It would seem to me that this rule might be a good place for possible change.
Tanta: is there a good reason why we should account for these as NPAs? if not, then it is just a deterrent for lenders to do a workout, and in the end workouts are what we want, no?
I thought that was part of HOPE NOW or whatever, to streamline and make it easier for lenders to do workouts...
""KPMG Can Has Accountants." Choose your own subtitle."
Tanta: is there a good reason why we should account for these as NPAs? if not, then it is just a deterrent for lenders to do a workout, and in the end workouts are what we want, no?
The issue is just calling a workout a workout.
What DSL did was call these "retention" loans. Traditionally, a "retention" program pops up in periods when you're seeing a lot of portfolio runoff, such as when interest rates are dropping and your ARM portfolio borrowers are all busy refinancing. In order to keep those borrowers, you offer them, basically, something cheaper than a refi: it's the same rate they'd get elsewhere (a market rate), but you're their servicer so you'll just do a streamlined mod, which is cheaper (less fees and hassle) than a full-blown refi. The idea is to "retain" a loan. Sure, you're reducing your portfolio yield, but that's better than no loan at all.
There isn't anything especially wrong with that. However, you can't use the fig-leaf of a "retention" program to cover up what are, really, workouts. KPMG decided that we had crossed the line from "modifying a performing loan to retain a good customer" to "modifying a performing loan because it was in reasonably forseeable danger of default" or something like that.
The thing is, without a loan file full of new documents (updated appraisal and credit underwriting), there is no documentation for claiming that these loans are not "impaired." Another way to look at that is that DSL's argument was that these borrowers got no better (lower) rate than a new borrower would have. However, a new borrower would not have been able to get that market rate without a new appraisal, new credit docs, etc. You are left to conclude, again, that there is nothing to distinguish these "retention" loans from a good old-fashioned workout. It walks like a duck, it talks like a duck, it's on the balance sheet as a duck.
Some auditor basically asked itself why DSL is trying to "retain" borrowers who maybe can't get a refi at market anywhere else. If you cannot answer the question--you can't say if they'd have gotten a refi anywhere else because you didn't reunderwrite the loan--then you must account for them as restructurings.
So then the question becomes: did we "streamline the process" just to be able to have a cost-effective retention program, or did we "streamline" it so that we wouldn't have to know how bad the loan is? The auditors are saying you will have to treat it as a troubled debt restructuring, not a plain old "retention mod," because the evidence is pretty clear in the overall mortgage market that your borrowers wouldn't qualify for a market-rate refi anywhere else. That's the "rebuttable presumption" now, but you can only rebut it with a file full of fresh documents. This, DSL does not have.
Tanta......how does this square up with Fannie Streamlines? Most of those were ARMs ready to reset and refi'ed into a fixed rate. Documentation required was a new title search and that's about it. Is that the same thing Downey was doing?
...did we "streamline the process" just to be able to have a cost-effective retention program, or did we "streamline" it so that we wouldn't have to know how bad the loan is?
Excellent question with many other applications. Just replace with retention with "origination", "due diligence", "securitization"...etc. and you have the root cause of an awful situation.
Tanta......how does this square up with Fannie Streamlines? Most of those were ARMs ready to reset and refi'ed into a fixed rate. Documentation required was a new title search and that's about it. Is that the same thing Downey was doing?
Well, see, there's where it gets murky.
First of all, if there is in fact a "streamline" market out there, then you do have a "rebuttable presumption" that your borrowers could get a deal elsewhere. But if, you know, even Fannie is tightening up and reducing max financing by 5% and adding on those "adverse market fees" and, you know, stuff, then you can't claim that "the market" offers a "streamlined" deal at these super interest rates any longer.
Second, these were OA borrowers who were just put into an amortizing hybrid ARM. It's one thing to convert an ARM borrower to a fixed: you can easily claim that fixing the rate is an obvious risk reduction, so the additional risk of having done that on streamlined docs is mitigated. It gets harder to argue that ARM-to-ARM is a sufficient risk reduction.
Plus the old standard Fannie Mae-style streamlined refi programs always assumed you did get docs the first time; you just aren't updating them because you have a 24-month clean payment history to work with. A lot of these OAs were, of course, stated deals to start with. If you basically made the loan in the first place on the strength of the appraisal, then you need a new appraisal. Even in a streamlined deal. DSL didn't get a new appraisal on these things, and that, in the current environment, is crossing the line from streamlined ARM conversion to workout.
Thanks Tanta. That sure is some top shelf activity and explanation from Downey Financial Corp. Wow! We're in good hands Downey Financial Corp. Save the day fellows! An island of sanity in an insane world.
Second, DSL has an even bigger problem than the one you covered namely, over 75% of its loan portfolio is in pay opting ARMs and over half of their "net interest margin" is "accrued but not paid" interest. My most fundamenatl quetion is why have the regulators allowed this fantasy accounting to get to the point where you have a financial institution that has net negative cash flow?
DSL is not going to "get better' Also worthy of note DSL was one of Cramer's favorite stock touts. Need I say more?
I view it being similar to the unintended consequences of the actions that got us here. More of the same won't fix it.
