Tuesday, December 30, 2008

Tug of war over CDS central clearing

From the Financial Times:

In 2008, “credit derivatives” almost became a household phrase. In the past three months alone, the term has been mentioned in the print media nearly as many times as during the whole of 2007.

There is barely a financial regulator – or politician – who has not expressed an opinion on credit default swaps (CDS), the most common type of credit derivative, trading in which ballooned to a peak of more than $60,000bn of contracts by the end of 2007.

Gerald Corrigan – a managing director at Goldman Sachs and the former head of the New York Federal Reserve who has led industry efforts to tackle the systemic risks around the use of over-the-counter derivatives – told a Congressional committee that it was not possible to know whether on balance, CDS contracts had “tempered or amplified the credit crisis”.

“While I believe that we will gravitate toward an informed answer to that question only with the passage of time, based on what we now know I see the CDS as a net plus in a setting in which we must acknowledge that the CDS and other segments of the financial markets have benefited from large scale central bank and governmental interventions,” he said.

Whether regulators believe CDS are at root useful or not, will play a large part on determining the shape of the credit derivatives industry beyond 2008. Already the opaque – but in recent years enormously profitable – part of the markets has been pushed to open up.

Every week, the Depositary Trust & Clearing Corp, the US clearer and settlement system estimated to represent about 90 per cent of the market, publishes the exposures on credit derivatives contracts (although oddly some opacity remains because only the current and previous weeks’ data are ever available publicly, meaning that non-insiders who wish to track developments must record and keep the data themselves).

Market participants are also trying to combat the fear of big numbers by tearing up old, duplicated, or neutralised contracts, reducing the outstanding notional size of the CDS market to $54,000bn by June this year.

But probably the most important and radical change underway is in the attempts to introduce a central clearing house and counterparty. This gained added urgency after the default of Lehman Brothers highlighted to regulators, politicians and bankers themselves the fallibility of important counterparties in the markets.

A central clearing house will dramatically alter the risk profile of the industry by concentrating in one place the market and the biggest dealers, though potentially not the hedge funds and others who make up the buyside. It could also similarly affect the costs and profitability.

“There appears to be a tug of war going on within the world of central clearing solutions,” says Brian Yelvington, analyst at CreditSights. “We thought these would be resolved by year end, but it now seems that these will continue into next year, and some important questions like the cost of the counterparty and margin postings are still not known. These, among others, will affect the profitability of the CDS market going forward.”

There is continued uncertainty about how far the central counterparty will reach, whether it will end up encompassing all credit derivatives or whether it will stop at some indices and individual names.

One issue is how far dealers are willing to go to standardise contracts. Every move to standardisation removes the potential profitability, and there remains some resistance.

Also, there are broader questions about how financial markets will be regulated in the future. In the US, there are discussions about whether various regulators should be merged.

It is also possible that US and European regulators will end up setting different rules, a move which could fragment a market which has so far been global in nature.

“A clearing house in itself does nothing to address the problems which can result from the use of derivatives, which is the leverage that can be created through their use,” says Joel Telpner, partner at Mayer Brown. “The question is whether there will be further legislation to address these concerns, and this will be an important question that will determine the future shape of the market.”

Andrew Feldstein, chief executive of BlueMountain, says the introduction of centralised clearing for credit derivatives on individual entities, like companies or governments, would make trading much more liquid.

“Credit is clearly getting very interesting right now. There is never a guarantee that you will make money, but there will certainly be plenty of incredible opportunities in the credit space and credit derivatives will be one of the most important markets through which to express those views,” he says.

DBRS to cut rating for new Canadian ABCP notes

By Tara Perkins in the Globe & Mail:

DBRS Ltd. has lowered the rating it plans to give to new notes that will come out of the 16-month process to fix the market for $32-billion worth of frozen asset-backed commercial paper.

The Toronto-based credit rating agency said yesterday that it will be assigning a single-A rating to the notes, because "a number of challenges have arisen" since April, when it had said it expected to assign a double-A rating.

Credit spreads have widened significantly and some of the assets that were underlying the commercial paper have faced pressure.

DBRS was the only agency to rate the commercial paper before the market seized up as a result of the liquidity crisis in August, 2007, and much of the paper had received top ratings. A report by Canada's brokerage industry regulator, the Investment Industry Regulatory Organization of Canada, found that most brokerages selling the paper said they did not conduct internal due diligence reviews of the complex product because they relied on the high credit rating the paper received from DBRS. The rating agency has taken significant heat as a result of its ratings.

It continues to be the only agency to rate the new notes. Yesterday, rival Moody's Investors Service said it is not rating them.

On Christmas Eve, the committee that's been working to restructure the frozen commercial paper market announced that it finally had a new plan that should allow the market to thaw early in the new year, thanks in part to support from the government and other backers.

A significant amount of the money that will be backing the restructuring plan was conditional on the notes receiving a credit rating of at least single-A.

"We do not believe that the A rating will affect the ability of note holders, who would have been able to hold AA rated notes, to hold the restructured notes," a source close to the committee said yesterday.

A number of investors, from corporations to pension plans, have rules that outline the minimum credit rating an investment product must receive in order for them to hold it.

The judge overseeing the restructuring of the market will be asked to sign off on the committee's latest plan in January, after which the commercial paper can be swapped for the new notes. It is not the first time that the committee has presented a plan, but it now hopes the restructuring will be completed by Jan. 16. A key element of this fix was an agreement from Ottawa, Alberta, Quebec and Ontario to provide a backstop credit line totalling $3.5-billion.

Saturday, December 27, 2008

Ecuador’s Correa Wants Debt Restructuring to Proceed in January

(Bloomberg) Ecuadorean President Rafael Correa wants debt negotiations triggered by the South American country’s second bond default in a decade to proceed in January.

In his regular Saturday radio-and-television broadcast, he repeated his call for bondholders to accept a “substantial” discount without offering specifics on the $3.9 billion owed. He will submit an offer to holders early next month, he said today.

“We will make a proposal to rebuy these bonds, many of which have already given great yields to these speculators,” Correa said. “It’s likely that those who hold the bonds now didn’t buy them at 100 -- rather at 20, 30, or 40 -- so it’s not like these people are being hurt.”

Correa, a 45-year-old economist, on Dec. 12 refused to give the order to release a $30.6 million interest payment due Dec. 15, when a monthlong grace period expired. He has alleged much of the debt is “illegal.” The $510 million bonds due in 2012 plunged to 23 cents on the dollar from 31 the previous session and 97.5 cents three months ago.

By defaulting, Correa, a close ally of Venezuelan President Hugo Chavez, fulfilled a threat he made during his 2006 presidential campaign. His decision comes as a deepening global economic slump throttles demand for oil, the country’s biggest export. Ecuador, which also defaulted in 1999, owes about $10 billion to bondholders, multilateral lenders and other countries.

A debt commission Correa formed last year said in a 172-page report in November that the global bonds due in 2012 and 2030 “show serious signs of illegality,” including issuance without proper government authorization.

Correa also said he would restrict some imports to reduce the withdrawal of dollars from the local economy.

“We import sweets and chewing gum for more than $60 million a year and perfume for more than $100 million a year,” he said. “That situation can’t continue.”

Thursday, December 25, 2008

'Tentative' Canadian ABCP plan touted

By Jim Middlemiss in the Financial Post:

It's deja vu all over again in the asset-backed commercial paper saga.

One year ago to the day that the Pan-Canadian Investors Committee first claimed victory by announcing a "tentative" deal to restructure the frozen $32-billion market, the committee has confirmed it has a new "tentative" agreement that would lead to some investors being paid in full and others left holding long-term notes that will pay back their capital in eight years or so.

While negotiations were continuing into the evening, a spokesperson said "the committee for third-party structured ABCP confirms the tentative agreements reached with the governments of Canada, Quebec, Ontario and Alberta to provide funding to support a restructuring of $32-billion of third party asset-backed commercial paper. Details of the agreement, which are broadly similar to those reported in the media since the weekend, are currently being finalized. The committee will issue a news releases at the appropriate time with relevant final details."

Retail investor Brian Hunter, who holds $660,000 of the frozen paper and has been key to rallying retail investors, said: "We've been whacked so many times by this thing. Each time you thought you were getting somewhere. You get too skeptical. Until the cash is in my account, I'm certainly not chilling any champagne."

"It's very difficult to polish a turd ... maybe these guys have done the unthinkable. Maybe they actually polished a turd, who knows. If they do, I will be very excited to get my resources back," he added.

