New 'Buckets' of Reasons for Borrowers Who Default
Three main reasons for default have emerged from an effort by a loss mitigation firm headquartered here to help Wall Street get a fix on pools of nonperforming mortgages.
The "majority of issues with borrowers fall into three major baskets, but they are new baskets we've never seen before," said Jeffrey Taylor, a partner in Digital Risk, which has been hired by several of the nation's largest securitization firms to assess the depth of their problems with delinquent and nonperforming assets, particularly subprime loans.
Until the recent debacle in the nonprime sector, it was commonly accepted that the major reasons for default by borrowers were divorce, unemployment and major illness.
But based on its investigation into what sparked the current spate of problem loans, Digital Risk says those factors now take a backseat to overextended investors, declining values and out-and-out fraud.
Some investors are so "stretched financially" that they are "underwater" and simply unable to make their payments, Mr. Taylor said.
In a number of other instances, housing values have fallen by 10% or more between the time the underlying property was appraised for the mortgage and the time borrowers stopped making their monthly payments. And the reason for the decline is not attributable solely to a declining market.
"Our investigation reaffirms what everybody has been saying, and that's there are an awful lot of inflated appraisals out there," Mr. Taylor said.
The third new basket is what the Digital Risk co-founder calls "related parties." This includes brokers, appraisers and loan officers who have worked together to pull the wool over lenders' and their investors' eyes.
"It is not uncommon to see the same group of people doing bad loans," Mr. Taylor said. "If it's not the company per se, then it's the same people within the company. But if the company didn't have protections in place to guard against these things, then in my mind, it's the company's fault."
Citing confidentiality agreements, Mr. Taylor would not reveal the name of Digital Risk's clients. But he said his firm has been hired to assess what went wrong with $30 billion worth of mortgage-backed securities.
"Everything has happened so fast [our clients] don't have the infrastructure to wrap their hands around the problem," he said. "Everyday we're getting in new files and signing up new clients. We're in a triage mode right now. Everybody is in a great panic."
Mr. Taylor said Wall Street is trying to get as much information as possible so solutions can be developed that are beneficial to investors as well as lenders.
"They realize that they are a big part of the problem because they created these products," he said of the interest-only loans, payment-option mortgages and other so-called toxic mortgages that have gotten many borrowers into trouble.
"They also realize that if they force lenders out of business (by requiring them to re-purchase delinquent loans), they have nothing. The message they want to convey to the investors who bought the bonds that are now being downgraded is that 'we know we erred, so here's the methodology we're going to use to project how new loans are going to perform during the next cycle.'"
Digital Risk is assessing mortgage securities, including pools with no loan histories, with a new, patent-pending technology based on what managing partner Peter Kassabov explained as "the same negative convexity methodology previously used to calculate the impact of early payment defaults of securities yields."
Until now, according to Mr. Taylor, securities have been priced based largely on trying to predict the impact of early pre-payment risk, and defaults were secondary in that process. "This new methodology is going to stabilize the market," he predicted.
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