It's also a question of using strategies that made sense at the end of the last credit crunch to stave off this one.
In other words, a lot of these things like "streamlined refis" and "retention programs" were invented back in the day, when we had just experienced a nasty credit crunch that had made lenders paranoid. Everyone had had to jump through many, many hoops just to get the loan in the first place. So it made some sense that a couple years later, when rates were coming down and things were looking up, you'd just modify the loan without jumping through all the hoops again. I can defend that behavior in that specific context.
Our current context is that the original loans involved no hoop-jumping of any kind, at ultra-low interest rates. In other words, they were "workouts" when they were originated. You can't go any lower, in terms of docs or rates, than you did at inception of the loan. Or at least, if you try to, you must call that a "workout." You cannot call it a sensible response to easing credit conditions.
If the Modified people were still current how did the Lender know who to contact to do the mods?
People who were consistantly late?
People in a neighborhood with a lot of foreclosures?
All people with a particularly horrible loan product?
All people with a horrible loan product who went stated?
All people who went stated?
A lottery of every 10th person with an adjustible mtg?
All people who responded to correspondence?
At Catholic School, we were told (and this was one of the few things I agreed with) was to avoid "the occasion of sin". In other words, if you are an alcoholic, avoid bars.
This stated income thing was the creation of an "occasion of sin". I think that if you tempt people beyond their ability to resist, then you bear most of the responsibility.
And yes, one of the things I didn't agree with was that you always have the ability to resist temptation.
This whole thing is too big to deal with. All the companies and governments can too is nibble around the edges. Extreme pain is gonna ensue for pretty much everybody.
OT, but something that hasn't been explained anywhere is what is going to happen as the counterparty risk unravels. I don't understand these side bets at all, but it seems to me that since the figures are so enormous, some awful things are going to have to happen when people default on them. What exactly? And how does it play out in the real economy.
And Tanta, I think you need to get your sleep. We need you around to hear your rants!! I battle insomnia also, and it is the awfullest thing.
It may help everybody to remember that "Hope Now" is (so far) basically about freezing a start rate of 8-9%. Not giving the borrower a current prime-credit-quality market interest rate on a new 5/1.
What DSL was doing was putting these folks into a market rate, but a very low market rate (probably not commensurate with the risk of the loan). Since they were originally OA borrowers, it's safe to assume that they simply could not have afforded the payments on anything but a freshly-discounted 5/1 ARM at "market" rates. Again, the auditor's question is, did you give them that rate because they qualify for it, or did you give them that rate because any rational risk-based pricing would have blown the loan up?
didn't we just have a huge discussion yesterday about how it would be more prudent to mod borrowers who have defaulted, in essence proving they need a mod?
Either way, getting some payments for 5 years, and not destroying a neighborhood for 5 years etc, is not a bad idea, if it works. And these people were current, so it might work for the 5 years.
I live and sleep on ET. The blog's time stamps are PT, because my co-blogger lives and sleeps on PT. So while this post appears to have been done at 5:00 am, it was really 8:00 am for its author.
why does everybody think Tanta isn't sleeping? if she wasn't sleeping, this post would probably be accompanied by a picture of a Pig on a balance sheet.
didn't we just have a huge discussion yesterday about how it would be more prudent to mod borrowers who have defaulted, in essence proving they need a mod?
Well, again, it's not that you cannot work out (mod or short sale) a not-yet-delinquent-but-probably-gonna-be borrower.
However, if you do that, you have to call it a "troubled debt restructuring." That's really what is going on here.
It might help to think of "retention mods" as borrowers who aren't in any danger of defaulting, they're in danger of refinancing with someone else. You modify their loan terms to keep them, because they're good borrowers and you don't want to lose them.
If you are modifying them because otherwise they'll stop making payments eventually when their OA hits a cap, you're working out. It's not a "retention" program, it's a "we're stuck with these people so we might as well try to keep them going" program.
We are having this whole problem because the game of refi stopped, and everybody has to hold its hot potatoes.
My point yesterday was that if you do have a non-delinquent loan that wants a workout, you have to root through the file and update the docs before you proceed. Or else, among other problems, your auditor will be climbing all over your ass for the same reason they're doing it to DSL.
The question we need to ask is, what is the flow-thru of loans-formerly-known-as-mods to non-current. Downey tells us the loans are mostly still current, but presumably that's on a net basis. Every month some portion becomes non-current, and every month they make new "mods" to replace them. The result is a constant 3% of current "mods", but lots of them are souring.
How much does the borrower really benefit from these mods? I'm guessing the new "market" rate is around 5% vs. the 6-7% OA rate. So they get a little break, but on the other hand, presumably, the loan immediately recasts to full principal and interest payments at a higher loan value. The result must be severe payment shock. Am I missing something here, or is this likely to accelerate the number of non-current payments?
talk about conflicting signals. whats a prudent underwater speculator to do to qualify for a mod? stay current or default?
KPMG wasn't saying that these mods should never have been done.
It said that they should have been accounted for as NPA, because the underlying assumption is if they weren't in default at the time, they would have been soon.