On Dec. 23 last year, after missing a number of self-imposed deadlines, the committee announced it had a deal in place to turn the short-term paper into long-term notes, which would see investors repaid their capital if they held them to term, about eight years.

Originally, Quebec pension giant Caisse de depot et placement du Quebec, which holds $13-billion of paper, and Desjardins Financial Group was also going to self-insure a tranche of those notes, and the rest was going to be backstopped by a $14-billion margin facility put up by a coalition of Canadian and foreign banks.

Since then, it has been a restructuring roller coaster, as credit spreads blew apart and retail investors flexed their muscles demanding to be paid, when the trusts holding the notes were turned into companies and put into creditor protection under the Companies Creditors Arrangement Act.

That lead to a side agreement where retail investors holding less than $1-million worth of paper would be paid out by their investment dealers, Canaccord Capital Corp. and Credential Securities.

The deal is expected to include a 14-month moratorium on collateral calls on loans related to the notes, a widening of the spread-loss triggers, which will reduce the likelihood of margin calls on the leveraged loans that the paper depends on, and an additional $3.5-billion in funding to backstop the notes from the government. That's in addition to the $39-billion of collateral and margin facility already in place to backstop the notes.

Originally, the committee was seeking $9.5-billion, but it's not clear whether or how much the parties involved in the market are being called upon to ante up more cash to backstop the notes.

Ontario Superior Court Justice Colin Campbell, who has been assigned to the case, must still approve any deal, which will likely happen in the first week of January, followed by a closing a week later.

Retail investors are expected to get paid 20 days later.

Court Extends Deadline for ABCP Restructuring (from the Canadian Press):

The Ontario Superior Court has extended the deadline for the restructuring of the $32-billion frozen asset-backed commercial paper investments until Jan. 16, a group involved in the talks said late Wednesday.

The Pan-Canadian Investors Committee for Third-Party Structured ABCP also confirmed that an agreement has been reached with all key stakeholders, including the governments of Canada, Quebec, Ontario and Alberta on the restructuring program.

The committee said it can now begin the process of completing the long-awaited restructuring and had posted related documents on the Internet.

The documents were made available by the court-appointed monitor, Ernst & Young Inc. on its website (www.ey.com/ca/commercialpaper).

A motion for court approval will be brought in early January, seeking approval of the closing process.

"Pursuant to the terms of an agreement reached among the governments, the dealer bank asset providers, the Canadian schedule 1 banks and the investors committee, the governments, together with certain participants in the restructuring will provide, in the aggregate, $4.45 billion of additional margin facilities to support the proposed restructuring plan," it said.

The committee said it was delighted with the support from the governments as well as from the asset providers and the banks.

"We are equally pleased to have crossed a major hurdle in completing the restructuring plan," said Purdy Crawford, chair of the committee.

Retail holders of the toxic investments, who represent only about one per cent of all involved ABCP, asked Monday that the governments make the success of any deal contingent on a separate deal for them.

In particular, the retail investors want the cap removed from a side deal promising to repay only those with $1 million or less invested in ABCP.

An estimated 99 per cent of the notes are held by institutional investors, such as pensions and businesses, but about $400 million is held by an estimated 1,800 retail accounts.

Wednesday, December 24, 2008

Special Notice: Mortgage News Migration

I've decided to hive off my housing market and mortgage-related posts to another blog that I'm calling the Mortgage Fanatic. I'm planning to focus the Market Pipeline more on financial stability issues. Also, a few months ago I set up another blog that's devoted to the transfer of insurance-type risks (e.g., catastrophe bonds) to another blog I'm calling the Frontiers of Risk Management. Sorry about any confusion this may cause, but in the long run this is a better way to go.

$300 billion FHA rescue funds available to homeowners -- with a hitch

From the Inland Empire & Inland Valley Breaking News:

A $300 billion Federal Housing Administration rescue plan aimed at cutting troubled homeowners' monthly payments by hundreds of dollars a month is available to lenders willing to use it.The White House has said the Hope for Homeowners plan has the potential of keeping as many as 400,000 homeowners from going into foreclosure.

But there's a hitch.

Kurt Eggert, a Chapman University law professor and former member of the Federal Reserve Board's Consumer Advisory Council, said the FHA program's challenge is to "build in enough motivation for the financial industry to play along."

For some banks, that motivation is in offering the same high-dollar incentives to loan officers and independent mortgage brokers that were offered before the housing crash, according to mortgage industry insiders in Washington, D.C.

The fear is that these middle men will use the rescue plan to once again line their pockets by putting borrowers into loans with inflated interest rates, which means higher monthly mortgage payments than what some of the plan's proponents intended."

They have to give lenders something so they'll do the FHA refinances, and so mortgage brokers will handle it," Eggert said. "The challenge is, how much do you give them? Certainly we don't want to give (loan officers and brokers) so much where we have a repeat of the abuses of the past, where borrowers were jammed into loans that weren't appropriate for them. I don't know if they've struck that balance."

On Oct. 1, FHA started administering the rescue program, which is mandated by the 2008 Housing and Economic Recovery Act.

The program doesn't put credit-score requirements on borrowers, whose scores drop with every payment they've missed. But there are no provisions mandating that banks and lenders buy into that approach.In fact, some mortgage lenders plan on turning away homeowners with credit scores below 580, sources in Washington, D.C., say.

For homeowners with credit scores above 580, and who are upside-down in their loans, mortgage lenders would write new government-backed mortgages. Upside-down homeowners are those who owe more on their mortgages than their properties are worth.

The new loans would be written based on a home's current value, which likely would be drastically lower than the original mortgage.Writing down these mortgages means huge losses for the lenders. Still, many homeowners with rewritten loans will be able to keep their homes, which lets the banks bypass the higher cost of foreclosure.

That's a win for all parties.But there's no provision in the law that stops lenders from shifting qualified borrowers into higher-cost loans, which is how much of the current mortgage mess was created.Because of this, lenders may push financially fragile homeowners into loans that generate extra income for independent mortgage brokers and bank loan officers.

The higher income comes through an incentive called a yield-spread premium, which allows independent brokers and bank loan officers to make more money when they sell a loan with a higher interest rate.And if a debt-straddled homeowner still ends up defaulting on the mortgage and goes into foreclosure, the lender is assured to be paid in full by the U.S. government.

Bill Glavin, special assistant to the FHA commissioner, said his agency has no control over banks and lenders' decision to do that."There's not much we can do about that," Glavin said.Congressman Joe Baca, D-San Bernardino and co-author of the Hope for Homeowners program, said a provision in the program forces independent brokers to disclose details on those higher-cost loans in a loan document's closing statement.

That's nothing new. Independent brokers are already mandated to do that by the Real Estate Settlement Procedures Act of 1974.But given their complexity, it's very possible some borrowers simply won't understand the yield-spread premiums -- a common occurrence during the housing boom.

And federal real-estate law has never required banks to disclose details on yield-spread premiums. Borrowers dealing with a bank loan officer may ask to see paperwork which shows the amount the officer is making on the deal, but the bank isn't required to show customers that information.

The problem with regulating yield-spread premiums: There's a higher chance that banks and lenders wouldn't participate in the FHA program if they can't use incentives, Baca said.

But if troubled homeowners getting loans through Hope for Homeowners don't understand how to read yield-spread premiums, there's a higher chance they'll sign off on these loans and never know how much money their independent brokers or bank loan officers made, said mortgage broker Paul Ostrowski, owner of Anaheim-based AmericasMortgageBlueBook.com.

Borrowers will most likely be paying higher mortgage rates than if they understood the yield-spread premium incentive and decided to shop around for a better deal, he said.Ostrowski and others are questioning why lenders are using this incentive model with a program that's backed by taxpayer money.

Some FHA participants on the brink of foreclosure might end up losing their homes anyway. Those FHA mortgages are government-insured, which means the government is holding the bag on any loans that go belly up.

Ostrowski, who has deep roots in the mortgage industry, worked as a home-loan officer for Wells Fargo in 2004 when the housing boom and subprime market were in full swing."I realized back then that there were going to be major problems because of the loans given to borrowers," he said.

Now, Ostrowski said, he's bewildered at banks and lenders being allowed to put their own spin on the FHA program.Martin Eakes, chief executive officer of the Durham, N.C.-based Center for Responsible Lending -- a nonprofit research and policy group -- said it's just not right."

