Foreclosure halt may be just the tip of the exposure iceberg.
A steady drumbeat of press coverage on US bank and mortgage firm documentation woes should raise risk awareness for treasurers on a number of fronts. Not only have foreclosures been halted by documentation concerns, but efforts to fix documentation issues have raised accusations of illegal behavior and outright fraud.
And looking past the foreclosure and rule-of-law implications, there are legitimate questions as to whether the lax documentation and procedural shortcuts of mortgage originators have in many cases left RMBS issues less than fully secured. For example, if ownership of the mortgages was not legally transferred to the trust behind the securities, they are not mortgage backed. The number of mortgages transferred incorrectly, at least since 2004, may be quite high. Yves Smith’s Naked Capitalism blog has been highlighting this issue and its implications extensively. More directly, the issues for treasurers are as follows:
- Bank counterparty risk. What comes next is anyone’s guess, but among the outcomes is that mortgages that were never properly transferred from the balance sheets of mortgage originators will come back to them—and many, if not most of the mortgages put back will be those most severely underwater. This could weigh heavily on bank balance sheets, particularly those that have been or have acquired big mortgage originators or service companies, perhaps even requiring them to raise additional capital. CDS spreads have ticked up on these banks (see Bank of America and Wells Fargo) and treasurers should be flagging this mortgage mess on their counterparty risk dashboards for closer monitoring.
- Risk to private RMBS as an investment. While agency-backed MBS is almost certainly going to be safe with its implicit government guarantee, holders of private MBS have reason for concern. It is probably worth double-checking portfolio holdings to identify whether your firm is exposed to assets at risk.
- Risk to asset-backed securities generally. With securitization documentation and processing so lax on RMBS, it is probably worth investigating the situation with other forms of asset-backed securities that are part of your firm’s investment holdings, financing, or balance sheet management.
- Reviews of conveyance chains. Part of this assessment should be the controls and audits being conducted to prevent the “mortgage mess” from spreading or being repeated with other underlyings (e.g., receivables). Such reviews should consider carefully the details of pooling and service agreements and extend from one end of the conveyance chain to the other. In mortgage securitization, for instance, title of the loan typically passes from A (the originator) to B (the sponsor) to C (the custodian) to D (the trust). Multiple layers help ensure bankruptcy remoteness and generally keep the underlying off balance sheet. Without proper processing at each stage, a “true sale” is jeopardized.
While the lack of adherence to procedure on mortgage processing in the post-Sox era is mind-bending, it is just another sign of how easily controls can fail in a bubble environment. This is why when a bubble has been exposed (by its bursting), it is time to seek assurance rather than to remain blind to the risk revealed.