"Reasonably forseeable danger of default" is, in fact, a legitimate reason to work out a loan. You just can't take the borrower's word for it in all cases that default is imminent. In yesterday's brouhaha, we had borrowers with a short sale offer who wanted lenders to start negotiation before there was any evidence that a default was forseeable.
So your choice is, currently in default or willing to cough up the documents to show you will be in default if your loan isn't worked out.
"Underwater speculators" are screwed because too many of them lied up front on their loan applications. We don't need to pity them.
Other underwater borrowers do not have to quit making payments in order to get a workout. They just need to work with their servicer. And their servicer/noteholder needs to show that loan on the books as a workout, not as a "retention mod."
Am I missing something here, or is this likely to accelerate the number of non-current payments?
It is quite possible, indeed likely, that DSL just picked the cherries.
In other words, the only loans that got these workouts were the ones who could handle the new (amortizing) payment (for now, at least).
What they couldn't handle was any more neg am making those LTVs look scarier and scarier. Quite possibly these were the slice of the higher-quality OA crowd who weren't making minimum payments. Those are the ones you would want to "retain." It's just that you can't justify retaining them without re-examining their credit quality in the current environment.
Therefore, I'd say it's likely that the weighted averages of the remaining OA portfolio just got way worse, because DSL skimmed off the top to put into amortizing 5/1s. DSL wanted to "offset" that (now) cruddy-looking OA porfolio with a nice pretty 5/1 portfolio. Now the auditors are making them impair that 5/1 portfolio, so we're probably back to where we started on an aggregate basis in terms of reported numbers.
Does it, net-net, improve overall credit quality of the portfolio? It should. Does it mean that DSL has a performing portfolio at the price of a much too low yield on these things? Quite possibly. Hell, anybody can "buy" credit quality if you're willing to give up yield. For a while.
This is the problem IMO with the "caveat emptor" crowd.
There is no way that a normal person can appropriately evaluate the performance of these companies unless they have a degree in finance and economics, as well as huge amounts of education as to the practical workings of the business...
once you explain WHY the auditor did what it did then it makes sense. Prior to your explanation, it seemed like DSL was just getting reamed by a stick in the mud! now we know better!
so what would u have done if u were DSL? mod the performing as they did or the non performing (those who need it most and presuumably could prove it)?
It's quite possible I'd have done with the loans exactly what DSL did. I can't say for sure because I can't see the details any more than anyone else can.
I simply would have called them "workouts" and given the accounting department the information they need to impair them properly.
Again, as far as I can tell KPMG isn't saying that what they did with the loans was improper. It said that they didn't take a big enough bite out of the balance sheet when they accounted for it.
Imagine a doctor who writes prescriptions for antibiotics to patients who have no lab results in the file, and no visible symptoms of infection on examination. There would be some question about malpractice, would there not? It doesn't mean that the patient wasn't really sick and that the prescription was improper, but it sure does mean you need to explain something here. If you say, "I spoke to the borrower on the phone and determined that the current symptoms are just like the last time we really had lab results," that might pass muster. If you say, "Hell, I just hand out Rx to anybody who calls and whines because it gets them off the phone," you might have a touch of a problem.
In any case, if you're giving someone an Rx for Keflex, you don't count them in the "healthy" bucket until they've taken it for 15 days. That's what all this business of putting these loans in non-accrual for six months is about. Once you've "diagnosed" them, they can't count as performing until your "cure" had a chance to work.
Tanta - Does it, net-net, improve overall credit quality of the portfolio? It should. Does it mean that DSL has a performing portfolio at the price of a much too low yield on these things? Quite possibly.
Increase portfolio quality? Possibly but marketability? No. While it will be impossible to tell how much impairment is due to reluctance to purchase a product from a company on probation and howmuch is market and such I have to believe there is some loss of goodwill value. This isn't 'The World According to Garp' where he excitedly buys a house after watching an airplane crash into it.
Aside from the ongoing cascade of negative economic news, I think the big event of the next 6 weeks will be clarification of the U.S. political scene.
For better or worse, Hillary is well positioned to take advantage of national economic anxiety. Despite his many strengths, Obama is not. So, I see a shift of Dems toward her, culminating in big win 02/05. Meanwhile, I think Republicans keep sinking into darkness and look very out-of-touch on economic issues, especially Iraq War.
What's the opportunity? There could be a backlash against health care and defense stocks, and the events described above should we negative for all stocks, because Dems will raise taxes on the rich, corporations and energy companies and Dems will end the war spending stimulus faster.
Neither party will offer any meaningful help for homeowners or mortgage crisis. Tax stimulus package could be held up in partisan in-fighting.
I think they did this strictly to F up CR's wonderful chart. We'll get a nice spike and then it's likely there will either be some flattening or even a reversal. No mattet. THis one's in the teens staring at the deep dark abyss.
Where's my 3% 30 fixed? Why won't they approach me based upon their review of my loan status? Don't they know I'd be more able to afford this product and they'd likely have me as a grateful long term customer?
Giving people loans based upon the greater the risk the better the terms may make sense to the bottom line but the public opinion backlash as costs that that they may not be valuing correctly.
