“Secret Seconds” Raise risk of MBS default, unknown to investors

[powayseller]

When investors purchase MBS, they have no idea of the much higher risk in the portfolio as a result of the borrower taking out a HELOC.

Chrisopher Cagan reports on ‘What you don’t see can hurt you – Silent seconds impact portfolio LTVs’

There is no reporting mechanism to MBS investor that says, “Hey, your $1 trillion of MBS just increased its risk 5 fold, because those borrowers took out HELOCs and moved from 80% LTV to 100% LTV”. Often, even the first mortgage lender is unaware of the HELOC!

Cagan’s study took 10 pools of loans, about 23,000 loans in all, and checked county recorder records to verify if they had any second liens after 2 years. He found that 2 years after securitization (origination of the first loan), 23% – 53% of the loans in each pool had a HELOC and thus a higher CLTV. (CLTV is combined loan to value; LTV is the loan to value of the first loan, whereas CLTV combines all the loans. Fannie Mae and most lenders do not include the second loans on their analysis, wrongly stating the LTV as if the second did not exist. All lenders, in my opinion, should be using CLTV.) Investors had no way of knowing that the CLTV of their pooled portfolio had increased at all, let alone knowing that it increased 23% or 53%. If a loan was 90% LTV at origination, and a junior lien was added, the loan could be underwater, and the MBS investor doesn’t even know it!!!!

This is a concern,because data shows that having a second loan raises the risk of default.

MBS investors, you are in for such a rude awakening.

The sad thing is: your pension fund is full of this stuff.

By dollar volume, MBS debt is GREATER than US corporate bonds or US Treasury bills!

[sdrealtor]

Don’t new loans have to be subordinated to the primary lien holder when taken out?

[powayseller]

That’s what perplexes me about this story; it sounds like subordination does not require notifying the primary lien holder.

[barnaby33]

Why would the primary or any superior lien holder care about junior lien holders? As long as he knows his place in line, the loan is supposedly backed by the asset. So as long as the asset doesn’t decline in value, the lien holder is secure. If it does decline in value, thats where the primary lien holder gets into trouble.

I suppose there is an argument to be made that overall a borrower becomes more risky as he takes on more debt. The primary lien holder might like to know about other debts, in order to assess his overall risk, but he is still first in line for the asset should the borrower default.

Josh

[davelj]

The senior lien holder cares about the junior lien holders because the mere presence of a junior lien (obviously) raises the odds of default; there’s more debt to service, after all. And while the senior lien holder’s position has more protection, servicing these loans becomes much more expensive as defaults and foreclosures rise.

Think of it this way. As a bank, holding interest rates constant, would you rather hold a portfolio of 70% LTV mortgages with practically zero odds of default OR would you rather hold a portfolio of 70% LTV mortgages all with 20% juniors behind them (for a CLTV of 90%)? Clearly the latter portfolio is more risky and more expensive. Yes, you’ll likely get your principal back, but it’s going to be more expensive from an operating standpoint (servicing, legal, etc.).

Holding the interest rate steady, you’d always rather have a lower risk of default, even if you feel your principal is protected. The mortgage business has very thin profit margins. Add in a lot of additional servicing on an additional 5% of your portfolio and an otherwise good portfolio turns bad pretty quickly even if your principal is protected.

[Steve Beebo]

I don’t think the owner of the first mortgage cares that much if there is additonal financing added later. First of all, they can’t do anything about it, and they’re probably not going to know about it anyway. And some, (that’s some – I’m not saying most), some people who take out second mortgages may use it for home improvement, or landscaping and pools on new houses, which may (that’s may) increase the value of the property.

[Wiley]

I think the real point is the buyers/holders of the mbs would care. If not then why would you even ask about the debtors debt/income ratio in the first place. True there isn’t anything they can do about it but the information may change how they view the overall markets fundamentals and further purchases going forward.

[Steve Beebo]

At the time the first loan is made, they care about everything having to do with the borrower. After the first loan is made, whether or not a homeowner obtains a second loan isn’t their business. They may prefer that another loan isn’t made, so that the owner may have more equity and less chance of bailing out, but they can’t do anything about it.

[powayseller]

davelj, your answer makes perfect sense to me. That’s why I don’t understand why the 2nd lien holder is not required to notify the 1st lien holder of the new loan; the vendor whose link I posted sells the information on CLTV to the MBS holders (or 1st lien holders)?

So it sounds like the 1st lien holder can’t do anything about it. Even if they know the guy got a HELOC, they cannot raise the interest rate or require his income or home value to be higher, since it’s too late for that. The 2nd lien holder makes the decision if the borrower qualifies, but the 2nd lien holder could have different underwriting guidelines, much looser…

[LookoutBelow]

I think if yu REALLY research this, you'll find out that most of the MBS's were bought by the chinese markets. The CHINESE who own 90% of this shakey debt are the ones in for a rude awakening. Check it out

[Anonymous]

I would rather have a 2nd lender behind me. If the borrower defaults on the payments the 2nd lien holder (in Calif.) will cure the default on the first to foreclose on the 2nd. If 2nd lienholder does not cure the first loan default then the first is protected by whatever equity remains. If the first loan is greater than 75-80% LTV then a probable loss will occur. Bottom line the borrower wants to avoid default and the 2nd lender also wants to prevent total loss of value of the 2nd loan. Therfore two parties are concerned about payments on the first loan.

[Anonymous]

I would rather have a 2nd lender behind me. If the borrower defaults on the payments the 2nd lien holder (in Calif.) will cure the default on the first to foreclose on the 2nd. If 2nd lienholder does not cure the first loan default then the first is protected by whatever equity remains. If the first loan is greater than 75-80% LTV then a probable loss will occur. Bottom line the borrower wants to avoid default and the 2nd lender also wants to prevent total loss of value of the 2nd loan. Therfore two parties are concerned about payments on the first loan.

[davelj]

RLA, that doesn’t really make much sense. Without the junior lien the odds of default are lower on the senior lien. So, as the senior lienholder, wouldn’t you just rather have no junior lienholder at all? In other words, wouldn’t you rather just have lower odds of a default period? And if the borrower does, in fact, default, the fact that there’s a junior lienholder that’s also interested in recovering their principal doesn’t really get me very excited. In fact, it’s just one more party that wants their money that I might have to deal with in some way.

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