If lenders are indeed using yield-spread premiums or credit scores to encourage mortgage brokers to steer distressed homeowners into FHA-backed loans that are more expensive than they need be, that is ethically outrageous and certainly not what Congress intended for this program," he said.

Yield Spread Premium: What You Need to Know (from the RefiAdviser)

The number one reason homeowners overpay for their mortgage loans is a little known fee known as Yield Spread Premium. Yield Spread Premium is so bad that the Secretary of Housing and Urban Development was recently quoted that American homeowners will overpay sixteen billion dollars this year alone.

What is Yield Spread Premium? Simply put Yield Spread Premium is the markup of your mortgage interest rate for a commission by the mortgage company or broker. The problem with this markup is that it is rarely disclosed and will cost you in addition to any other fees you pay for loan origination.

Here’s an example of how hidden Yield Spread Premium drives up your monthly mortgage payment costing you thousands of dollars unnecessarily. Suppose you are refinancing your existing home loan for $350,000. Your mortgage company quotes you a mortgage rate of 6.25% and charges you an origination fee of 3% for their part in arranging your loan. This means you will be required to pay $10,500 at closing for loan origination.

What your mortgage company isn’t telling you is that you actually qualified for a 5.5% mortgage rate and they have marked it up for a commission from the lender. The lender behind your loan rewards the mortgage company or broker for overcharging you by paying one percent of your loan amount for every .25% they markup your mortgage rate. In this example the mortgage company was paid an additional $10,500 for overcharging you in addition to the $10,500 you’re paying for loan origination. That’s right; your mortgage company doubled their commission by lying to you about your mortgage rate.

What does this mean for your monthly mortgage payment? With the mortgage rate you got at 6.25% your monthly payment will be $2155. If you had gotten the mortgage rate you deserve at 5.5% your payment would have been only $1980. That’s a difference of $175 per month or $2,100 you’re overpaying every year!

There is good news today since you’ve found this website. The free mortgage videos available online will show you how to avoid Yield Spread Premium when refinancing your mortgage and will get a wholesale mortgage rate. You will also learn which fees charged by the mortgage company and broker are garbage and can be avoided. There are a number of fees mortgage companies and brokers charge like rate lock fees that are complete garbage…if you want the best deal for your home loan you’ll need to avoid these fees in addition to Yield Spread Premium.

HUD Dumps Limits on FHA Origination Fees (Peter G. Miller at FHALoanPros)

As a parting gift to the lending industry, HUD has published its final rule to “Simplify and Improve the Process of Obtaining Mortgages and Reduce Consumer Settlement Costs.”

“Millions of families go to the settlement table each year without clearly understanding what they are paying for,” says HUD Secretary Steve Preston. “In many respects, it’s clear that the current way people buy and refinance their homes isn’t serving us very well at all and has contributed to the current housing crisis.”

But, oh my, buried on page 68227 what do we find but a decision to dump limits on loan origination fees.Previously FHA mortgage borrowers were protected because HUD limited origination fees to 1 percent of the mortgage amount for most FHA loans. However, with the new final rule, the limitations are out and borrower beware is in.

Why? Because HUD says that its new good faith estimate (GFE) forms should protect borrowers.

What’s remarkable about HUD’s explanation of the matter is that its proposed ruling was opposed by the National Community Reinvestment Coalition. No one, apparently, agreed with HUD’s position otherwise another comment would surely have been cited.

No matter. HUD did what it was going to do in a last-minute ruling that the new Administration will have to undo. Meanwhile, borrowers have still-another complexity with which to deal.
ruling and comment are below.

3. FHA Limitation on Origination Fees of Mortgagees
Under its codified regulations, HUD places specific limits on the amount a mortgagee may collect from a mortgagor to compensate the mortgagee for expenses incurred in originating and closing a FHA-insured mortgage loan (see 24 CFR 203.27).1 The March 2008 proposed rule would have removed the current specific limitations on the amounts mortgagees are presently allowed to charge borrowers directly for originating and closing an FHA loan. Under HUD’s proposal, the FHA Commissioner would have retained authority to set limits on the amount of any fees that mortgagees charge borrowers directly for obtaining an FHA loan. In addition, the proposed rule would have also permitted other government program charges to be disclosed on the blank lines in Section 800 of the HUD1/1A.

There was little comment on this issue. NCRC (the National Community Reinvestment Coalition) disagreed with the proposal to remove the specific limitations on the amount mortgagees are allowed to charge for originating and closing an FHA loan. NCRC stated that a government-guaranteed loan product should shield borrowers from excessive charges by establishing reasonable limits on fees. According to NCRC, while it may be acceptable to carefully raise origination fee limits, this should be done only in conjunction with establishing reasonable limits on YSPs. This commenter stated that by establishing standard limits on origination fees and YSPs, the FHA loan product can keep the nongovernment guaranteed products competing by constraining direct fee and YSP costs.

HUD Determination
HUD believes that its RESPA policy statements on lender payments to mortgage brokers restrict the total origination charges for mortgages, including FHA mortgages, to reasonable compensation for goods, facilities, or services. (See Statement of Policy 1999-1, 64 FR 10080, March 1, 1999, and Statement of Policy 2001-1, 66 FR 53052, October 18, 2001.) Moreover, the improvements to the disclosure requirements for all loans sought to be achieved as a result of this rulemaking should make total loan charges more transparent and allow market forces to lower these charges for all borrowers, including FHA borrowers. Therefore, HUD has determined to finalize the proposed rule to remove the current specific limitations on the amounts mortgagees presently are allowed to charge borrowers directly for originating and closing an FHA loan. The FHA Commissioner retains authority to set limits on the amount of any fees that mortgagees charge borrowers directly for obtaining an FHA loan.

Note 1: Under 24 CFR 203.27(a)(2)(i), origination fees are limited to one percent of the mortgage amount. For new construction involving construction advances, that charge may be increased to a maximum of 2.5 percent of the original principal amount of the mortgage to compensate the mortgagee for necessary inspections and administrative costs connected with making construction advances. For mortgages on properties requiring repair or rehabilitation, mortgagor charges may be assessed at a maximum of 2.5 percent of the mortgage attributable to the repair or rehabilitation, plus one percent on the balance of the mortgage. (See 24 CFR 203.27(a)(2)(ii), and (iii).)

Jumbo Mortgage Shoppers Get Little Relief From Fed Rate Cuts

(Bloomberg) Jumbo mortgage shoppers in the most expensive U.S. housing markets such as New York and San Francisco aren’t getting much relief from lower borrowing costs.

The average 30-year fixed rate for home loans of more than $729,750 remains almost 2 percentage points above conforming rates and the spread between them may set a record this month, according to financial data firm BanxQuote.

Banks remain reluctant to lend after recording $678 billion in mortgage-related losses and writedowns in the past year and as house prices plunge. Jumbo mortgage rates may come down next year as more buyers refinance, helping banks improve liquidity, said Keith Gumbinger, vice president of mortgage-research firm HSH Associates Inc. in Pompton Plains, New Jersey.

“A guy in a low-cost market like Des Moines probably doesn’t care much about helping someone in New York buy a million-dollar apartment, but if he refinances his conventional loan, that’s exactly what he’ll be doing,” Gumbinger said. “He’ll be giving lenders the liquidity they need to rebalance their loan portfolios and compete for jumbo borrowers who typically are the best in terms of credit quality.”

The average 30-year fixed jumbo loan rate was 7.32 percent on Dec. 22, compared with 5.38 percent for a conforming loan, according to BanxQuote of White Plains, New York.

Wide Spread
The difference between them has averaged 2.13 percentage points in December, 10 times the average spread from 2000 to 2006 and above last month’s 1.95 percentage points that was the highest on record.

Jumbo borrowers New York, San Francisco, and Boston may see rates fall in 2009 because of Federal Reserve Chairman Ben Bernanke’s plan to buy at least $500 billion of agency debt, said Gumbinger.

The Fed’s mortgage-bond buying program, announced Nov. 25, also provides for the purchase of $100 billion in direct debt of Fannie Mae, Freddie Mac and the Federal Home Loan Banks.

Bernanke’s plan adds to previous government actions aimed at lower home-financing costs, including the September seizure of mortgage-finance companies Fannie Mae and Freddie Mac. As part of that takeover, the Treasury announced its own program to buy mortgage-backed securities to bolster the worst housing market in at least 70 years.

Loan Applications Rise
Mortgage applications in the U.S. jumped 48 percent last week as the lowest borrowing costs in five years promoted a surge in refinancing.