I don't understand: how is getting borrowers out of OAs and into 5/1 ammortizing ARMS supposed to help them? They always had the OPTION of making an ammortizing payment before. THE problem is that they have agreed to a price that they have no reasonable hope of making payments on. If they can't afford non-amortizing payments a short sale or some forgiveness of principal are their only chance of avoiding forclosure.
They always had the OPTION of making an ammortizing payment before.
Sure, they just didn't have the "option" of making the amortizing payment on 5% instead of 7%.
My guess is they'd have tried to "freeze" the rate on these things, except that it had already exceeded sustainable.
They'd have loved to have modified them into a new OA, but they knew damned good and well that KPMG would have spotted that instantly (instead of needing July-December to think about it, as apparently happened when they rolled the OAs into "safer" 5/1s.)
This should have some negative consequences to DSL's Q1 report. They will have less non-cash earnings to report and probably some to reverse that they already booked in Q4. I would expect a pretty miserable Q1 with massive revisions down to '08 projections. Charade can't last much longer...
I think we have a simple old-fashioned net interest margin problem.
Can we compromise and call this an 'Ugly Child with Porkchops tied to Her Ankles so the Dog will Play with Her' problem? Use enough porkchops and it doesn't matter how ugly.
I know you are correct that there used to be no problem so bad that a discount from par couldn't correct or at least paper over defects. I am wondering if we might be in a new playground where character not only counts but cannot be purchased with the usual scrip.
Although this news is net net negative (or positive for shorts)...does this have the effect of overstating NPA's in the short term (sandbagging)? Thereby creating the possibility for an upside surprise (lower npa's) in the coming months as many of these make timely payments and get reclassified as performing? Just trying to figure out what the impetus for a "good news" bounce will be and plan accordingly (disclosure: short DSL).
As interesting as the accounting details are, I think the more interesting fact to emerge is KPMG standing up to a client.
I have no idea how to quantify this, but the entire landscape changed post Enron. Auditing used to be a loss leader to get in and sell consulting. You also have Sarbox on the corporate side. The working level of corporate finance people are less excited about creative, win/win ideas then in the past.
This is certainly not new news, and most of this stuff is just timing anyway. It just speeds up recognition of reality.
"did you give them that rate because they qualify for it, or did you give them that rate because any rational risk-based pricing would have blown the loan up?" and since Downey couldn't prove the former the auditors were forced to assume the latter.
I agree that in the absence of documentation or some other convincing explanation, GAAP should require us to assume the worst and count these streamlined refis as some form of impaired restructuring.
But there is a potentially meaningful distinction between a streamlined refi and a loan that was placed on nonaccrual because it was actually not performing. If I were an investor (or regulator or other interested party), I'd want to know both numbers.
Moving a whole block of loans to NPA and then back again after six months seems like the sort of thing GAAP and the regulators would try to discourage.
Good heavens, how does that play into the loss reserve calculations?
JBL,
Changing the interest rate within the boundries of reasonableness given market conditions (i.e.: current interest rates and terms) will not by itself impact the reserves. It wouldn't impact anything besides interest income going forward. If a lender were to reduce the interest rate below current market conditions, you would presume a write-down of principal, take the loss to current and future earnings. The bank would also be required to issue a 1099 unless it falls under the recent regulation (which I haven't read).
Just like anywhere else, the management is very important in infusing some accountability. I have worked with the CFO of Downey in the past and know for a fact that he is a man of integrity. I am not surprised with his concurrence with the auditors and reassessment of the NPAs
Silly question, but what about KPMG's not objecting to the treatment during the third quarter review?
I've seen auditors give the "I'll give you a green light now, but I'm not going to dive into it until the year end audit" before...frustrating as hell when you're actually trying to run a business.
So is it the servicing departments problem for not ensuring that accounting had all the relevant facts to bring to KPMG, or is it KPMG's issue that they gave a (tentative) green light without having all the facts?
I've never fully understood the importance of being first. But, at least in this case, no sacrifices were involved.
Second is the new first.
I for one, welcome my new streamlined overlords.
It would seem to me that this rule might be a good place for possible change.
Tanta: is there a good reason why we should account for these as NPAs? if not, then it is just a deterrent for lenders to do a workout, and in the end workouts are what we want, no?
I thought that was part of HOPE NOW or whatever, to streamline and make it easier for lenders to do workouts...
""KPMG Can Has Accountants." Choose your own subtitle."
I choose "All your houses are belong to us".
DSL had $493.6 million of its $13.54 billion in total assets in Nov counted as nonperforming. This was 3.65%.
Because of accounting change they now grow NPA by $99M to about $600M - this should have come out around 4.6% of their total (declining) asset base.
But it came out as 7.8% ....
which means that 3.2% (at least) were added last month w/o the accounting change.
Think about it - a jump from 3.65% to 6.85% in one month....
Arf! Arf!
Tanta: is there a good reason why we should account for these as NPAs? if not, then it is just a deterrent for lenders to do a workout, and in the end workouts are what we want, no?
The issue is just calling a workout a workout.
