Succesful Investments in Mortgage-Backed Securities

October 28, 2014

Private investors risked several trillion dollars in the U.S. housing market from 2004 through the first quarter of 2007.  For the most part, investments in residential mortgage-backed securities had poor results. After the economic collapse of 2008, many segments of the economy recovered, but investors were and still are very wary of the U.S. housing market.  Investors need confidence that the loan pools are more likely to succeed.

The loan pools made in 2004-2007 usually had 1,500 to 5,000 mortgages with an aggregate principal balance of $500 million to $2 billion.  These pools almost always included loans that would be among the first or most costly to fail.

Loan pools could be structured to eliminate the higher risk loans and attract investors.  The suggestions below are additions or modifications to the standard loan pool requirements.

 

Here are 15 steps to create much-improved mortgage loan pools:

In the loan pools made 2004-2007, there were always a few (25-50) loans included that had very high and very low balances – with the high end loans frequently having balances of over $8 million and the low end loans with balances of less than $50,000.

First, the Improved Mortgage Loan Pools would not have large variances of the loan principal balances at inception.

In the Improved Mortgage Loan Pools:

1.    Every loan in this pool has a scheduled principal balance of no greater than $700,000 and no less than $200,000.

Second, eliminate the large variances of mortgage rates at inception.

In the Improved Mortgage Loan Pools

2.    Every loan in this pool has a mortgage rate as of the cut-off date of no less than 3% and no greater than 7%. 

Third, eliminate the loans with interest rates that will adjust to very high levels.

In the Improved Mortgage Loan Pools:

3.    The maximum mortgage rate for every loan in this pool is 8%.

Fourth, eliminate the loans with initial interest-only mortgages.  These mortgages do not allow the homeowner to build any equity and are often indicative of a buyer taking on too-much risk, especially when combined with little or no down payment. Interest-only loans result in higher delinquencies and losses.

In the Improved Mortgage Loan Pools:

4.    None of the loans in this loan pool is an interest-only loan.

Fifth, eliminate the most egregious underwriting practices that involved “stated income” or “lite documentation” or “no documentation” loans.

In the Improved Mortgage Loan Pools:

5.    Each of the loans in this loan pool is a full documentation loan.

Sixth, eliminate second lien loans and loans originated with a simultaneous second lien because both are more likely to fail.

In the Improved Mortgage Loan Pools:

6.    Each of these loans is a first-lien loan and each was originated without a simultaneous second lien.

Seventh, reduce the risk of a falling real estate market or too high of an appraised value.

In the Improved Mortgage Loan Pools:

7.     Each of the loans has a loan-to-value ratio of 80% or below.

Eighth, reduce the risks from geographic concentration of loans.

In the Improved Mortgage Loan Pools:

8.    No greater than 7% of the aggregate principal balance as of the cut-off date will be from homes located in any one state. No more than 10 loans will have the same zip code.

Ninth, offer a product for investors who are interested in single-family homes only.

In the Improved Mortgage Loan Pools:

9.    At least 90% of the loans in this pool are secured by a single-family home.

Tenth, assure the minimum quality of the homes.

In the Improved Mortgage Loan Pools:

10.    90% of the homes securing the loans in this pool were built after January 1, 1960 and have a minimum of 1,400 square feet.

Eleventh, reduce the risk from real estate speculation.  The pools made 2004-2007 all included the following risk warning: “The mortgage pool includes several instances of multiple mortgage loans made to the same borrower.” In many cases, the pool included five or more loans made to the same borrower.

In the Improved Mortgage Loan Pools:

11.    No two or more loans in this pool were made to the same borrower. All of the loans in this pool were made to individuals, and none of the borrowers are partnerships, business entities, corporations, LLCs or LPs.

Twelfth, reduce the loan documentation issues arising from non-filed mortgage assignments.

In the Improved Mortgage Loan Pools:

12.    Within 90 days of the closing date, Assignments of Mortgage shall be filed with the county recorder of deeds for each county where the mortgage homes are situated showing the assignment of the mortgage to the trust.  Transfer of loans on the MERS system must also be recorded. An assignment to the trustee only will not be accepted – the trust must be specifically identified as the assignee.  The trust depositor must be the assignor on these assignments.  At he same time, the assignments to the depositor must also be filed, from the originator or any intervening assignee, to the depositor.  The date of the assignment must be set forth as a date certain – and not an “or before” date.  The trustee, document custodian or servicer shall establish a website where the recorded assignments may be reviewed by investors or potential investors.  The homeowners will be provided with a copy of every mortgage assignment.

Thirteenth, reduce the loan documentation issues arising from note endorsement issues.

In the Improved Mortgage Loan Pools:

13.    The notes must be specifically endorsed to the trust, with the date of the endorsement set forth.  The depositor must be the grantor on the endorsement to the trust and the endorsements must show an unbroken chain of title from the originator to the trust. .  The trustee, document custodian or servicer shall establish a website where the notes and endorsements may be reviewed by investors or potential investors. 

Fourteenth, require that a schedule of loans be filed with the SEC showing the initial loan amount, loan origination date and zip code of the mortgaged property.

In the Improved Mortgage Loan Pools:

14.    A schedule of loans including initial loan amount, loan origination date and zip code of the mortgaged property will be filed with the SEC within 90 days of the closing date and available to investors inline.

Fifteenth – and most important of all these rules – there must be strict compliance with these rules.  In the pools made 2004-2007, there was always a catchall exception provision stating that “each case is weighed individually and on its own merits and exceptions to underwriting guidelines are allowed if sufficient compensating factors exist to offset any additional risk due to the exception.”  These exception provisions were so broad that the underwriting guidelines were often meaningless.

In the Improved Mortgage Loan Pools:

15.    There shall be strict compliance with these rules.

Investors’ lack of faith in mortgage-backed securities relates directly to the failure of law enforcement to prosecute even the worst Wall Street offenders from the era leading up to 2008.  Even in cases where the bankers’ emails show that they knowingly shorted the market while pushing their products on investors (“This bond blows” and “That said I can probably short this name to some CDO fool” and “Half of these are crap and the rest are ok.”) well-deserved prosecutions never happened, nor did a strong regulatory response.  Rules are only as good as the enforcers.  The housing market continues to pay the price in 2014 for the failure of enforcement from the 2008 crisis, but if securities companies make an effort to supply an honest and responsible product, perhaps the next crisis can be avoided.