Payback: Big Money Gets Tough On Bad Mortgages

Small mortgage lenders, often specializing in high risk and highly convoluted mortgages are facing the dark side of Wall Street as major investment banks and brokers are demanding their money back on defaulting loan packages.One of the most traditional hedges in the real estate market, the reselling of mortgages, is delivering major blows to small firms, with bankruptcies in the sector rising. According to the Wall Street Journal: "As more Americans fall behind on mortgage payments, Merrill Lynch & Co., J.P. Morgan Chase & Co., HSBC Holdings PLC and others are trying to force mortgage originators to buy back the same high-risk, high-return loans that the big banks eagerly bought in 2005 and 2006."According to the Journal: 'Merrill demanded in December that ResMae Mortgage Corp. -- which in 2006 sold it $3.5 billion in subprime mortgage loans, or loans to borrowers with poor credit records -- buy back $308 million of loans whose borrowers had defaulted. In a filing this week for bankruptcy law protection, ResMae said those demands "crippled" its operations. The Brea, Calif., company said that repurchase requests were "severe and unexpected."' And Resmae is not alone. According to the Journal: "Accredited Home Lenders Holding Co., a subprime mortgage lender based in San Diego, reported a loss of $37.8 million for the fourth quarter, partly due to heavy repurchases of dud loans from large loan buyers, compared with a year-earlier net income of $43.3 million."In effect, what is happening is that the chain reaction has begun, as "as home-price appreciation fell and borrowers faced rising interest rates, more people defaulted on their mortgages. That prompted Merrill Lynch and others to exercise their contractual right to demand the sellers buy back the loans. Under mortgage contracts, mortgage originators must often repurchase loans that default very early in their term or that come with underwriting mistakes, such as flawed property appraisals."Aside from exercising safety clauses in contracts, some investment banks are going further. The Journal reports that "HSBC, which last week added $1.76 billion to its bad-debt costs for 2006 to cover ailing mortgages, has sued several small lenders in federal court in Illinois after they refused HSBC's repurchase requests."what makes this most interesting, is that it is a rare occurrence for investment banks and others in the mortgage reselling market to go after the seller. The Journal noted: '"Nobody was doing this in earnest before late last year," says Kevin Kanouff, president of Clayton Fixed Income Services, adding that he expects the volume of putbacks "to trail off in the third or fourth quarter. The carnage that you are seeing...is not over."'Clayton Holdings is increasingly busy in the current situation and is "working with a half-dozen investment-banking firms to identify loans that should be repurchased. Clayton has also been hired by two hedge funds to review mortgage bonds they own for potential repurchases."