What DSL did was call these "retention" loans. Traditionally, a "retention" program pops up in periods when you're seeing a lot of portfolio runoff, such as when interest rates are dropping and your ARM portfolio borrowers are all busy refinancing. In order to keep those borrowers, you offer them, basically, something cheaper than a refi: it's the same rate they'd get elsewhere (a market rate), but you're their servicer so you'll just do a streamlined mod, which is cheaper (less fees and hassle) than a full-blown refi. The idea is to "retain" a loan. Sure, you're reducing your portfolio yield, but that's better than no loan at all.
There isn't anything especially wrong with that. However, you can't use the fig-leaf of a "retention" program to cover up what are, really, workouts. KPMG decided that we had crossed the line from "modifying a performing loan to retain a good customer" to "modifying a performing loan because it was in reasonably forseeable danger of default" or something like that.
The thing is, without a loan file full of new documents (updated appraisal and credit underwriting), there is no documentation for claiming that these loans are not "impaired." Another way to look at that is that DSL's argument was that these borrowers got no better (lower) rate than a new borrower would have. However, a new borrower would not have been able to get that market rate without a new appraisal, new credit docs, etc. You are left to conclude, again, that there is nothing to distinguish these "retention" loans from a good old-fashioned workout. It walks like a duck, it talks like a duck, it's on the balance sheet as a duck.
Some auditor basically asked itself why DSL is trying to "retain" borrowers who maybe can't get a refi at market anywhere else. If you cannot answer the question--you can't say if they'd have gotten a refi anywhere else because you didn't reunderwrite the loan--then you must account for them as restructurings.
So then the question becomes: did we "streamline the process" just to be able to have a cost-effective retention program, or did we "streamline" it so that we wouldn't have to know how bad the loan is? The auditors are saying you will have to treat it as a troubled debt restructuring, not a plain old "retention mod," because the evidence is pretty clear in the overall mortgage market that your borrowers wouldn't qualify for a market-rate refi anywhere else. That's the "rebuttable presumption" now, but you can only rebut it with a file full of fresh documents. This, DSL does not have.
Thanks Tanta. take a look above and see what Huge increase in NPA hidees behind all this announcment... it is 3 times larger...
Tanta......how does this square up with Fannie Streamlines? Most of those were ARMs ready to reset and refi'ed into a fixed rate. Documentation required was a new title search and that's about it. Is that the same thing Downey was doing?
...did we "streamline the process" just to be able to have a cost-effective retention program, or did we "streamline" it so that we wouldn't have to know how bad the loan is?
Excellent question with many other applications. Just replace with retention with "origination", "due diligence", "securitization"...etc. and you have the root cause of an awful situation.
Tanta......how does this square up with Fannie Streamlines? Most of those were ARMs ready to reset and refi'ed into a fixed rate. Documentation required was a new title search and that's about it. Is that the same thing Downey was doing?
Well, see, there's where it gets murky.
First of all, if there is in fact a "streamline" market out there, then you do have a "rebuttable presumption" that your borrowers could get a deal elsewhere. But if, you know, even Fannie is tightening up and reducing max financing by 5% and adding on those "adverse market fees" and, you know, stuff, then you can't claim that "the market" offers a "streamlined" deal at these super interest rates any longer.
Second, these were OA borrowers who were just put into an amortizing hybrid ARM. It's one thing to convert an ARM borrower to a fixed: you can easily claim that fixing the rate is an obvious risk reduction, so the additional risk of having done that on streamlined docs is mitigated. It gets harder to argue that ARM-to-ARM is a sufficient risk reduction.
Plus the old standard Fannie Mae-style streamlined refi programs always assumed you did get docs the first time; you just aren't updating them because you have a 24-month clean payment history to work with. A lot of these OAs were, of course, stated deals to start with. If you basically made the loan in the first place on the strength of the appraisal, then you need a new appraisal. Even in a streamlined deal. DSL didn't get a new appraisal on these things, and that, in the current environment, is crossing the line from streamlined ARM conversion to workout.
This is relevant to our discussion yesterday. Is this a by product of streamlining the back end?
I view it being similar to the unintended consequences of the actions that got us here. More of the same won't fix it.
But it's probably different this time, yes?
Thanks Tanta. That sure is some top shelf activity and explanation from Downey Financial Corp. Wow! We're in good hands Downey Financial Corp. Save the day fellows! An island of sanity in an insane world.
First, Tanta when do you sleep?
Second, DSL has an even bigger problem than the one you covered namely, over 75% of its loan portfolio is in pay opting ARMs and over half of their "net interest margin" is "accrued but not paid" interest. My most fundamenatl quetion is why have the regulators allowed this fantasy accounting to get to the point where you have a financial institution that has net negative cash flow?
DSL is not going to "get better' Also worthy of note DSL was one of Cramer's favorite stock touts. Need I say more?
Better to bark than let this happen again:
Fannie Sues KPMG for Approving Bad Numbers - washingtonpost.com
Since Enron, all the Big-4 tend to bark more over misstatements and salivate less over fees.
I view it being similar to the unintended consequences of the actions that got us here. More of the same won't fix it.
It's also a question of using strategies that made sense at the end of the last credit crunch to stave off this one.
In other words, a lot of these things like "streamlined refis" and "retention programs" were invented back in the day, when we had just experienced a nasty credit crunch that had made lenders paranoid. Everyone had had to jump through many, many hoops just to get the loan in the first place. So it made some sense that a couple years later, when rates were coming down and things were looking up, you'd just modify the loan without jumping through all the hoops again. I can defend that behavior in that specific context.