The Mortgage Bankers Association’s index of applications to buy a home or refinance a loan rose to 1,245.4, the highest since 2003, from 841.4 a week earlier. The group’s refinancing gauge rose 63 percent and purchases gained 11 percent.

While many homeowners are trying to lower their mortgage payments, buyers remain on the sidelines as prices fall.

The median U.S. home price plunged 13 percent in November from a year earlier, the largest drop on record and likely the biggest decline since the Great Depression of the 1930s, the National Association of Realtors said yesterday in a report.

Home prices are tumbling as foreclosure-related sales accounted for 45 percent of the month’s transactions, according to the Chicago-based trade group.

“The real elephant in the room is falling house prices,” Glenn Hubbard, former chairman of the Council of Economic Advisers under President George W. Bush who is now dean of the Columbia University Graduate Business School, said in an interview on Monday. “We can fix this by lowering mortgage interest rates.”

Prices Sink
Declining prices won’t be helped by the Federal Housing Finance Agency’s announcement last month that it will lower the size of so-called jumbo conforming mortgages that can be purchased by Fannie Mae and Freddie Mac. Congress authorized raising the conforming limit of $417,000 to as high as $729,750 in about 90 of the nation’s most expensive housing markets in 2008 as a temporary measure to support

On Jan. 1 that cap drops to $625,500 following the formula set out by July’s Housing and Economic Recovery Act. The law, known as HERA, specified a loan limit of 115 percent of an area’s median home price, rather than the 125 percent limit approved for this year by Congress, said Andrew Leventis, an FHFA economist. The change means more buyers in high-priced areas will have to use jumbo mortgages, he said.

The Fed on Dec. 16 cut its benchmark interest rate target to a range of zero to 0.25 percent and said it will add to the announced $500 billion in mortgage bond purchases as needed.

“Over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities,” the policy makers said in a statement.

Termination of FHASecure

From a December 19, 2008 HUD press release:

While FHA will retain its standard rate-and-term refinance program for borrowers who are current on their existing mortgages, the FHASecure program under which FHA was able to insure refinance transactions for borrows delinquent on their mortgages, will terminate on December 31, 2008, as per FHA’s initial guidance. Maintaining the program past the original termination date would have a negative financial impact on the MMI Fund that would have to be offset by either substantial across-the-board single family program premium increases or the suspension of FHA’s single family insurance programs altogether.


As of December 31, 2008, FHA will not issue any new case numbers for lenders seeking to refinance borrowers into FHASecure loans. Any loans for which the lender has requested a case number and taken a loan application prior to December 31, 2008 may be processed and will be insured by FHA.

Other Refinance Options

Please note: FHA will retain its standard rate-and-term refinance program, as well as cash-out and streamlined refinance products. The standard rate-and-term refinance product is available to borrowers who are current on their existing mortgages. The policy guidance associated with these other refinance programs (Mortgagee Letter 08-40 and 05-43) remain in effect. Further, the HOPE for Homeowners program is available to help borrowers who may be delinquent on their current mortgages. FHA encourages lenders to consider this product for meeting the needs of distressed homeowners.

Lehman Roils Municipal Swap Market as Collapse Forces Payments

(Bloomberg) Six years after embarking on an effort to lower borrowing costs using derivatives, New York is watching those savings evaporate.

The state says it paid bankrupt Lehman Brothers Holdings Inc. and other Wall Street banks at least $75.9 million since March to end interest-rate swap contracts that were supposed to lock in below-market rates. That money and the costs of issuing new debt to replace bonds linked to swaps gone awry are eroding the $207 million in savings New York budget officials say the derivatives produced since 2002.

New York isn’t alone. Lehman’s bankruptcy filing on Sept. 15 triggered the termination of similar contracts across the country, forcing state and local governments and other borrowers in the $2.67 trillion municipal-debt market to buy out the agreements. They suddenly find themselves making unexpected payments at a time when their revenue is already under pressure from the worst recession since World War II.

“People are fixing problems right now,” said Nat Singer, managing partner at Swap Financial Group in South Orange, New Jersey, and the former head of municipal derivatives at Bear Stearns Cos. The number of new deals has shrunk to a “fraction” of the amount a year ago as issuers unwind failed swaps with Lehman, Singer said.

Bentley University in Waltham, Massachusetts, and a school district in Pennsylvania vowed never to use swaps again after losing money. The added costs in New York come as the state faces a record $15.4 billion budget deficit over the coming 15 months.

Lowering Costs

In a swap, parties agree to exchange interest payments, usually a fixed payment for one that varies based on an index. Borrowers may benefit by using swaps to lower interest expenses or lock in rates for future bond sales.

New York agencies used them to lower the cost of almost $7 billion in bonds sold between 2002 and 2005, according to an Oct. 30 report from the budget division. The average fixed rate the agencies agreed to pay Lehman and other banks was 3.78 percent, compared with 4.5 percent if they had sold conventional tax-exempt debt, officials calculated.

The state failed to comprehend the extent of the risks involved in entering into the long-term contracts, which often last more than 20 years, the report said. They included the likelihood an investment bank would go out of business, triggering the termination of the agreement.

930,000 Contracts

“One of the main risks with swaps, which is that a sudden bankruptcy of a counterparty could terminate a swap in unfavorable mark-to-market conditions, was not effectively addressed in the existing laws and agreements,” the budget division wrote in its annual report.

A budget-division spokesman, Matt Anderson, said in an e- mail that “given the current volatility in the market, we currently don’t anticipate entering into further swap agreements at this time.”

Lehman had about 930,000 derivatives contracts of all types when it collapsed, according to bankruptcy filings. About 30,000 remain open, Robert Lemons, a Weil, Gotshal & Manges lawyer representing Lehman, said last week. The contracts are worth billions of dollars to Lehman’s creditors, though their exact value isn’t clear, he said.

The cost of ending a contract depends on current interest rates. Since New York and other issuers agreed to pay a fixed rate to Lehman when borrowing costs were higher, they must pay the bank to end the deals. The three-month dollar London interbank offered rate, or Libor, upon which many agreements are based has tumbled to 1.466 percent from 5.5725 percent in September 2007.

Swaps Approval

Because they are private agreements, no comprehensive data exist on how many municipalities are involved in the almost $400 trillion interest-rate derivatives market or the total paid to exit the contracts. Derivatives are contracts whose value is tied to assets including stocks, bonds, commodities and currencies, or events such as changes in interest rates or the weather.

New York passed a law in 2002 expanding the ability of state agencies and authorities to use swaps. It was signed by then-Governor George Pataki, a Republican. New Jersey, California and other states also use derivatives in their public financing.

Bentley University entered into swaps with Lehman and Charlotte, North Carolina-based Bank of America Corp. on $85 million of debt between 2003 and 2006. The school also had to pay a fee to end the swaps when Lehman collapsed, based on its contracts with the bank.

Upfront Cash

“It’s going to take awhile for people to get comfortable again, if ever,” said Paul Clemente, the chief financial officer at Bentley, who declined to disclose the amount of the fee. “As far as the future for interest-rate swaps, for me there is no future.”

Some borrowers also use swaps as a way to generate upfront cash, an attractive feature as the recession eats into municipal finances. At least 31 states and the District of Columbia face a combined budget shortfall of $24 billion this fiscal year, the Center on Budget and Policy Priorities in Washington, a non- partisan budget and tax analysis group, said Nov. 12. The estimate on Oct. 10 was $8.9 billion.

The Butler Area School District in Pennsylvania decided in August to pay JPMorgan Chase & Co. $5.2 million to back out of such a deal, more than seven times what it was paid to enter the agreement, rather than risk losing even more money over the 18- year contract. The district superintendent, Edward Fink, said he now thinks it’s inappropriate for school systems to dabble in such trades, even though they were explicitly backed by the General Assembly in 2003.

Valuing Risk

JPMorgan said in September it would stop selling derivatives to states and local governments amid federal probes into financial advisers and investment bankers paying public officials for a role in swap agreements.

Borrowers “never put a value on the risks associated with the swaps,” said Joseph Fichera, president of New York-based Saber Partners LLC, a financial adviser to corporate and public sector borrowers. They only estimated the savings investment bankers and advisers were telling them they would get, he said.

The use of swaps began faltering in February when the market for auction-rate securities collapsed. States, local governments and nonprofits sold about $166 billion of the debt, and as much as 85 percent of that was then swapped to fixed rates, according to Fichera.

