August 23, 2007
Assurances on Buybacks Cost a Lender
By GRETCHEN MORGENSON
Expanding rapidly as the nation’s largest home mortgage company, Countrywide Home Loans quietly promised investors who bought its loans that it would repurchase some if homeowners got into financial difficulties.
But now that Countrywide itself is struggling, it may not be able to do so, making it even harder for troubled borrowers to reduce their interest rates or make other changes to their loans to avoid foreclosure.
The possibility that Countrywide may have to buy back mortgages that it sold comes on the heels of its announcement last week that the tightening credit markets had forced it to draw on its $11.5 billion line of credit from a consortium of banks, a move that sent the market plummeting.
But yesterday, Bank of America agreed to invest $2 billion in Countrywide, buying preferred shares that carry an interest rate of 7.25 percent and can be converted into common stock at $18 each.
“Bank of America’s investment in Countrywide represents a vote of confidence and strengthens our balance sheet, enabling us to position Countrywide for future growth and success,” Angelo R. Mozilo, chief executive of Countrywide, said in a statement.
Countrywide, with its stock depressed, had been seen as a prospect for a takeover. But any obligation the company has to buy back loans may complicate discussions with potential investors or buyers.
The repurchase obligations are discussed in Countrywide’s prospectuses and pooling and servicing agreements that cover about $122 billion worth of mortgages packaged and sold to investors from early 2004 to April 1 of this year.
The agreements said that Countrywide Home Loans, a unit of Countrywide Financial, would buy back mortgages in the pools if their terms were changed to help borrowers remain current. Such changes are known as loan modifications. In general, it is difficult for homeowners to get loans modified if they are in a securitization pool.
It is unclear how many modified loans are involved. But it would cost $1.2 billion for the company to repurchase 1 percent of the loans in the pools at issue. Repurchasing 5 percent would cost $6.1 billion. When such buybacks are made, the original amount of the loan is paid into the pool and divided among the investors.
Under the terms of the loan pools, the decision to modify a mortgage is left to the company that services it. Servicers deal directly with borrowers, taking in monthly mortgage payments and sending them out to the investors in the pools. Most of Countrywide’s loans are serviced by its Home Loan Servicing unit.
But Countrywide’s servicing unit may have less incentive to help troubled borrowers who are interested in working out their loans, analysts said, because doing so could put the parent company on the hook to buy back a loan.
“With the volume of adjustable-rate mortgages that Countrywide has originated, their liquidity crunch potentially eliminates a viable tool to keep mortgages affordable in the face of impending interest rate resets,” said Kevin Byers, a principal at Parkside Associates, a consulting firm in Atlanta and an authority on securitizations.
According to company figures, last year 45 percent of Countrywide’s loans had adjustable rates; many begin with low rates and adjust to much higher levels.
Agreeing to buy back loans that are modified is highly unusual and perhaps unique among pools issued by companies like Countrywide, Mr. Byers said. Pools backed by mortgages issued by Fannie Mae and other government-sponsored entities typically include such language.
It is likely that Countrywide put the language into its agreements as an incentive to make its mortgage pools more attractive to investors, in turn generating more money for Countrywide when it sold them.
A Countrywide spokesman, Rick Simon, said that the company’s servicing unit was interested only in keeping loans performing and that its modification decisions would be based on that goal.
“Investors rate servicers based on their ability to keep loans in a performing state and to turn nonperforming loans into performing loans,” he said. “The fees collected for servicing are based on the loans performing.”
Loans that reach foreclosure are expensive for both lenders and servicers, Mr. Simon added.
But servicers must also consider the interests of investors who bought the mortgage pools for the cash flow they generate. If the cash flow drops because of loan modifications, some investors will be unhappy.
Mr. Simon would not say how many loans Countrywide had modified and bought back as a result of the pooling agreements. But Countrywide’s financial statements from last year show that it bought fewer delinquent loans out of securitization entities than in previous years. Those purchases totaled $1.5 billion last year, down from $3.8 billion in 2005 and $3.4 billion in 2004.
Under most agreements, the amount of loans that can be modified in any pool is limited to 5 percent, unless the mortgage borrowers are defaulting or seem to be about to default. Mr. Simon said that the pooling agreements indicating that Countrywide was obligated to buy back modified loans applied only to mortgages that are not in danger of defaulting.
But the language in the pooling agreements from 2004 through much of 2007 does not state this clearly. Only as of April 1 do Countrywide’s pool terms begin stating that the company is not required to repurchase modified loans.
Mr. Simon said this change in language was made to clarify the original intent of the agreements.
Many subprime loans being serviced by Countrywide are in trouble. As of June 30, almost one in four subprime loans serviced by the company were delinquent, up from 15 percent in the period a year ago. Almost 10 percent were delinquent by 90 days or more versus last year’s rate of 5.35 percent.
Loans can be modified to try to keep homeowners from losing their property. Major changes like reducing the interest rate are considered a loan modification.
Lesser changes are not, strictly speaking, modifications. Getting a delinquent borrower current on a loan by adding the payments that are owed is considered a forbearance, not a loan modification.
Update: Housing Wire critiques the Times article.