Our current context is that the original loans involved no hoop-jumping of any kind, at ultra-low interest rates. In other words, they were "workouts" when they were originated. You can't go any lower, in terms of docs or rates, than you did at inception of the loan. Or at least, if you try to, you must call that a "workout." You cannot call it a sensible response to easing credit conditions.
gold 908.80?
If the Modified people were still current how did the Lender know who to contact to do the mods?
People who were consistantly late?
People in a neighborhood with a lot of foreclosures?
All people with a particularly horrible loan product?
All people with a horrible loan product who went stated?
All people who went stated?
A lottery of every 10th person with an adjustible mtg?
All people who responded to correspondence?
At Catholic School, we were told (and this was one of the few things I agreed with) was to avoid "the occasion of sin". In other words, if you are an alcoholic, avoid bars.
This stated income thing was the creation of an "occasion of sin". I think that if you tempt people beyond their ability to resist, then you bear most of the responsibility.
And yes, one of the things I didn't agree with was that you always have the ability to resist temptation.
This whole thing is too big to deal with. All the companies and governments can too is nibble around the edges. Extreme pain is gonna ensue for pretty much everybody.
OT, but something that hasn't been explained anywhere is what is going to happen as the counterparty risk unravels. I don't understand these side bets at all, but it seems to me that since the figures are so enormous, some awful things are going to have to happen when people default on them. What exactly? And how does it play out in the real economy.
And Tanta, I think you need to get your sleep. We need you around to hear your rants!! I battle insomnia also, and it is the awfullest thing.
It may help everybody to remember that "Hope Now" is (so far) basically about freezing a start rate of 8-9%. Not giving the borrower a current prime-credit-quality market interest rate on a new 5/1.
What DSL was doing was putting these folks into a market rate, but a very low market rate (probably not commensurate with the risk of the loan). Since they were originally OA borrowers, it's safe to assume that they simply could not have afforded the payments on anything but a freshly-discounted 5/1 ARM at "market" rates. Again, the auditor's question is, did you give them that rate because they qualify for it, or did you give them that rate because any rational risk-based pricing would have blown the loan up?
Tanta,
didn't we just have a huge discussion yesterday about how it would be more prudent to mod borrowers who have defaulted, in essence proving they need a mod?
Either way, getting some payments for 5 years, and not destroying a neighborhood for 5 years etc, is not a bad idea, if it works. And these people were current, so it might work for the 5 years.
And Tanta, I think you need to get your sleep
I live and sleep on ET. The blog's time stamps are PT, because my co-blogger lives and sleeps on PT. So while this post appears to have been done at 5:00 am, it was really 8:00 am for its author.
why does everybody think Tanta isn't sleeping? if she wasn't sleeping, this post would probably be accompanied by a picture of a Pig on a balance sheet.
talk about conflicting signals. whats a prudent underwater speculator to do to qualify for a mod? stay current or default?
didn't we just have a huge discussion yesterday about how it would be more prudent to mod borrowers who have defaulted, in essence proving they need a mod?
Well, again, it's not that you cannot work out (mod or short sale) a not-yet-delinquent-but-probably-gonna-be borrower.
However, if you do that, you have to call it a "troubled debt restructuring." That's really what is going on here.
It might help to think of "retention mods" as borrowers who aren't in any danger of defaulting, they're in danger of refinancing with someone else. You modify their loan terms to keep them, because they're good borrowers and you don't want to lose them.
If you are modifying them because otherwise they'll stop making payments eventually when their OA hits a cap, you're working out. It's not a "retention" program, it's a "we're stuck with these people so we might as well try to keep them going" program.
We are having this whole problem because the game of refi stopped, and everybody has to hold its hot potatoes.
My point yesterday was that if you do have a non-delinquent loan that wants a workout, you have to root through the file and update the docs before you proceed. Or else, among other problems, your auditor will be climbing all over your ass for the same reason they're doing it to DSL.
The question we need to ask is, what is the flow-thru of loans-formerly-known-as-mods to non-current. Downey tells us the loans are mostly still current, but presumably that's on a net basis. Every month some portion becomes non-current, and every month they make new "mods" to replace them. The result is a constant 3% of current "mods", but lots of them are souring.
How much does the borrower really benefit from these mods? I'm guessing the new "market" rate is around 5% vs. the 6-7% OA rate. So they get a little break, but on the other hand, presumably, the loan immediately recasts to full principal and interest payments at a higher loan value. The result must be severe payment shock. Am I missing something here, or is this likely to accelerate the number of non-current payments?
stocks making a big headfake.
talk about conflicting signals. whats a prudent underwater speculator to do to qualify for a mod? stay current or default?
KPMG wasn't saying that these mods should never have been done.
It said that they should have been accounted for as NPA, because the underlying assumption is if they weren't in default at the time, they would have been soon.
"Reasonably forseeable danger of default" is, in fact, a legitimate reason to work out a loan. You just can't take the borrower's word for it in all cases that default is imminent. In yesterday's brouhaha, we had borrowers with a short sale offer who wanted lenders to start negotiation before there was any evidence that a default was forseeable.
