LAS VEGAS -
Rob Landauer, president and founder of New York City-based Andrew Davidson & Co., told attendees of WesCorp's Credit Union Outlook conference here the reset of adjustable-rate mortgages and hybrid loans to higher rates, along with declining home values, are significant problems (for more coverage on this issue, see pages 1 and 15).
Another major issue is lurking in the shadows, he warned: poorly underwritten or fraudulent loan files.
"Appreciation solves a lot of problems," he said. "When house prices keep going up, homeowners can keep working things out. Defaults will accelerate due to a decline in home price appreciation, and fewer lenders will carry mortgages.
"Most losses have not yet been realized," he added.
The development of a "chasm" between mortgage originators and the investors who eventually buy the loans was a "recipe for meltdown," Landauer asserted.
Back in the days when a financial institution would make a mortgage directly to a borrower and then either enjoy or suffer the loan's performance, the originator and investor were the same entity.
Separation Of Lender, Underwriter
"There was no separation, so the lender had an interest in underwriting policies," he said.
The secondary market was developed to add liquidity and capital to the mortgage market, Landauer continued.
He said agencies and insurers involved in the lending process protected themselves through underwriting guidelines, because there is substantial risk in acquiring loans originated by others.
As the process evolved, more layers were added, Landauer explained: aggregators buy mortgages and package them into securitization to be sold to investors, CDO (collateralized debt obligation) managers buy mortgage-backed securities to back debt issues, investors buy CDOs, rating agencies rate securities and debt, and investment banks underwrite and distribute CDO deals.
The result, according to Landauer: "There is a huge expanse between the originator of a loan and the final investor in a loan. It creates a chasm where the originator of a loan doesn't care how the loan performs."
A crucial cog in the current mortgage loan marketplace is the rating agencies, he explained.
Landauer said the rating agencies do not recheck loan files, meaning low-doc, high loan-to-value loans are included in files with a low default correlation.
The agencies get paid on CDO deals when the sale is completed, creating "an inherent conflict between what the rating agencies should be doing and their business model."
Another "big problem," he said, is CDO managers receive fees based on assets under management, not collateral performance.
In recent years, investors ignored the risk-return paradigm and grabbed for yield. What they should have been doing, Landauer argued, is re-underwriting loan files.
Don't Rely On AAA Ratings
"I don't think they should rely on AAA ratings without doing their homework. Investors need to know the FICO scores of the borrowers, examine the documents and dig into the underwriting standards. Credit unions involved in mortgages also must look at loan portfolios carefully and be sure to examine FICO scores and loan-to-value ratios."
The Federal Reserve's Sept. 18 decision to cut the Federal Funds rate by 50 basis points (see related story this page) was announced during Landauer's educational session. He told the audience the rate cut should ease the credit crunch, at least by a "little bit."
"Mortgage rates have gone up over the last couple months, even for prime borrowers, simply because of a lack of available funds," he said.
