Foreclosure and distressed property topics

NEW -> Contingent Buyer Assistance Program
<em>"Why put your renter to spend the money in moving, when he's just going to get kicked out? It's not right, I said. He said right has nothing to do with it."</em>





If I am understanding your correctly, this guy is knowingly going to rent skim, a crime in California. Perhaps someone can go kick this guys ass...
 
From<a href="http://en.wikipedia.org/wiki/Structured_finance"> Wikipedia:</a>





Definition

<p>The Global Financial System provided a definition of structured finance in their January 2005 report, "The role of ratings in structured finance: issues and implications". It stated "Structured finance instruments can be defined through three key characteristics: (1) pooling of assets (either cash-based or synthetically created); (2) tranching of liabilities that are backed by the asset pool (this property differentiates structured finance from traditional “pass-through” securitisations); (3) de-linking of the <a title="Credit risk" href="http://en.wikipedia.org/wiki/Credit_risk">credit risk</a> of the collateral asset pool from the credit risk of the originator, usually through use of a finite-lived, standalone special purpose vehicle (SPV)."</p>




I don't foresee the end of asset pooling or tranching, but I see could SIVs going the way of the dodo - for awhile. I suspect the number of tranche deals to be reduced significantly, as well as synthetic asset pool transactions. Of course, all this depends on whether any of the existing ratings agencies can get their reputations back, and/or if a new reliable ratings agency is created. The whole sector is going to be in a world of hurt for awhile. Possibly adding insult to injury will the Supreme Court's ruling on the deductability of muni bond interest payments.
 
<p>As far as I know, rent skimming isn't a crime in Florida, never heard the term until I started reading this blog.</p>

<p>But of course fraud is a crime. The economic crime prosecutors have enough on their hands and will probably not go after this sort of thing. My hub was an economic crimes guy before he went back into science. He was more interested in persecuting, ahh, prosecuting people who dumped toxic stuff into the aquafer, and nasty nurses aides who stole money from little old ladies.</p>

<p>So many crimes. . . . so little time.</p>
 
Realistically, structured finance itself is not the problem. The failure of the ratings agencies to properly identify and evaluate the risk to the cashflow stream gave investors a false sense of security. Of course, these ratings agencies are only going to look at historic default rates on the products. They don't take a holistic view of the entire system to evaluate whether or not the default rates would change based on various conditions in the market. Or, if such an analysis is done, they discount the risk of loss by saying there is only a small percentage chance of it happening. In either case, the actual risk is severely underestimated.





I can relate a similar experience with stock trading. The style of trading I use in stocks for longer term holds has a very high percentage profitable. One would think that trading such a system would have very low risk. In the real world, the losses all tend to happen at the same time when the market violently corrects. If you have loss exposure during these time periods, you are due for a drawdown much greater than should be theoretically possible.





One of the things I think you will see come out of this mess will be a new field of financial analysis based on systems and game theory. I remember recently there was a local analysis who was trying to start a rating system to evaluate the risk of decline in housing markets to be used as an an additional risk measure lenders could apply to loan analysis. If such a system were in place and functioning properly, overvalued markets such as ours would see increasing equity requirements as prices began to rise. This would have the effect of reducing speculation by pushing the risk onto the speculator. It would also make bubbles less inflated because they won't be fueled by 100% financing. This won't prevent bubbles, but it will prevent the risk of collapse of our banking industry because of it.
 
<p>This would have to be done on a "global" scale. Local Fla. builders tried to protect themselves by requiring 30% down for investors. They bought anyway, and I think most have lost their entire 30%. The builders did not foresee that things might go down 40% (or, whatever), or that speculators would not be discouraged by this huge deposit. But it's certainly a good idea.</p>

<p>Especially if the brakes were put on early before the psychology got out of hand.</p>

<p>How helpful would past history be? Of course, It's all we have. </p>

<p>Did the rating agencies actually have enuf information (or was it even available) in order to evaluate this stuff? I have no clue as to how they would do this, assuming they were honest and not affected politically. Is there something on say, Calculated Risk that says how this is done?</p>

<p>Humm, maybe it's proprietary.</p>

<p> </p>
 
Hitting the high end (from the LA Times):


<em>


In California, foreclosures are concentrated largely in outlying areas such as the Inland Empire, the Antelope Valley and the Central Valley, where swarms of people with modest incomes used loans with low "teaser" rates to finance their purchases. But data released Friday show that the pain is spreading to higher-priced neighborhoods in Los Angeles and Orange counties and is even trickling into wealthy communities.





