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Mortgage Hot Potatoes: BanksTry to Unload High-Risk Loans
By Carrick Mollenkamp
and James R. Hagerty
and Ruth Simon
From The WallStreetJournalOnline
Efforts by major banks and Wall Street firms to unload bad U.S. housing loans are speeding up a shakeout in the subprime mortgageindustry.As more Americans fall behind on mortgage payments, Merrill Lynch & Co., J.P. Morgan Chase & Co., HSBC Holdings PLC and others aretrying to force mortgage originators to buy back the same high-risk, high-return loans that the big banks eagerly bought in 2005 and 2006.Merrill demanded in December that ResMae Mortgage Corp. -- which in 2006 sold it $3.5 billion in subprime mortgage loans, or loans toborrowers with poor credit records -- buy back $308 million of loans whose borrowers had defaulted. In a filing this week for bankruptcy lawprotection, ResMae said those demands "crippled" its operations. The Brea, Calif., company said that repurchase requests were "severeand unexpected."
As more subprime lenders face losses or bankruptcy, big banks also face another problem: Many lent money to small firms like ResMae sothat those firms could make more mortgage loans to borrowers. It isn't clear how much of these loans will be paid back to the banks. WallStreet firms also are increasing their own internal generation of subprime loans by acquiring smaller mortgage loan originators or processing companies.In 2005 and 2006, banks such as HSBC and brokerage firms like Merrill Lynch went on a buying spree, snapping up subprime loans fromtypically small mortgage banks that had lent money to homebuyers. At the same time, many lenders were loosening their credit standardsand making riskier loans.HSBC kept many of the loans, while Wall Street firms chopped the loans into pools sold to investors as mortgage-backed securities.In recent months, as home-price appreciation fell and borrowers faced rising interest rates, more people defaulted on their mortgages. Thatprompted Merrill Lynch and others to exercise their contractual right to demand the sellers buy back the loans. Under mortgage contracts,mortgage originators must often repurchase loans that default very early in their term or that come with underwriting mistakes, such asflawed property appraisals."Following early payment defaults, we exercised our contractual rights to return loans to ResMae and protect our financial interests," aMerrill spokesman said. HSBC declined to comment. J.P. Morgan declined to comment.Yesterday Accredited Home Lenders Holding Co., a subprime mortgage lender based in San Diego, reported a loss of $37.8 million for thefourth quarter, partly due to heavy repurchases of dud loans from large loan buyers, compared with a year-earlier net income of $43.3million.Accredited uses credit lines from eight financial institutions to fund its mortgage lending. Those lines of credit contain covenants that couldallow the lenders to demand prepayment of the outstanding balance if Accredited has two consecutive quarters of losses, the companysaid.Accredited already has received waivers in some cases on those covenants and will need to seek more waivers from the lenders if thecompany remains in the red during the current quarter, it said.Investment-banking firms and investment firms that bought mortgage-backed securities are hiring firms to scrutinize subprime portfolios for loans that violate contracts.Clayton Holdings Inc. is working with a half-dozen investment-banking firms to identify loans that should be repurchased. Clayton has alsobeen hired by two hedge funds to review mortgage bonds they own for potential repurchases."Nobody was doing this in earnest before late last year," says Kevin Kanouff, president of Clayton Fixed Income Services, adding that heexpects the volume of putbacks "to trail off in the third or fourth quarter. The carnage that you are seeing...is not over."