporate credit, who said the purpose for asking the borrower to state income is 'because our investors require the borrower's stated income.' By investors, she says she was referring to the likes of Fannie Mae, which buys loans when they're packaged and sold as part of a securitization."

"The counter-suit is the latest in a string of legal actions between NovaStar and PMI. NovaStar sued PMI, alleging that the insurer had breached its contract by not covering claims on 10 loans that went belly up. Five of them were stated-income loans. NovaStar then amended its original suit to include 12 additional mortgages, five of them stated income, on which PMI refused to pay. NovaStar says that last year it sold recourse loans that have an outstanding balance of $11.4 billion, up from $6.4 billion the year before."


At 7:36 AM, Anonymous boulderbo said...


think about it. fannie is reselling this stuff to investors who treat is like it's treasuries because it's a gse product. as the same time their low yield portfolio is sinking further as short term rates cause an inverted curve. very enronesque.

At 7:53 AM, Blogger Ben Jones said...

The MBS bust may be bigger than housing, and certainly just as damaging to the economy.

A spooky Friday to be sure!

At 9:02 AM, Anonymous Anonymous said...

Time to start shorting mortgage insurers?

At 9:15 AM, Blogger Ben Jones said...

Watch MBIA, AIG, PMI (those aren't neccesarily the market symbols)

At 9:16 AM, Anonymous boulderbo said...

i think the better play would be firms like novastar, new century, etc. mortgage insurers are a pretty careful group, actuarial types. they actually collect money from many borrowers to pay on claims later. on the other hand nfi is selling for around $40 because of a 15% yield, a great selling point to grandmothers around the country. just because their funding the dividend with raised money is no reason not to buy the stock. when they fall they won't go to $20.00, they'll go to $.20 just mho

At 9:17 AM, Anonymous Anonymous said...

The rats are starting to fight, clawing their way off the sinking ship.

The insurance companies couldn't be that ignorant. It's been obvious that oversight on these loans has been pathetic for years now. That 80/20 crap has been going on in plain sight too.

At 10:30 AM, Anonymous Anonymous said...

This article has some gems. Thanks for posting it.

Here are some of my favorites:

"PMI has cut back on insuring all kinds of subprime loans from all lenders, claiming that it found an increase in fraud among defaults."

Yes, there is a huge surge in mortgage fraud. I know an FBI agent in the Financial institution Fraud division, and she says that fraud is rampant in stated income/no-doc/lo-doc loan apps, as well as rampant appraisal fraud and insider gangs bidding up properties.

"In its SEC filings, NovaStar warns that in the ordinary course of business it sells loans that it would have to repurchased if "a defect occurred in the loan origination process" and if there had been a guarantee to cover investor losses should origination defects occur. "Defects may occur in the loan documentation and underwriting process, either through processing errors made by us or through intentional or unintentional misrepresentations made by the borrower or agents during those processes. If a defect is identified, we are required to repurchase the loan."

NovaStar says that last year it sold recourse loans that have an outstanding balance of $11.4 billion, up from $6.4 billion the year before. Defect-related repurchases, it adds, have been insignificant, and "as such, there is minimal liquidity risk.""

This is astounding. $11.4 billion in recourse loans? Imagine what would happen if even 10% defaulted (a very possible scenario in a market crash). $1.14 billion in non-performing assets = bank failure, in my view. Extrapolate this out to the rest of the banking industry.

Fannie, Freddie, and Ginnie residential MBS all have recourse I believe. If the mortgages go into default they get kicked back to the originating banks to deal with.

Rising interest rates mean people get squeezed on payments and appreciation slows. As payments on I/O and ARMs go up, marginal buyers begin to default. Those loans sit on the banks' balance sheets. House supply increases. As appreciation slows, speculators are faced with either renting for less than their carry costs or selling to lock in gains. Speculators sell. Supply increases even more. Prices begin to decline as supply swells. As prices decline, owners go upside down on LTV. More owners default. New bankruptcy bill prevents people from walking as easily as they could before. More owners default. Suply balloons, and prices drop rapidly as everyone tries to run for the exits. Banks can't sell non-performing assets since potential buyers are afraid to get into the market and wait out the drops.

S&L scandal part 2.

The worst part is that I work at Countrywide, and I will probably lose my job.


At 1:35 PM, Anonymous stock jockey said...

Watch out when shorting the mortgage players. They throw off big dividends (even though they are paid out of raised capital and not income). If you are short, you are responsible for paying off the dividend. So if you are short NFI which throws off 15% right now, even if it fell 15% over the next year, you'd only break even.

But I agree. They are going down. A company like NFI, in a credit crunch, will go to zero. The trick in shorting is that the plunge will happen nearly overnight. If you look at a chart over the past year, the stock climbs for months on low-volume, then plunges in a few days.

If you are not short for those few days, you can't make any money.


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