In four Newport Beach-area ZIP Codes, for example, there were 11 foreclosures in the third quarter, up from just three in the same period last year. There were seven foreclosures in Bel-Air, and none a year ago.





"It's definitely increasing," said Joyce Essex, a Coldwell Banker real estate agent based in Beverly Hills who specializes in selling foreclosed homes.</em>





<a href="http://tinyurl.com/2h4eqa"> Whole article here.</a>
 
Okay I'll try to explain the chart that IR posted:





Left hand side:





1) Lender provides cash to the borrower (they vet the borrower through a loan broker or directly). The borrower signs documents that explain the conditions of the loan with regards to interest rate, points (money paid at the beginning of the mortgage), prepayment penalties (money you pay for paying your loan off before a certain date), the term that the loan remains fixed if it is an adjustable rate product, and the index used to calculate payments. On an option mortgage you may be provided with the choice to make a) a minimum payment that is calculated based on the rate you would pay on a fully amortizing mortgage at a low teaser rate such as 1% b) a interest only payment: you are not paying down principal if you make this payment c) 30 year amortizing payment: you will pay off the loan in 30 years if you make this payment every month or d) 15 year amortizing payment: if you make this payment you will pay off your loan in 15 years.





2) The cash from the payments made by the borrowers goes to a servicer who is paid to deal with the borrowers and assign the payments to the correct lenders. Typically these pools are tranched so that means that there is an order of who gets paid. You can slice and dice the mortgage into any number of securities with fixed or variable coupons (interest payments are either the same each month or increase or decrease with interest rates). Generally the idea is to make securities with a high probability of payment so that banks, insurers, and other entities that are required to take low risk investments can purchase them. Even if the borrower is a 500 FICO the first 50% of payments may have a very high probability of payment and would be assigned a AAA rating. Generally you have multiple securities with multiple credit ratings so investors with different risk tolerances can invest in them. The equity tranche is paid last so it generally has a high interest rate but high uncertainty of payment. Usually the banks or nonbank entities that put the deal together hold a portion of the equity tranche. This is one reason why Merrill Lynch is taking such huge losses.





Relationship between Lenders and Banks:





As I stated banks and insurers tend to be big investors in mortgage backed securities. So they get cash flows as the borrowers make payments, the properties get refinanced (both return of capital and the prepayment penalties), and as properties are taken back as REO and sold. Generally you get less than the amount owed inclusive of legal expense for properties that are taken back as REO so you might get 70 cents on the face value + legal fees on these properties.





PMI and Lender's Insurance Policies:





The borrower or the lender can take out insurance to protect the lender against losses in excess of 80% of the original loan balance. This is often referred to as private mortgage insurance. Downey Savings has a policy protecting them against losses in excess of 20% on each asset in their portfolio. Whatever insurer wrote that policy is likely to make substantial payments to Downey.





Special Investment Vehicles:





Banks do not like holding assets on their balance sheets because they have to hold reserves against the probability of nonpayment on loans. So they set up SIVs to buy mortgage securities or credit default obligations off balance sheet then issue commercial paper. The risk is that the mortgage securities often had a longer duration 3-5 years than the commercial paper (30-180 days). There is also the risk that the securities may decline in value or payment may not be assured. In the current credit crunch there has been significant unease that some of these assets are worth less than their outstanding debt and some banks have had to either extend credit to their SIVs or move the assets back on to their balance sheets.





Relationship between SIVs and the Commercial Paper Market:





Generally companies and financial firms tend to invest their cash in commercial paper for short term cash needs. Commercial paper from SIVs and asset backed issues became substantially less liquid so companies were unable to access this money. So futures traders cash was tied up and couldn't be used for settlement and miners in Canada could not be fed. Generally Commercial Paper is viewed as relatively unrisky due to the short durations but some investors wanted to get higher returns by taking more risk like Fidelity and very likely Citicorp's Money Market funds. My understanding is the goal of the Super SIV may be to prevent Citicorp from breaking $1 on their money market funds. This would create losses for investors but the loss of face for Citicorp and loss of capital would be very damaging to them. From Citicorp's perspective it may be worth paying fees to assign a par value and place the assets into the Super SIV even if that makes no economic sense if it allows them to avoid breaking $1 on their money market mutual funds. The alternative is being forced to raise more bank capital which would likely come at a substantially greater cost than bank deposits.