Bond Insurers

The collapse of the auction-rate market left issuers such as the Port Authority of New York and New Jersey paying weekly or monthly rates of up to 20 percent. The swap agreements failed to adjust to swings in the underlying variable rates, leaving New York and others exposed to higher borrowing costs.

Interest rates on other types of municipal variable-rate debt also rose this year as investors boycotted bonds backed by MBIA Inc., Ambac Financial Group Inc. and other insurers that lost their AAA ratings because of their expansion into subprime- linked credit markets.

“The combined message from all of that is you cannot have complete confidence in your counterparty,” said Milton Wakschlag, a municipal finance lawyer in Chicago at Katten Muchin Rosenman LLP. “People will be taking a hard look at some of the conventions of the marketplace” after they finish cleaning up from Lehman’s bankruptcy.

Pay Option ARMs - The Implosion Is Still Coming Despite Low Rates

Mr. Mortgage:

There is some serious Pay Option ARM (POA) misinformation going around. Everywhere you look there are stories about how the low index value on the LIBOR will automatically ‘fix’ Pay Option ARMs and drop borrower’s payments to almost nothing. Sorry folks, no cigar. It is shotgun stories by the major media and television personality analysts that set the market and consumer up to for disappointment every time. Over the past year and a half this is my forth story on why a particular bailout or market event will not help the POA’s.

Like the failed mortgage modification efforts and foreclosure moratoria you read about almost daily, this will be a non-starter for most. It is truly a shame how badly constructed these loans really are and how many home owner and bank balance sheets they have destroyed. These loans are much more toxic than Subprime ever was - at least with Subprime the principal balance doesn’t grow each month! They are in a class of their own and ultimately will need a bailout of their own I am sorry to say.

The POA was a favorite across all borrower types especially the middle to upper-end home owner in the bubble states. The broad failure of this loan type will have severe consequences on already depressed CA real estate and on the middle to upper-end home owners in particular.

Monthly Payments / Neg-Am Set-up / Recasts / Qualifying / Negative-Equity

Pay Option ARMs have four or five monthly payment choices. The majority pay the minimum monthly fixed payment rate, known as the ‘teaser’ rate. The percentage of borrowers who opt for the lowest payment has increased as values have fallen. The minimum monthly payment increases 7.5% per year regardless of what happens to the underlying index value. Therefore, this recent drop in rates means nothing for most POA home owner’s monthly mortgage-related outgo.

With the low underlying index values borrowers won’t accrue as much negative amortization but at the end of the first 5-years, most will still see their payment jump sharply. If the underlying indices stay low for years into the future it will make for lower adjustments upward several years from now on subsequent resets, which may be helpful for some.

But this drop in rates does little for those who have had their loan for a few years in the near-term. These borrowers accrued large amounts of negative-amortization as the indices soared from mid-2004 to 2007 and this has to be factored into the first reset.

Past Underwriting Indiscretions — for much of the time that POA’s were in existence many banks qualified the borrowers at the minimum monthly payment rate or based upon interest only payments. Additionally, over 80% were stated or limited income documentation loans. Both of these factors make knowing how the borrower will react to even the standard 5-year hard recast nearly impossible to forecast given they were never underwritten to take into consideration a reset of any type.

What also must be taken into consideration is that a large percentage of underwater, over-leveraged Subprime, Alt-A and POA borrowers are defaulting even prior to their reset date due to the epidemic amount of negative equity. POA’s were mostly originated at higher LTV/CLTV’s in the hardest hit states meaning they are significantly underwater even without the compounding effects of negative amortization. In CA, a heavy POA state, 60% of all mortgage holders are either underwater or within 5% of being underwater unable to sell or refinance.

Pay Options Have a Floor Rate That Always Results in a Payment Spike

The margins (lender profit) were very high on these loans during the ‘POA mania’ portion of the great bubble. I have seen as high as 5% but the average for Prime MTA-based POA’s is probably around 3.25% to 3.5%. The rates below from a large-named lender still in existence today show margins as high as 4%. The margin rate will always have to be paid regardless if the underlying index value falls to zero, which is not possible. The 1HPP (one year hard pre-payment penalty) loan below was the most popular carrying a margin from 3.025% to 4.000% followed closely by the 3-year prepayment penalty loan.

The program and rates below are from July 2006, which was the peak of ‘POA mania’. It is based upon the MTA index, as 80% of all POA’s were and 80% of all Pay Option owners pay the minimum monthly payment.

Reference key for program below: Start Rate = fully amortized ‘payment’ rate. This increases 7.5% per year. Points = broker rebate (yield spread premium. This is the percentage of the loan amount paid by the lender to deliver that rate and margin). NPP Margin = No Prepayment Penalty. 1HPP = 1 year Hard Prepayment Penalty. 3HPP = 3 year Hard Prepayment Penalty.

After 5-years, most POAs (other than Wachovia’s 10-year) will hard recast to pay off the remaining balance in 25-years. When the loan is recast, the payment required to fully amortize the loan over the remaining term becomes the new minimum payment, and the previous payment cap does not apply.

Standard 5-Year Recast vs. Negative Amortization Limit Recast

The 1st Standard 5-Year Recast occurs when the 61st payment is due. Standard 5-Year Recasts occur each 60 months thereafter.

A new minimum payment is calculated for the payment due on the 61st month based on the fully indexed rate at that time, the remaining term of the loan and the loan balance at that time. There are no other payment options for this (61st) month. This new recast payment becomes the new minimum payment for the upcoming 12 months subject to a 7.5% (or whatever your payment cap is) increase the following 12 months and subject to a full recast 5 years from this payment recast, i.e. when the 121st payment is due.

The 1st Negative Amortization Limit Recast occurs when (or if) the negative amortization cap is reached. Most Pay Options have a neg-am cap of 110% to 115%. Wachovia has one of the highest at 125%. At this point, the loan is automatically recast for the remaining portion of the standard recast term (5 years) and then subject to recast at the normal scheduled (5 year) recast period.

For example, if the loan reaches the negative amortization cap on month 59, the loan goes through a Negative Amortization Limit Recast. At the end of the 5th year, on the 61st month, the loan goes through a scheduled Standard 5-Year Recast.

Most Pay Options Based Upon MTA Not LIBOR

Roughly 80%+ of all Option ARMs were based upon the MTA, which is still over 2%. The remainder is based upon the COFI, COSI and LIBOR…probably in that order as well. Very few loans outstanding are true ARM loans of any kind are based upon a short-term LIBOR index.

The MTA, also known as the 12-Month Moving Average Treasury index is the 12-month average of the monthly average yields of U.S. Treasury securities adjusted to a constant maturity of one year. It is calculated by averaging the previous 12 monthly values of the 1-Year CMT (Constant Maturity Treasuries) Index.

There is more…

The CMT is a set of “theoretical” securities based on the most recently auctioned “real” securities: 1-, 3-, 6-month bills, 2-, 3-, 5-, 10-, 30-year notes, and also the ‘off-the-runs’ in the 7- to 20-year maturity range. The Constant Maturity Treasury rates are also known as “Treasury Yield Curve Rates”. The CMT indexes are volatile and move with the market but more quickly than the COFI Index or the MTA Index (see historical graph below).

Therefore, it would be something else if the CMT followed short-rates down to zero. I think if this happened there would be other things to worry about than a few hundred billion in Pay Options blowing up.

**Please note in the chart above that even though the MTA is down to 2% now, it was as high as 5.25% in 2006 and 2007 forcing large amounts of negative-amortization on most all POA’s originated from 2004 until 2007. When payment rates are so low and margins so high, many are sitting right up against their respective 110% or 115% maximum negative amortization limit which forces a hard reset prior to the 5-year scheduled reset.

Actual Pay Option ARM Payment Choices and 6-Year Payment Schedule

Below are the five payment choices available of which the majority chose the ‘Minimum Monthly Payment’, option 1). Each year the minimum monthly payment rate increases 7.5% regardless of what happens to the underlying indices.

Also below are the annual payment rates for the first 5-years up until month 61 and the hard recast. The loan scenario uses a $300k loan amount, 1.25% payment rate, 7.5% annual payment cap, 3.5% margin and is based upon the MTA taken out to the 61st month and first recast. With a 2.03% MTA and 3.5% margin the fully indexed rate is 5.53%.