So your choice is, currently in default or willing to cough up the documents to show you will be in default if your loan isn't worked out.
"Underwater speculators" are screwed because too many of them lied up front on their loan applications. We don't need to pity them.
Other underwater borrowers do not have to quit making payments in order to get a workout. They just need to work with their servicer. And their servicer/noteholder needs to show that loan on the books as a workout, not as a "retention mod."
DSL getting hammered as u might expect. i think this will drive all financials down further b/c of this KPMG move.
Am I missing something here, or is this likely to accelerate the number of non-current payments?
It is quite possible, indeed likely, that DSL just picked the cherries.
In other words, the only loans that got these workouts were the ones who could handle the new (amortizing) payment (for now, at least).
What they couldn't handle was any more neg am making those LTVs look scarier and scarier. Quite possibly these were the slice of the higher-quality OA crowd who weren't making minimum payments. Those are the ones you would want to "retain." It's just that you can't justify retaining them without re-examining their credit quality in the current environment.
Therefore, I'd say it's likely that the weighted averages of the remaining OA portfolio just got way worse, because DSL skimmed off the top to put into amortizing 5/1s. DSL wanted to "offset" that (now) cruddy-looking OA porfolio with a nice pretty 5/1 portfolio. Now the auditors are making them impair that 5/1 portfolio, so we're probably back to where we started on an aggregate basis in terms of reported numbers.
Does it, net-net, improve overall credit quality of the portfolio? It should. Does it mean that DSL has a performing portfolio at the price of a much too low yield on these things? Quite possibly. Hell, anybody can "buy" credit quality if you're willing to give up yield. For a while.
Tanta,
thanks for your great perspective. oh the groaning goes on.
Tanta:
thanks for the awesome explanations.
This is the problem IMO with the "caveat emptor" crowd.
There is no way that a normal person can appropriately evaluate the performance of these companies unless they have a degree in finance and economics, as well as huge amounts of education as to the practical workings of the business...
once you explain WHY the auditor did what it did then it makes sense. Prior to your explanation, it seemed like DSL was just getting reamed by a stick in the mud! now we know better!
Tanta for Mortgage Tsczar!
OMG=oh my gold
Tanta,
so what would u have done if u were DSL? mod the performing as they did or the non performing (those who need it most and presuumably could prove it)?
Tanta,
That makes perfect sense. I was wondering what criteria DSL used to mod, and higher-than-minimum-payment sounds right.
Thanks!
don't buy this NASDAQ pumping! both AMZN and GRMN sinking; both previous high flying momentum stocks.
so what would u have done if u were DSL? mod the performing as they did or the non performing (those who need it most and presuumably could prove it)?
It's quite possible I'd have done with the loans exactly what DSL did. I can't say for sure because I can't see the details any more than anyone else can.
I simply would have called them "workouts" and given the accounting department the information they need to impair them properly.
Again, as far as I can tell KPMG isn't saying that what they did with the loans was improper. It said that they didn't take a big enough bite out of the balance sheet when they accounted for it.
Imagine a doctor who writes prescriptions for antibiotics to patients who have no lab results in the file, and no visible symptoms of infection on examination. There would be some question about malpractice, would there not? It doesn't mean that the patient wasn't really sick and that the prescription was improper, but it sure does mean you need to explain something here. If you say, "I spoke to the borrower on the phone and determined that the current symptoms are just like the last time we really had lab results," that might pass muster. If you say, "Hell, I just hand out Rx to anybody who calls and whines because it gets them off the phone," you might have a touch of a problem.
In any case, if you're giving someone an Rx for Keflex, you don't count them in the "healthy" bucket until they've taken it for 15 days. That's what all this business of putting these loans in non-accrual for six months is about. Once you've "diagnosed" them, they can't count as performing until your "cure" had a chance to work.
Tanta - Does it, net-net, improve overall credit quality of the portfolio? It should. Does it mean that DSL has a performing portfolio at the price of a much too low yield on these things? Quite possibly.
Increase portfolio quality? Possibly but marketability? No. While it will be impossible to tell how much impairment is due to reluctance to purchase a product from a company on probation and howmuch is market and such I have to believe there is some loss of goodwill value. This isn't 'The World According to Garp' where he excitedly buys a house after watching an airplane crash into it.
This isn't 'The World According to Garp'
that's right, it's The World According to GAAP.
OT
Aside from the ongoing cascade of negative economic news, I think the big event of the next 6 weeks will be clarification of the U.S. political scene.
For better or worse, Hillary is well positioned to take advantage of national economic anxiety. Despite his many strengths, Obama is not. So, I see a shift of Dems toward her, culminating in big win 02/05. Meanwhile, I think Republicans keep sinking into darkness and look very out-of-touch on economic issues, especially Iraq War.
What's the opportunity? There could be a backlash against health care and defense stocks, and the events described above should we negative for all stocks, because Dems will raise taxes on the rich, corporations and energy companies and Dems will end the war spending stimulus faster.
Neither party will offer any meaningful help for homeowners or mortgage crisis. Tax stimulus package could be held up in partisan in-fighting.