Collateralized Debt Obligations to the Asset Backed Securities Market:





Collatalized Debt Obligations typically buy a portfolio of asset backed securities then make a new waterfall of tranched securities of varying credit risk and payment structure. The term waterfall is used because the payments flow down from the AAA security to AA securities and so on down to the equity securities. Think of a CDO as like an actively managed mutual fund of asset backed commercial paper. In theory the manager does due diligence of what the collateral is for each of the securities and the investors are paying a fee for that service. CDOs can issue AAA paper that is backed by a range of credit which may include equity pieces of subprime mortgage securities, car loans, home equity loans, GE commercial paper, etc.





Relationship between CDOs and Insurers:





You can insure a CDO just like an Asset Backed Security to increase the credit rating or credit profile of that offering or that particular security. In exchange for a fee the insurer will make payments in the event of a default on the underlying assets. Many hedge funds were buying the low rated offerings of the CDOs because they offered a high coupon rate. They may have felt that there was some arbitrage whereby the AAA buyers were paying too much premium for the certainty of payment. There was an argument amongst hedge funds that China and the oil producers were driving down AAA yields to values that were too low. They were partially right but neglected to realize that the underlying collateral of their CDO equity slice was a piggyback mortgage on a $1,000,000 houses with no cash down and 510 FICO borrower.
 
ISM bows down humbly to bishie...then she excuses herself to spend the next three hours working through above explanation. Kinda reminds ISM of the good ol' college days spending all day at the library working through one concept in physics or orgo. (Much more fun, though.)
 
Bish - what happens when the AAA rated insurers (e.g., MBIA, FSA, etc.) start to pay out on the insurance and <em>their</em> balance sheets turn ugly?





P.S. Link to LA Times article fixed.
 
<p>I read the beginning and then I read the end, and when my head stops spinning I will read the middle.</p>

<p>Bishie the only woman/man in the world for you is Tanta. Nobody else is smart enuf to bring you coffee in the morning.</p>

<p>How long do they have to pay out on the insurance? Forever? Is anybody paying yet?</p>

<p>And, as to ugliness, don't forget the title insurers, tho they are not part of your disquisition. (I was going to say explanation, but a $100.00 word was called for.) Their income stream has halved, maybe. And their defalcation/insured closing letter/closing protection letter claims are soaring.</p>
 
Investors in MGIC are basically already betting the company will be bankrupt by 2010. The company is already trading at 0.2 price/book and the January 2010 puts are insanely expensive. The question is are the bonds that rely on insurance from MGIC accurately priced to reflect the 90%+ chance of MGIC going under? My guess is the answer to that is no. Trading long bonds without insurance and short bonds with insurance would be the "play" on that but that is a too risky for my blood.





Substantial payments are already being made on some deals. Even more payments will come in the future as prices in California and Florida return to values based on fundamentals. All of the assets of MGIC and Radian + all of the reinsurance they might have had can be used to support deals but the issue is that will only help investors in pools that go badly quickly. Basically the pricing of bonds with insurance will drop to the value of the bonds without insurance. Not every pool is entirely composed of piggyback seconds with high Florida and California concentrations so some pools do have some value.





There is also the substantial risk of bankruptcy from MBIA and Ambac. These insurers guarantee pools of municipal bonds. As home values fall property tax collections will fall as well although not proportionally in some states. The income from permitting fees to municipalities has dropped off a cliff already. If these insurers fail you should see a repricing of municipal bonds to reflect the value of the securities if insurance was not around. The magnitude of this correction could be immense and ratings for many issues could fall immensely. Many municipal bond issues have AAA ratings solely due to insurance.





Title insurers will get pounded but they are not tied to the securitization market. Their income depends on closings of real estate which has been falling sharply. You are right their claims will increase in a falling market particularly for closing protection and closing letters.
 
Documentary stamps, and intangible tax for filing deeds and mtges is a significant part of Florida's income; that has fallen off drastically. And I figured that out about the taxes. Tho not for the year 2007 for Florida. You can challenge valuation, but the value for tax purposes is set on January 2007, for the year 2007, tho the taxes aren't paid til November, and the comps were pretty high then. I have advised my main clients that they should definely challenge valuation next September. (A very short time to challenge is specified; but it only costs $15.00. It is in very fine print on the yearly document that says "This is not a bill", which everyone igores, since, well, it's not a bill.)



But I had not invested the 1 minute of deep thought necessary to realize that this will drastically affect holders of municipal bonds. I must call my mom and find out if any of her portfolio is in munis. We already had a talk about financial stocks, and her broker is taking her out of them. Or so he says.



Oh, my. my worries about depression are more and more justified.
 
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