Bank of America in its record-setting regulatory settlement of misrepresentations related to securitized loans acknowledges it and its predecessors bent underwriting rules to the point where there virtually weren't any.
A 30-page statement of facts from the U.S. Department of Justice released as part of the settlement shows how Countrywide and Merrill Lynch, both of which B of A acquired — as well as B of A itself — removed an increasing number of underwriting requirements over time without clear disclosure to investors.
Countrywide, for example, had a policy where branch underwriters could refer loan applications that failed to meet guidelines to a "Structured Loan Desk" that would consider exceptions.
The desk would approve exception requests based on a second set of what it called "shadow guidelines" that allowed underwriters to approve loans with loan-to-value and credit criteria below normal standards.
If an application failed to meet the shadow guidelines, the Structured Loan Desk underwriters could return it to branch underwriters with a "counter offer," essentially suggestions for how the application could be originated using a different loan product or asking the borrower to increase the size of a down payment. The branch underwriter could then decide whether to approve the loan.
In other cases when an application before the Structured Loan Desk didn't meet the shadow guidelines, underwriters could submit it to Countrywide's "Secondary Market Structured Loan Desk." This desk would determine whether the secondary market would buy the loan. If the Secondary Market Structured Loan Desk determined the loan saleable, it would price it and return the application to the branch underwriter for a decision.
Countrywide also asked third parties reviewing samples of loans to consider these underwriting exceptions. Countrywide gave due diligence providers "Seller Loan Program Guides" that reflected the credit attributes of loans the company previous sold into the secondary market. These often allowed higher debt-to-income and LTV ratios than either the branch underwriters or the Structured Loan Desk.
An unnamed executive in a July 28, 2005 e-mail directs the Structured Loan Desk to "the widest extent possible" immediately start allowing exceptions on all mortgages as long as they have a balance less than $3 million.
By 2006, Countrywide had an Extreme Alt-A program, which expanded Structured Loan Desk underwriting parameters in areas like credit and LTV. This program not only encouraged underwriting exceptions, but also removed the need to offset any new risks created by the exceptions.
"The Extreme Alt-A guidelines did not require SLD underwriters to identify compensating factors in connection with underwriting the loans," according to the Statement of Facts.
An April 5, 2006 e-mail from another unnamed executive at Countrywide suggests the company knew the loans were very risky and that the company planned to address that risk by selling them off. The e-mail indicates a second unnamed Countrywide executive had referred to Extreme Alt-A as a "hazardous product." That second executive apparently had wanted "to see a detailed implementation plan which addresses the process for originating the selling these loans such that we are not left with credit risk."
Merrill Lynch didn't seem to be at all concerned that it might be selling loans with a considerable degree of credit risk to the secondary market.
Due diligence providers conducting compliance and credit reviews found as much as 50% of loan samples were not compliant with laws and regulations or applicable underwriting guidelines, lacked the sufficient offsetting compensating factors, or had a loan file missing a key piece of documentation.
Due diligence providers and sometimes whole loan traders re-evaluated some of these loans and "'waived" particular loans into a purchased pool.
A consultant and Merrill's due diligence department asks in an email excerpted in the statement of fact "[h]ow much time do you want me to spend looking at these [loans] if [the co-head of Merrill Lynch's residential mortgage-backed securities business] is going to keep them regardless of issues?"
In representing the quality of the securitized loans to investors, Merrill indicated that originators generally made the securitized loans within guidelines unless there were "compensating factors" that justified exceptions.
These Merrill Lynch and Countrywide underwriting exceptions occurred within the private market, but B of A itself — which acquired Countrywide in 2008 and Merrill in 2009 — made some questionable loans under the auspices of a government program after those acquisitions.
"Review of Bank of America's early default loans indicates that for many loans, Bank of America did not always meet FHA requirements," according to the Statement of Facts. These were Federal Housing Administration-insured loans that B of A originated on or after May 1, 2009. "Reviews of samples of FHA loans originated by Bank of America showed unacceptable rates of material underwriting defects," the statement said.
A notorious example in the Statement of Facts is a $156,491 loan backed by a 24-year old mobile home that contained "numerous unresolved income discrepancies."
"The borrower also was delinquent on his initial loan at the time of closing. In addition the borrower was improperly permitted to roll $12,623 of credit card and auto debt into the new loan. The borrower only made two payments before defaulting on the new FHA loan."
In another FHA loan, the bank "failed to verify the borrower's employment and omitted the borrower's debts from the credit analysis."
Bank of America inherited Countrywide's suite of custom technologies that had been built during its heyday, including a servicing system of record still in use today, and an automated underwriting system called Countrywide Loan Underwriting Expert System, or CLUES. According to the Statement of Facts, when B of A began using the AUS, it "sometimes changed an applicant's financial information and then resubmitted the loans multiple times in an effort to get a CLUES 'accept.'"