Below the Line Confusion

If you are old enough to be making these loans then you are old enough to remember that the lender was once a local mortgage company. Usually the lender had a deal working with an out of town purchaser who warehoused loans. That purchaser was an assignee of the loan, and if collection ever became necessary you knew that the Assignee owned the loan. Sometimes the Assignee would look back to the local mortgage company for restitution if bad loans were made outside of existing policy. If a mortgage went into default the borrower or his agent would call the lender and try to work it out, give the property back, or sometimes be foreclosed. The economics of the deal were clear.

An important change occured about the year of 2000, after the “securitization” of mortgages became popular. The really big banks, called in the chart the “Sponsor”, created a nominee which it called the “Depositor.” The Depositor put together hundreds of mortgages in billion dollar packages and issued securities called Residential Mortgage Back Securities (RMBS’s). Those securities were sold to investors. The mortgages were moved into the Special Purpose Vehicle, “SPV” that you see at the bottom of the chart. The SPV is always a New York trust that has no purpose other than to hold this billion dollar package of mortgages. Investors hold no mortgages, they purchase only investment securities. The trust has no function and no power other than to hold their legal title to one billion dollars (more or less in some cases) worth of mortgages.

The entire symphony of participants is bound together by a Pooling and Servicing Agreement “PSA” which states the rights of all parties.

Each billion dollar bundle of mortgages is divided into tranches, each of which is defined by the quality of the mortgages it contains. Really good mortgages from really good borrowers make up the higher tranches. There are a minimum of eight tranches in each trust, and typically these Pooling and Servicing Agreements require “waterfall payments”, or payments in full to the higher tranch before a lower tranch is paid.

After the settlement date the sponsor bank has little or no investment, and a multi-million dollar payday from the sale of each pool of mortgages. Payments and collections are controlled by a servicing agent that gets instructions from the PSA.

Because of the enormous cash payments that went directly to the bottom line of the sponsor bank at settlement, the pressure to do these loans very quickly reversed. The sponsor banks could only put these packages together if they had continuous supply of street level mortgages. The quality of those mortgages made no difference to the sponsor, since each was immediately sold to Investors and moved to the SPV. That need for street level mortgages created designer loans such as 80/20 loans, stated income loans, low interest teaser loans, and other non-traditional loans whose sole purpose was to feed the need for securitization inventory.

I apologize that all of the above is confusing. But it matters to you. The result of the securitization process is that a servicing agent is bound by a PSA over which it has no control, often times cannot change, and from which it always has conflicting demands.

There are over 1,500 pools, and PSA’s, and typically a borrower will have no idea what pool his mortgage is in, or what instructions are given in the PSA controlling that pool. Every PSA is different. Instead of loans initiated by Borrower demand, they began to be loans initiated by the sponsors, because of enormous cash fees the sponsor realized. Often the servicing agent is an affiliate of the sponsor bank, and the sponsor frequently holds the 20% of an 80/20 mortgage. That gives the servicing agent and sponsor a direct conflict with the depositor whose investment is in the 80% of the mortgage.

The reason for the above discussion is to tell borrowers that short sales and mortgage modifications are not treated the same for every mortgage, because the financial motives, ownership interest, and financial investment “below the line” are different, and conflicting.

There is an obvious need for regulation in the industry. But until then lawyers, realtors, and borrowers will benefit by knowing all they can about what goes on below the line. For a greater understanding of securitization see “Through the Looking Glass” written by author for Republic Title Insurance Company. Also, read “The Big Short”, by Michael Lewis, and “Reckless Endangerment” by Gretchen Morgenson and Joshua Rosner.