A new era: what does the future hold for the securitization model of mortgage lending? Could the era of the independent mortgage banking firm be a thing of the past?

Mortgage Banking, Nov, 2007 by Howard Schneider

Countrywide Financial Corporation, Calabasas, California, became the nation's largest mortgage lender by thriving in chaotic times. After past periods of turmoil--such as the unexpected April 1994 interest-rate spike--Countrywide has been able to increase its market share in both originations and servicing. [??] Warning shots signaling coming challenges were fired earlier this year, as major subprime lenders struggled for survival. On April 2, New Century Financial Corporation, Irvine, California--the second-largest subprime mortgage lender nationally--filed for bankruptcy protection and laid off most of its staff. In a statement, New Century Chief Executive Officer Brad Morrice cited "the sudden and significant challenges facing our industry." [??] High defaults on recently originated subprime home loans had left financial markets unwilling to buy securities backed by those assets. "The credit squeeze cut off sources of funding," states London's Financial Times. Delinquencies on variable-rate subprime mortgages rose rapidly from the middle of 2005, notes San Francisco-based First American LoanPerformance. Early in 2005, delinquencies on subprime fixed-rate mortgages (FRMs) and adjustable-rate mortgages (ARMs) were about the same. Today, delinquencies on the adjustable-rate loans are twice as high, according to First American LoanPerformance data.

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Countrywide found itself caught in the grip of difficult financial markets late this summer. "Secondary-market demand for non-agency mortgage-backed securities has been disrupted in recent weeks," said Countrywide's chief operating officer, David Sambol, in mid-August. At that point, Countrywide had tapped $11.5 billion in previously arranged bank credit lines.

Shortly afterward, Countrywide accepted $2 billion in financing from Bank of America Corporation, Charlotte, North Carolina, in the form of preferred stock yielding 7.25 percent. Bank of America also has the right to purchase "as much as a 16 percent stake in Countrywide at a cut-rate price of $18 a share," notes The Los Angeles Times. Additionally, Countrywide soon arranged for $12 billion more in secured credit lines.

Early in September, Countrywide announced plans to lay off "up to 20 percent of its current work force" over the following three months, according to a company press release.

At a Sept. 18 investment conference, Angelo Mozilo, Countrywide's chairman and chief executive officer, gave a presentation that stated the firm's "long-term vision" was to "build a large, mortgage-centric bank." Mozilo said, "The current credit environment has made the mortgage banking model difficult." Countrywide now is committed to funding "nearly all production" through Countrywide Bank, a federally chartered thrift, added Mozilo, the firm's co-founder.

Loan underwriting also has been tightened, by reducing allowable loan-to-value (LTV) ratios and increasing minimum FICO[R] score requirements. Some products also have been eliminated, Mozilo noted.

Countrywide's new strategy raises new questions about the ongoing viability of mortgage banking as a standalone business model over the long run. More than 100 mortgage lenders have been forced "to close operations, file for bankruptcy or put themselves up for sale since the beginning of last year," reports Bloomberg News.

Another cycle

Liquidity crises are a recurring concern for the mortgage industry. In 1989, Dallas-based Lomas Financial Corporation "became one of the largest financial companies to seek court protection under Chapter 11 of the Federal Bankruptcy Code," reported The New York Times that year.

"Our problems are essentially liquidity problems," said Jess Hay, Lomas' chairman and chief executive officer. Previously the firm--operating as Lomas & Nettleton--had been the country's largest mortgage banker.

Today, high delinquencies on subprime ARM loans--as their rates adjusted upward and borrowers were unable to refinance--have created a downward spiral for lenders and consumers. Investment manager AllianceBernstein, New York, adds that serious-delinquency rates on subprime loans originated in 2006 were "more than double the delinquency rate of loans issued in 2004" during the first 15 months of their life.

Late payments and defaults on subprime mortgages "are set to rise as some 2.5 million households face rapidly rising mortgage payments in the next 18 months," The Financial Times reported in late September. It added that Lehman Brothers, New York, estimates those higher payments "will send 1.5 million subprime borrowers into foreclosure."

An average subprime ARM loan over the past two years offered an initial rate of 7 percent, according to The Financial Times. However, those will reset at between 9.45 percent and 10.85 percent, according to research from Deutsche Bank, New York, and LoanPerformance.

Wall Street influence

Investment bankers are watching the subprime market closely because they are deeply involved in it. At a time when yields were low on traditional bonds, collateralized debt obligations (CDOs) packaged higher-yielding sub-prime mortgages and sold them worldwide. "CDOs allowed the subprime market to grow quickly, because there was always a ready pool of aggressive investors eager to take on credit risk in return for high yields," notes AllianceBernstein. "Many hedge funds, in fact, borrowed in order to buy even more CDOs, pumping up their yield and risk."