By stockpiling foreclosed homes and declaring borrowers current — sometimes unilaterally — Carrington received payments that would otherwise have protected other investors from future losses. In a single deal that American Banker analyzed, Carrington's actions likely netted its investment fund more than $20 million.
"They appear to have managed their book for their own personal benefit in a way that screws the investors," said Laurie Goodman, an Amherst Securities analyst who flagged Carrington's modification practices in research notes.
Carrington is not a bank; it competes with them, and its inner workings raise unsettling questions about the mortgage market and some of the proposals to fix it.
Carrington's performance suggests that forcing securitizers to retain exposure to their own deals may not reliably guarantee quality origination and aligned incentives among investor classes, and shows how hard it is for investors to figure out how pools of collateral are being managed. It also demonstrates how the basic structure of a securitization — that the claims of some classes of investors outrank others — can be turned on its head.
Depending on how the Obama administration structures planned retention requirements, the same incentives that Carrington created for itself could be institutionalized nationwide.
"A lot of people say, well, there's not enough skin in the game," said Eric Higgins, a professor of management and finance at Kansas State University who has researched the performance of private-label mortgage securities. "But maybe it's more of a regulatory issue. … Drawing $20 million of overcollateralization out of a deal that's going to end up with a 45% delinquency rate, you should not be allowed to do that."
An internal audit viewed by American Banker shows Carrington holds similar stakes in at least 17 more deals.
While Carrington's servicing practices benefited itself, Carrington argues that its strategy also aligned the interests of both homeowners and the trusts it oversees. The company's real estate disposal strategies were reasonable, it said, and it has salvaged value by giving borrowers repeat modifications. Moreover, Carrington's bottom-ranked positions in its deals come with special discretion over default management, the company notes.
Carrington's strategy has been "to reduce losses and maintain payment streams for the trusts, by modifying loans for homeowners who are having difficulty and avoiding the sale of properties at historic market lows," company spokesman Chris Orlando said.
Evaluating Carrington's claim of good results is difficult because the company's actions, regardless of their long-term impact, have had the effect of improving the deals' short-term appearance. While Goodman and some Carrington investors anticipate that senior bondholders will eventually face greater losses due to Carrington's actions in the deal reviewed by American Banker, those losses have not materialized yet.
BIRTH OF A STRATEGY
Carrington is the product of Bruce Rose.
A former airline mechanic and pilot, Rose moved into finance at the beginning of the 1980s. While working at Solomon Brothers, he became familiar with subprime through helping to finance the early shops producing such securities, according to a Reuters profile. In 2003, he left Citigroup Inc. to start his own mortgage securities hedge fund. Carrington Capital Management's business was to package subprime debt into private-label securities, retaining the highest-yielding, lowest-ranking portion of the deals for itself.
"From its inception, [Carrington] had a consistent philosophy: maximize asset value over the long term, focus on return over volume and align interests and incentives," Orlando said. "That's where you see the risk-retention concept come into play."