It is very important to note when evaluating the following schedules that:

a) for much of the time that POA’s were in existence many banks qualified the borrowers at the minimum monthly payment rate or based upon interest only payments. Additionally, over 80% were stated or limited income documentation loans. Both of these factors make knowing how the borrower will react to the standard 5-year hard recast nearly impossible to forecast given they were never underwritten to take into consideration a reset of any type .

b) the schedules below are for new loans originated today and not take in account many who have had their loans for a few years when the underlying index values soared. All of the previously accrued negative amortization has to be re-calculated into the payment upon hard recast at 5-years or at the maximum allowable negative amortization amount of 110% to 125%.

POA Monthly Payment OPTIONS with MTA at Current 2.03% (Fully-Indexed Rate 5.53%)

  • 1) Minimum Monthly Payment: $999.76 (Deferred Interest/Neg-Am = $388.49)
  • 2) Interest Only Payment: $1388.25
  • 3) Fully Amortizing 30-year Payment: $1713.26
  • 4) Fully Amortizing 15-year Payment: $2459.70
  • 5) Fully Amortizing 40-year Payment: $1558.14

POA Monthly Payment OPTIONS if MTA Falls to 1.03% in 12-Mo’s (Fully-Indexed Rate 4.53%)

  • 1) Minimum Monthly Payment: $999.76 (Deferred Interest/Neg-Am = $138.45)
  • 2) Interest Only Payment: $1138.25
  • 3) Fully Amortizing 30-year Payment: $1529.52
  • 4) Fully Amortizing 15-year Payment: $2303.11
  • 5) Fully Amortizing 40-year Payment: $1358.93

Actual Year 1 through Year 6 - Monthly Payment Increase Schedule

  • 1) Year 1: $999.76 = Choice 1 - Minimum Monthly Payment (80% of cases)
  • 2) Year 2: $1074.74 = ($999.76 + 7.5% mandatory annual payment increase)
  • 3) Year 3: $1155.35 = ($1074.74 + 7.5% mandatory annual payment increase)
  • 4) Year 4: $1242.00 = ($1155.35 + 7.5% mandatory annual payment increase)
  • 5) Year 5: $1335.15 = ($1242.00 + 7.5% mandatory annual payment increase)
  • 6) *Month 61: = $1952.29 (Hard Recast to pay off loan in remaining 25-years)

IF the MTA drops to 1.03% from its present 2.03% over the next 12-months (no change monthly until month 61):

  • 1) Year 1: $999.76 = Choice 1 - Minimum Monthly Payment (80% of cases)
  • 2) Year 2: $1074.74 = ($999.76 + 7.5% mandatory annual payment increase)
  • 3) Year 3: $1155.35 = ($1074.74 + 7.5% mandatory annual payment increase)
  • 4) Year 4: $1242.00 = ($1155.35 + 7.5% mandatory annual payment increase)
  • 5) Year 5: $1335.15 = ($1242.00 + 7.5% mandatory annual payment increase)
  • 6) *Month 61: = $1,707.59 (Hard Recast to pay off loan in remaining 25-years)

In summary, while low interest rates are good overall, the effects that lower rates will have on the now ‘infamous’ Pay Option ARM will be muted for many reasons. The broad failure of this loan type will have severe consequences on already depressed real estate values in the bubble states.

The only way to ‘fix’ POA’s is to re-underwrite and aggressively modify like I talk about in my recent report Mr Mortgage: My Case FOR Mortgage Principal Reductions .

**For those of you looking for another take on the Pay Option crisis with the same outcome, please check out my good buddy Dr Housing Bubble’s recent report entitled: Option ARMs For Dummies - Why 4.5% Rates Will Do Absolutely Nothing For These Toxic Assets.

For FHASecure, a Quiet End Nears

Paul Jackson in the Housing Wire:

A Bush administration program originally designed as a refinancing option for severely delinquent subprime mortgage borrowers is likely to meet a quiet end as 2008 ticks off its remaining days, a source at the U.S. Department of Housing and Urban Development confirmed to HousingWire late Tuesday. The once highly-hyped program never really lived up to its original billing, and eventually became a catch-all for refinancing any “at-risk” borrowers as the mortgage crisis outgrew its original boundaries.

National Mortgage News first reported on the likely demise of the program earlier this week, citing unnamed industry sources.

HW’s source at HUD said the program had become “something of an albatross” and duplicative in the face of the recently-legislated Hope for Homeowners program, which casts an allegedly broader net and serves the same purpose. “The thinking is probably that there isn’t a need for two FHA-led programs for troubled borrowers,” said the source, who asked not to be named in this story. “Pick one, and make it work.”

When FHASecure was launched in late Aug. of 2007, administration officials suggested at the time that the program could help 240,000 delinquent subprime mortgage holders avoid foreclosure. But by December, the program had only endorsed 266 loans for borrowers that were delinquent at the time of refinancing, forcing HUD officials to redefine the program with a wider net for any at-risk borrower, delinquent or not. HUD officials have maintained steadfastly that such a focus was always the intent of FHASecure.

But the program never seemed to gain much traction with key Democratic lawmakers, who pushed to create the Hope for Homeowners program that went into effect the past October (with similar dismal numbers at the outset, too). Part of that was because the Bush administration attempted to leverage FHASecure as a bargaining chip during negotiations over the Emergency Economic Stabilization Act of 2008, suggesting that the program could handle at-risk and underwater borrowers without the need for a $300 billion expansion to the FHA program under the H4H proposal.

While Congress was haggling over the housing bailout package, the Bush administration unveiled an expansion of the FHASecure program designed to make it easier for underwater borrowers to participate. Assistant secretary for housing Brian Montgomery said the revised program would help “hundred of thousands of borrowers” at a hearing of the House Financial Services Committee on April 9; the official estimate at HUD was that 500,000 additional borrowers would be helped by insuring refinanced mortgages for borrowers who were late on a few payments, or those who receive a voluntary mortgage principal write-down from their lender. The original FHASecure program excluded both groups.

On May 19, HUD officials again touted the program, suggesting that the Hope for Homeowners program likely wasn’t needed to help at-risk homeowners.

That’s not to say H4H has been anything close to a resounding success on its own account, either. In fact, anything but. HousingWire first reported on Oct. 31 that just 42 mortgage applications were filed under the H4H program during the first two weeks in was in place, and none were endorsed; this came after legislators had warned servicers sternly not to foreclose on loans that might qualify for the program. Through Dec. 18, just 312 applications had been received for the program, leading current HUD chief to slam the program as ineffective and the fault of a Democratic Congress for forcing implementation of such an unwieldy program.

“What most people don’t understand is that this program was designed to the detail by Congress,” Preston told the Washington Post in an interview. “Congress dotted the i’s and crossed the t’s for us, and unfortunately it has made this program tough to use.”

Of course, Democratic lawmakers have since contended publicly that the Bush White House forced them to water down H4H, in part by flaunting FHASecure as a viable alternative. “The administration was critical of the program and kept putting pressure on us to make it cheaper and more restrictive,” House Financial Services Committee chairman Barney Frank (D-MA) told the Washington Post. “If it hadn’t been for the Bush administration’s opposition, we would have written it in a better way in the first place.”

On Nov. 20, HUD relaxed its criteria for loans under the program, raising the loan to value ratio for eligible loans from 90 to 96.5 percent for some H4H loans.

The bickering over Hope for Homeowners comes as Congress appears set to consider yet another round of homeowner aid, this time tied to future provisioning of funding for the Treasury’s Troubled Asset Relief Program. The first $350 of the $700 billion allocated to the program has already been used; House Speaker Nancy Pelosi (D-CA) has that any effort by Bush administration officials to access further funding via the TARP must come with a plan to help troubled homeowners stay in their home.

“It was very clearly spelled out in the initial legislation that funds would be used for mortgage foreclosure forbearance,” she said at a news conference recently.

We’d assume that such an ultimatum will hold even if a Democratic administration requests those funds, after Jan. 20 of next year. The only question that anyone should ask at this point, however, seem to be this: is the third time really the charm here? Or is Congress trying to solve something that is perhaps best left to its own devices?

Tuesday, December 23, 2008

SEC OKs LCH.Clearnet for U.S. swaps clearinghouse

(Reuters) - The Securities and Exchange Commission gave the go-ahead on Tuesday for LCH.Clearnet Ltd to begin operating as a U.S. central counterparty for credit default swaps.

LCH already acts as a central counterparty in Europe, where it assumes the legal counterparty risk involved when two of its members trade financial instruments.

