URBANDALE, Iowa (Dow Jones)--In two squat, suburban office-park buildings
here, Richard Barrent is digging through loan files that could help decide who
pays for the mortgage-paperwork debacle.
The former Wells Fargo & Co. (WFC) quality-assurance manager's
two-year-old company is part of a cottage industry of loan detectives obsessed
with detecting fraud, misrepresentations and violations of underwriting
guidelines. Such discoveries can be used as ammunition to force banks and other
lenders to buy back loans from bond insurers, holders of mortgage-backed
securities and other customers of forensic loan-review firms.
"There is a growing interest across the board" for such reviews, says
Charles Cacici, managing member of Risk Management Group, a Brooklyn, N.Y.,
company that also scours mortgage files for problems. Competitors include
Digital Risk, Clayton Holdings and Allonhill.
The tedious business, usually involving hundreds of pages per loan, has
taken on new urgency since the foreclosure problems erupted in mid-September.
Losses to U.S. banks from loan repurchases could reach $40 billion to $90
billion, according to J.P. Morgan Securities. Previous estimates were much
higher, but have declined partly because it is so difficult to compel lenders to
take back loans.
Loan files sometimes can be hard to get. And mortgage companies often dig
in their heels when confronted with a demand to repurchase a loan. That can
result in negotiations or lawsuits that can stretch for months or more--or a
stalemate.
(This story and related background material will be available on The Wall
Street Journal website, WSJ.com.)
"It is a day-to-day, hand-to-hand combat," Bank of America Corp. (BAC)
Chief Executive Brian Moynihan said recently when describing the Charlotte,
N.C., bank's resistance to loan-repurchase requests.
In the worst-case scenario for investors, months of effort can result in
nothing. Those odds are likely to discourage some investors from pursuing loan
repurchases, which could reduce overall losses for banks. The payoff for
investors and bond insurers when a bank eats a shaky loan: The lender typically
must pay the difference between the original loan amount and what was recovered
in foreclosure, or unpaid principal plus accrued interest if the loan is
outstanding.
Losses on troubled loans can sometimes hit 80% of the original loan
amount, says Barrent, the 49-year-old president and chief operating officer of
Barrent Group. He won't identify any of the company's clients, though he says
the firm is talking with bond investors about how to recoup losses from sloppy
mortgage servicing.
Among the companies trying to make banks eat shaky loans are Fannie Mae
(FNMA) and Freddie Mac (FMCC). Last month, a group of large investors objected
to the handling of 115 bond deals issued by units of Countrywide Financial, now
part of Bank of America.
In one typical example, Gayle Hanson, a senior loan auditor for the
Barrent Group, sifted through 331 pages of loan documents as part of her autopsy
of a $ 165,000 home-equity line of credit on a Colorado Springs, Colo., home.
The file included multiple copies of the mortgage and notes detailing efforts to
contact the delinquent homeowner.
She also scours credit reports, property records, appraisals, telephone
listings, photographs of the house for signs that it was an investment rather
than a primary residence, and any indication that the borrower owned property
not disclosed on the loan application or that the appraisal was inflated.
Hanson found that the Colorado Springs borrower had at least three
undisclosed mortgages totaling $520,000 in addition to nine investment
properties listed on the loan application.
The files contained little information to support the borrower's claim
that he earned $13,500 a month, as well as $5,700 a month in income from
rental properties. "The underwriter didn't do due diligence on this," she said.
Barrent wouldn't identify the borrower or lender.
Barrent works with clients to select mortgages with a high probability of
problems. Misrepresenting income is the most common defect in loan files
reviewed by the company's 38 employees. That isn't surprising given that many
loans it reviews didn't require borrowers to document their earnings.
One borrower whose loan was scrutinized claimed to be a shoe salesman
earning $35,000 a month. A regional sales manager who cited earnings of
$250,000 a year actually made $47,000 as a clerk for the same company.
About 65% of Barrent's reviews result in a loan-repurchase request. Banks
have bought back about 1,100 loans, or about half, with clients of the
loan-review firm recovering nearly $142 million in losses, according to the
company. The figures reflect reviews for bond insurers and exclude loans for
which negotiations are continuing.
Closely held Barrent gets paid an undisclosed fee for each loan it
inspects or in some cases, a portion of the recovery. "You are going to have to
pound the table and go the distance," Barrent says.
Investors in mortgage-backed securities face tougher obstacles than Fannie
Mae, Freddie Mac or bond insurers, says Glenn Schorr, an analyst at Nomura
Securities International Inc. Bond investors typically must prove that an
underwriting breach, not tumbling home prices or rising unemployment, "
materially and adversely" affected a loan's value, he says.
In addition, contracts on bond deals often require investors to win
support from 25% of the voting rights in the trust before they can petition for
access to loan files. Even then, "the servicer will, in many cases, refuse,"
says Talcott Franklin, a lawyer in Dallas who has been organizing bond investors
to pursue such claims and represents investors with at least a 25% stake in more
than 3,000 bond deals.
Some investors are using outside data to build their case. David Grais, a
New York lawyer representing two Federal Home Loan banks in lawsuits against
securities firms that sold mortgage-backed securities, recently hired CoreLogic
Inc. (CLGX), a Santa Ana, Calif., company, to supply public records data on 750,
000 loans in more than 250 bond deals.
Grais used the information to look for signs of inflated appraisals,
undisclosed liens and investment properties or second homes that had been listed
as primary residences. Nearly half the loans had at least one material flaw, he
says, adding that he is optimistic that the results will convince a judge to
give him full access to the loan files.
"We have lined up a battalion of loan file reviewers," he says.
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