I think they did this strictly to F up CR's wonderful chart. We'll get a nice spike and then it's likely there will either be some flattening or even a reversal. No mattet. THis one's in the teens staring at the deep dark abyss.
Where's my 3% 30 fixed? Why won't they approach me based upon their review of my loan status? Don't they know I'd be more able to afford this product and they'd likely have me as a grateful long term customer?
Giving people loans based upon the greater the risk the better the terms may make sense to the bottom line but the public opinion backlash as costs that that they may not be valuing correctly.
I don't understand: how is getting borrowers out of OAs and into 5/1 ammortizing ARMS supposed to help them? They always had the OPTION of making an ammortizing payment before. THE problem is that they have agreed to a price that they have no reasonable hope of making payments on. If they can't afford non-amortizing payments a short sale or some forgiveness of principal are their only chance of avoiding forclosure.
They always had the OPTION of making an ammortizing payment before.
Sure, they just didn't have the "option" of making the amortizing payment on 5% instead of 7%.
My guess is they'd have tried to "freeze" the rate on these things, except that it had already exceeded sustainable.
They'd have loved to have modified them into a new OA, but they knew damned good and well that KPMG would have spotted that instantly (instead of needing July-December to think about it, as apparently happened when they rolled the OAs into "safer" 5/1s.)
Increase portfolio quality? Possibly but marketability?
Rob, I don't know that we have a goodwill problem.
I think we have a simple old-fashioned net interest margin problem.
Look, I can write loan terms that almost guarantee you'll never have a default, if it's credit quality you want.
That would just involve my charging the borrower less interest than I pay to depositors. Bummer city.
We're looking at the shell that the pea used to be under ("credit quality"). It is now under the "net interest margin" shell.
This should have some negative consequences to DSL's Q1 report. They will have less non-cash earnings to report and probably some to reverse that they already booked in Q4. I would expect a pretty miserable Q1 with massive revisions down to '08 projections. Charade can't last much longer...
I think we have a simple old-fashioned net interest margin problem.
Can we compromise and call this an 'Ugly Child with Porkchops tied to Her Ankles so the Dog will Play with Her' problem? Use enough porkchops and it doesn't matter how ugly.
I know you are correct that there used to be no problem so bad that a discount from par couldn't correct or at least paper over defects. I am wondering if we might be in a new playground where character not only counts but cannot be purchased with the usual scrip.
Although this news is net net negative (or positive for shorts)...does this have the effect of overstating NPA's in the short term (sandbagging)? Thereby creating the possibility for an upside surprise (lower npa's) in the coming months as many of these make timely payments and get reclassified as performing? Just trying to figure out what the impetus for a "good news" bounce will be and plan accordingly (disclosure: short DSL).
I battle insomnia also, and it is the awfullest thing.
Lawyerliz | 01.14.08 - 9:29 am | #
A word of warning: Don't start reading CR after dark.
From one who knows
As interesting as the accounting details are, I think the more interesting fact to emerge is KPMG standing up to a client.
I have no idea how to quantify this, but the entire landscape changed post Enron. Auditing used to be a loss leader to get in and sell consulting. You also have Sarbox on the corporate side. The working level of corporate finance people are less excited about creative, win/win ideas then in the past.
This is certainly not new news, and most of this stuff is just timing anyway. It just speeds up recognition of reality.
"did you give them that rate because they qualify for it, or did you give them that rate because any rational risk-based pricing would have blown the loan up?" and since Downey couldn't prove the former the auditors were forced to assume the latter.
Tanta, thanks for converting that impenetrable jargon ... you are a genius at this!
I agree that in the absence of documentation or some other convincing explanation, GAAP should require us to assume the worst and count these streamlined refis as some form of impaired restructuring.
But there is a potentially meaningful distinction between a streamlined refi and a loan that was placed on nonaccrual because it was actually not performing. If I were an investor (or regulator or other interested party), I'd want to know both numbers.
Moving a whole block of loans to NPA and then back again after six months seems like the sort of thing GAAP and the regulators would try to discourage.
Good heavens, how does that play into the loss reserve calculations?
JBL,
Changing the interest rate within the boundries of reasonableness given market conditions (i.e.: current interest rates and terms) will not by itself impact the reserves. It wouldn't impact anything besides interest income going forward. If a lender were to reduce the interest rate below current market conditions, you would presume a write-down of principal, take the loss to current and future earnings. The bank would also be required to issue a 1099 unless it falls under the recent regulation (which I haven't read).
Just like anywhere else, the management is very important in infusing some accountability. I have worked with the CFO of Downey in the past and know for a fact that he is a man of integrity. I am not surprised with his concurrence with the auditors and reassessment of the NPAs
Credit Bubble Stocks: Downey Financial Restates Non-Performing Assets
Silly question, but what about KPMG's not objecting to the treatment during the third quarter review?
I've seen auditors give the "I'll give you a green light now, but I'm not going to dive into it until the year end audit" before...frustrating as hell when you're actually trying to run a business.
So is it the servicing departments problem for not ensuring that accounting had all the relevant facts to bring to KPMG, or is it KPMG's issue that they gave a (tentative) green light without having all the facts?