The SEC approved some temporary exemptions that allow LCH to act as a counterparty, a move which should help add transparency to the unregulated multi-trillion-dollar credit default swaps market, SEC Chairman Christopher Cox said in a statement. "These conditional exemptions will allow a central counterparty to be quickly up and running, while protecting investors through regulatory oversight," Cox said.

The SEC developed the temporary exemptions after consulting with the Board of Governors of the Federal Reserve System, the Federal Reserve Bank of New York, the Commodity Futures Trading Commission and the U.K. Financial Services Authority.

The exemptions will let LCH launch a clearinghouse in the U.S. market while giving the SEC time to review their operations and decide if they should be given permanent permission to operate, the agency said.

The virtually-unregulated over-the-counter market in credit default swaps has played a significant role in the credit crisis, including the multi-billion-dollar taxpayer rescue of American International Group (AIG.N).

From the WSJ:

In October, Depository Trust & Clearing Corp. announced plans to take over European-based LCH.Clearnet in a €739 million ($1.03 billion) deal. The deal will result in the formation of the world's largest clearinghouse company owned largely by users.

U.S. Regulator Approves CME Group Credit Default Swap Clearinghouse Plan

(Bloomberg) -- The U.S. Commodity Futures Trading Commission approved CME Group Inc.’s application to guarantee credit-default swaps with its clearinghouse, potentially generating $400 million in new annual revenue for the company.

“The advent of clearing solutions for the credit default swap market will benefit the financial system significantly,” CFTC Acting Chairman
Walt Lukken said in an e-mailed statement today.

CME Group is competing with
Intercontinental Exchange Inc., NYSE Euronext and Eurex AG to clear credit-default swap trades in the $28 trillion market. A clearinghouse owner could earn between $100 million and $400 million a year in revenue from clearing the trades, according to estimates by Wachovia Capital Markets and Keefe Bruyette & Woods Inc.

A clearinghouse is part of U.S. efforts to oversee credit- default swap market after the contracts contributed to the demise of Bear Stearns Cos. and the government takeover of American International Group Inc. Banks, hedge funds and other investors currently negotiate credit-default swaps privately in the over-the-counter market.

CME Group has still not received licensing approval from Markit Group Ltd., a bank-owned service that provides the most widely used indexes and pricing methods in the credit swap market. The CME Group also needs an exemption from the Securities and Exchange Commission before it can begin clearing contracts.

A clearinghouse, rather than a single bank, would be the counterparty to trades and help absorb losses should another dealer fail, as Lehman Brothers Holdings Inc. did in September. Funded by its members, a clearinghouse is intended to add stability to markets by becoming the buyer to every seller and the seller to every buyer.

European Index
NYSE Euronext began clearing a European CDS index on Dec. 22. Intercontinental Exchange is awaiting regulatory approval from the Federal Reserve Bank of New York. Intercontinental’s clearinghouse, ICE U.S. Trust, was granted a New York state banking license earlier this month. Eurex has said it hopes to begin clearing CDS trades in the first quarter.

Credit-default swaps are contracts that were conceived to protect bondholders against default and are now widely used to speculate on the creditworthiness of companies. The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements. An increase in the price indicates deterioration in the perception of credit quality; a decline signals the opposite.

The value of the contracts outstanding is determined by weekly data from the Depository Trust Clearing Corp. The market value has come down from over $50 trillion in recent weeks due to netting of trades and counterparties agreeing to exit trades.

The most actively traded contracts in the credit-default swap market are indexes of U.S. and European companies with investment-grade debt ratings. Contracts based on specific companies also trade.

CME in talks with dealers on CDS platform

(Reuters) CME Group Inc (
CME.O) is also in advanced discussions with six dealers to take equity stakes in its credit default swaps (CDS) trading and clearing platform, the Wall Street Journal said. (CME could not be immediately reached for comment by Reuters.)

CME's rival IntercontinentalExchange Inc (
ICE.N) has said it expects to clear CDS by the end of the year.

Subprime, Alt-A Delinquencies Piling Up

By Paul Jackson on the Housing Wire:

Think of those highway pileups, where one car stops and 50 more cars behind it run into each other — that’s pretty much what appears to be taking place in the nation’s mortgage market, thanks to a growing trend towards foreclosure moratoria that have slowed foreclosure roll rates. New data released Friday morning by Clayton Holdings, Inc. highlights just how much of a pileup is really taking place across both Alt-A and subprime loan products.

The company’s monthly InFront report provides an early look at loan-level surveillance on pools monitored by the firm, well ahead of monthly remittance reports provided by most servicers; the current report looks at November data. In a nutshell, what the data shows is this: increasing 60+ day delinquencies, slowing prepayments, increasing rolls except for foreclosures, and decreasing cure rates (see below for a definition of "rolls"). And that’s essentially across all vintages. For subprime, and for Alt-A.

Among subprime first liens, the 2006 and 2007 vintages clearly remain the most problematic: 60+ day delinquencies rose 4.16 percent and 6.41 percent from month-ago totals, respectively, Clayton reported. More than 43 percent of the 2006 subprime vintage is now severely delinquent. Cure rates fell a whopping 17.54 percent and 11.40 percent, respectively, for the two vintages as well — throwing at least some cold water on the idea that putting a halt to foreclosures would bring about greater resolutions for troubled borrowers.

It’s pretty much the same story in recent Alt-A vintages, as well: 29.71 percent and 27.21 percent of the 2006 and 2007 vintages are 60+ days delinquent, well above October’s totals. Likewise cure rates tanked, falling 13.74 percent and 12.29 percent respectively.

Despite growing delinquencies, foreclosure roll rates dropped sharply — subprime foreclosure rolls fell to their lowest level this year in November, reaching just 5.40 percent. That’s the lowest foreclosure roll since June 2007. Despite this, aggregate rolls across all statuses reached 8.45 percent, Clayton reported — the highest total roll rate at least as far back as Dec. 2006. Likewise, Alt-A loans saw rolls hit a two-year high in November, while foreclosure rolls hit their lowest level since May of 2007.

Add in the slowing prepayments — meaning fewer borrowers are able to refinance their way out of an existing mortgage — and dropping cure rates, and what do you have? In our opinion, you’re looking at the definition of a foreclosure surge to start Q1 of next year. And, given a looming set of Alt-A recasts and resets in the middle to back half of next year, you have to wonder just how many economists are factoring this into their forecasts of the length and severity of the current recession.

To learn more about InFront, visit http://www.clayton.com.

About roll rates:“Rolls,” BTW, refer to roll rates, which assess the percentage of loans that worsened in delinquency status; rolls can be calculated in the aggregate or for any group of loans moving from one status to the next. Because vintage pools are static and tend to prepay over time, decreasing the number of loans in the pool, it’s usually the case that delinquencies will go up as a vintage seasons, regardless of the relative performance of the vintage itself — borrowers who can revintage usually do, while those who cannot don’t, leaving the riskier loans behind in any given vintage. Roll rate analysis is one way to get around this artifact in most data.

Loan Modification Quality Matters

Posted by Tara Twomey on Credit Slips:

Yesterday new foreclosure and loss mitigation data was released by HOPE NOW in its "Loss Mitigation National Data July 07 to November 08" and by the OCC/OTS in their "Mortgage Metrics Report."

Combined the reports show a steadily increasing number of loan modifications and a slight decrease in foreclosures. That's the good news. The bad news is a large number of loans that have been modified are redefaulting. The OCC/OTS report shows 37% of loans were 60 or more days delinquent after six months. Here's an example to put this in real numbers. The HOPE NOW report shows nearly 870,000 loan modification in 2008. Using the 37% redefault rate means that just over 317,000 borrowers will enter the foreclosure pipeline again within 6 months.

The reasons that borrowers are falling back into default is the source of much debate. Industry representatives claim that every modification is affordable when it is made and borrowers redefault because their circumstances change. Consumer advocates argue that servicers are not creating long-term, affordable loan modifications.

Whose side does the data support?

Here's the rub. The data provided by industry is practically useless in determining the quality of loan modifications. For example, OCC/OTS defines a loan modification as a "Mortgage for which terms of the loan are contractually changed with respect to interest rates or other terms of the loan." HOPE NOW's definition provides: "A modification occurs any time any term of the original loan contract is permanently altered. This can involve a reduction in the interest rate, forgiveness of a portion of principal or extension of the maturity date of the loan." Under these definitions a three-month rate freeze and a life-of-loan interest rate reduction are both counted as loan modifications. Similarly, the capitalization of arrears, which increases the principal balance, and principal forbearance or forgiveness both fall in the loan modification box.

The best publicly available data that we have comes from
Prof. Alan White. His most recent analysisshows that "[o]nly 35% of modifications in the November 2008 report reduced monthly payments below the initial payment, while 20% left the payment the same and 45% increased the monthly payment." Prof. White also notes that many of the modifications being made are temporary (5 years or less) and that some include balloon payments or other negative amortization features that will be problematic down the road. With this quality of loan modification, it is not surprising many borrowers have already redefaulted or that more borrowers will redefault in the future.

Industry has focused their attention on increasing the quantity of loan modifications, but resolving the foreclosure crisis will take more than higher loan modification numbers. If we want to keep families in their homes, loan modification quality matters.

Mortgage activity surges at US banks

By Saskia Scholtes in the Financial Times:

US banks are having trouble handling a surge of mortgage applications spurred by dramatically lower interest rates, after record loan defaults and thousands of job cuts have stretched mortgage industry resources to the limit.

Applications for home loans more than doubled in the two weeks after the Federal Reserve said it would buy mortgage bonds to help stabilise the market, prompting mortgage rates to fall by more than three-quarters of a percentage point.

With average rates for a 30-year, fixed-rate mortgage now at about 5.2 per cent, growing numbers of borrowers have an incentive to refinance to bring down their mortgage costs.

But tighter underwriting standards for prospective borrowers, combined with funding and staffing difficulties for mortgage originators, are likely to restrict the supply of new mortgages.

“The mortgage industry is collectively unprepared to deal with a cascade of business; staffs were pared to the bone as the market for mortgages shrank over the past year,” analysts at HSH Associates wrote in a note to clients.

Mahesh Swaminathan, mortgage analyst at Credit Suisse, said that as a result, lower rates would not necessarily create a wave of mortgage refinancing on the scale that was seen in 2003, when credit markets were healthy.

“There is a lot of pipeline congestion. Originators don’t have the staffing or the credit lines to fund a lot of loans,” said Mr Swaminathan. “You have more due diligence which requires more staffing. It is not something that can be changed overnight.”

Part of the problem is that banks have directed the bulk of their manpower toward their servicing arms in a bid to stem the tide of mortgage defaults and foreclosures.

While banks have pledged to use capital they have received from the US Treasury to boost consumer lending, they are also under intense political pressure to modify loan terms for struggling borrowers. Loan modifications have continued to grow more quickly than other strategies such as subsidy programmes or refinancing into government loans, according to the Office of the Comptroller of the Currency.

The number of new loan modifications grew 16 per cent in the third quarter to more than 133,000, said the OCC. The rate of loan modification is likely to be even higher in fourth-quarter data, say analysts, as a result of recent initiatives by Fannie Mae and Freddie Mac, the two large mortgage financiers.

HOPE NOW Projects Big Increases in Foreclosure Prevention Successes in 2009

WASHINGTON, Dec. 22 /PRNewswire-USNewswire/ -- HOPE NOW, the private sector alliance of mortgage servicers, counselors, and investors that has been working aggressively to prevent foreclosures and keep homeowners in their homes, today announced that it expects to double the number of foreclosures prevented in 2009 by enhancing and expanding its very successful 2008 efforts.

HOPE NOW's success is evident from the total 2008 results it can now project based on the actual 11-month data it is reporting today:

  • A projected total of approximately 2.2 million foreclosure preventions
  • Almost 950,000 mortgage modifications
  • More than 20,000 homeowners helped at 29 workshops held across the United States
  • More than 1 million total calls from homeowners to the Hope Hotline.
  • An average of more than 7,000 calls per day to the Hope Hotline that was available 24 hours a day, 7 days a week, and 365 days a year.
  • 2.9 million letters sent to at-risk homeowners
  • An 18% response rate to the letters sent by HOPE NOW to at-risk homeowners, 6 times more than the typical response rate servicers receive when they send their own mailings.

In addition to these numerical achievements, in 2008 HOPE NOW also accomplished two important procedural milestones that have greatly expedited the foreclosure prevention process:

  • In June, HOPE NOW members agreed to a set of guidelines that, among other things, committed servicers to a much faster and simplified foreclosure prevention process. The guidelines also established the first-ever agreement for dealing with second liens, which until then had been a major sticking point in the foreclosure prevention process.
  • In November, HOPE NOW worked with Fannie Mae, Freddie Mac, and the Federal Housing Finance Agency to create the Streamlined Modification Program (SMP), a much faster modification approval process for the most at-risk homeowners that went into effect December 15.

"No one did more to prevent foreclosures in 2008 than HOPE NOW," said Faith Schwartz, HOPE NOW's executive director. "But, because there's more to do, in 2009 HOPE NOW is going to substantially expand its already successful efforts to make it even easier for at-risk homeowners to avoid foreclosure."

HOPE NOW's 2009 plans include:

  • An expected doubling of the number of modifications from the already high 2008 level. This will result an increased capacity of servicers to handle modification requests, the streamlined modification program, and the commitment by major institutions to modify loans on purchased portfolios. Depending on unemployment and other economic conditions, this could increase the number of modifications to 2 million or more next year.
  • At least 30 additional homeowner workshops
  • At least a 50% increase in the number of homeowners who attend workshops
  • Additional innovative ways to provide counseling and other assistance to homeowners such as phone-a-thons
  • A major web-based initiative that will supplement the existing ability of homeowners to begin the foreclosure prevention process through the Hope Hotline
  • A very important and extremely visible enhancement to HOPE NOW's existing efforts to reach at-risk homeowners that by itself could double or triple the number of homeowners helped by HOPE NOW
  • Significantly enhanced loan-level data that will help the industry further analyze trends and make necessary adjustments to help prevent foreclosures and provide policymakers with important additional information.

"HOPE NOW deserves a great deal of credit for the nearly 3 million foreclosures it will have prevented by the end of 2008," said Steve Bartlett, president and CEO of the Financial Services Roundtable. "The weak U.S. economy will present additional problems in 2009 and HOPE NOW's success this year will be the solid foundation needed to meet those challenges," he said.

"The mortgage lending industry has shown enormous flexibility and commitment in the face of this past year's constantly changing economic outlook," said John Courson, chief operating officer of the Mortgage Bankers Association. "The plans HOPE NOW has for 2009 demonstrate clearly that the whole mortgage lending industry will continue to serve the needs of homeowners no matter what the situation," he added.

Colleen Hernandez, president and executive director of the Homeownership Preservation Foundation, which owns and operates the Hope Hotline, said that the 2008 results prove that phone counseling of homeowners is extremely effective. "The Hope Hotline was the only mortgage counseling service that was available to homeowners this year whenever they wanted or needed to call," she said. "That level and quality of service will be needed even more in 2009."

November Foreclosure Prevention Results

HOPE NOW also announced today that the mortgage industry prevented 208,000 foreclosures in November 2008 and a total of 651,000 in September, October, and November. This is the highest three-month total since HOPE NOW began to compile data in July 2007.

The November results, which are a slight change from the 225,000 foreclosure preventions completed in October, is the result of the five fewer working days in that month. The number of foreclosure preventions per day was greater in November than it was in October.

Approximately 2 million foreclosures have been prevented by the mortgage lending industry in the first 11 months of 2008, 25% more than the approximately 1.5 million prevented in all of 2007. If the current trend continues, in 2008 the mortgage lending industry will prevent approximately 2.2 million foreclosures, 45% more than in 2007.

November was the third consecutive month that total modifications exceeded 100,000. Since HOPE NOW began to compile data, over 1 million modifications have been completed, including a projected 950,000 in 2008.

Over the past three months, the number of modifications has increased by almost 29%, while the number of payment plans has increased by almost 6%. This increasing reliance on modifications rather than payment plans is expected to continue as economic conditions warrant.

The HOPE NOW November data also shows:

  • For the first time, HOPE NOW members and the broader mortgage lending industry prevented more than 200,000 foreclosures in three consecutive months.
  • Almost 30% of the homeowners with prime loans who received workouts in November received modifications.
  • Nearly 62% of the homeowners with subprime loans who received workouts in November received modifications.
  • The number of foreclosures started in November was 16,000 less than the number started in October.
  • For the sixth month in a row, the number of foreclosure starts for prime loans exceeded those for subprime.

A summary table of the results is attached and can be found at