Archive for the “Alt-A Securities” Category

The year of 2008 will likely be remembered as the year subprime mortgages and corporate scandals changed the face of Wall Street. Buried under the weight of the subprime crisis, financial institutions took nearly $800 billion in writedowns and losses. The value of stocks worldwide plummeted by more than $30 trillion. Goliath investment houses like Bear Stearns fell apart. State, municipal and corporate pension funds reported massive losses from investments tied to faulty valuation models and high-risk mortgage-backed securities and their derivative spin-offs, collateralized debt obligations (CDOs).

Then there’s the near financial collapse of mortgage giants Fannie Mae and Freddie Mac and American Insurance Group (AIG), which required a financial intervention courtesy of the U.S. government. Lehman Brothers, the fourth-largest investment bank in the United States, filed for bankruptcy protection in 2008. Washington Mutual and IndyMac, along with some 20 other banks were forced to close their doors. Government bailouts reached an astronomical $9 trillion. And as a final nod to 2008, investors lost some $50 billion in a Ponzi scheme orchestrated by the former Nasdaq chairman, Bernard (Bernie) Madoff.

For investors, 2008 is the year that went from bad to worse. It began with the collapse of the auction-rate securities market in February and continued with credit default swaps and structured investment products. For the first time since the 1930s, the Dow Jones Industrial Average experienced losses of more than 30%, closing the year at 8,776.39. By comparison, the Dow finished out 2007 at 13,264.82. Bank stocks in particular took a beating in 2008, with Bank of America and Citigroup losing nearly 70% of their value. As for shareholders, they saw about $7 trillion of their wealth wiped out.

In the world of ultra-short bond funds, 2008 provided the lesson that ultra short does not translate to “ultra safe.” A number of supposedly safe and conservative ultra-short funds got into trouble in 2008 by investing in risky mortgage-backed securities and collateralized mortgage obligations (CMOs). When losses in those toxic assets began to skyrocket, investors lined up to pull their money out in droves, sparking a wave of fund redemptions.

As a result, several fund managers were forced to liquidate their funds’ assets. State Street Global Advisors’ SSgA Yield Plus Fund began liquidating in May after the fund fell 19%. It turns out more than 50% of the fund’s assets were tied to mortgage-related securities funds. One month later, the Evergreen Ultra-Short Opportunities Fund liquidated, as well, when its assets plunged more than 20% in value. Finally, there is Charles Schwab’s YieldPlus Fund. Marketed to investors as a safe alternative to cash, the fund suffered the most losses of any ultra-short bond fund in 2008, losing more than 40% of its value.

Investors, meanwhile, are suing all three funds, charging that they investments were represented as conservative “cash alternatives” and similar to money-market funds. Far from safe or conservative, the funds were heavily concentrated in risky mortgage and asset-backed securities. And, in the case of Schwab’s YieldPlus Fund, several investors who have filed lawsuits claim various Schwab executives and fund manager Kimon Daifotis committed “acts of gross misconduct” by encouraging investors to hold on to their YieldPlus shares, while simultaneously dumping millions of YieldPlus shares from the portfolios of Schwab’s other mutual funds.

Capping out 2008, of course, is the Bernie Madoff scandal. The disgraced hedge fund manager was arrested Dec. 11 by federal agents on charges of securities fraud for scamming $50 billion from investors. Meanwhile, the Securities and Exchange Commission (SEC), the supposed protector of investors and their investments, apparently turned a blind eye to Madoff’s subterfuge over the years by ignoring red flags that signaled problems with his funds and their “too-good-to-be-true” returns.

For investors, the Madoff affair may well be the final nail in the coffin when it comes to confidence in Wall Street. Already shaken from a year that was punctuated by the subprime crisis and corporate scandals - including the implosion of Bear Stearns, the collapse of the auction rate securities market, the bankruptcy of Lehman Brothers and inept accounting practices by Fannie Mae and Freddie Mac and other institutions - Wall Street has its work cut out in 2009 as it tries to renew investors’ faith once again.

Our affiliation of securities lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses. 

At $9 billion, IndyMac’s collapse from the weight of the subprime crisis is one of the costliest bank failures in United States history. Now it looks like the Federal Deposit Insurance Corp. (FDIC) may have finally found a buyer for the failed savings and loan. Three private equity and hedge fund firms consisting of J.C. Flowers & Co., Dune Capital Management and Paulson & Co. reportedly are in talks with the FDIC to buy the bank.

If the deal comes to fruition, it will mark one of the first times unregulated private equity firms acquire a majority stake in a bank holding company.

Before its seizure by federal authorities on the evening of July 11, Pasadena-based IndyMac specialized in Alt-A mortgages, or liar’s loans - a type of mortgage that didn’t require borrowers to provide income documentation.

Meanwhile, new information regarding IndyMac’s financial statements reveals that the mortgage lender intentionally delayed the disclosure of its problems prior to its collapse in July. As reported Dec. 23, 2008, in the Los Angeles Times, Darrel W. Dochow, the Western regional director of the federal Office of Thrift Supervision, agreed to allow IndyMac to record a $50-million capital infusion received on May 9 from its parent company as if the lender had received the funds before March 31.

The backdating allowed IndyMac to report that it was “well capitalized” at the end of the first quarter, sending a message to shareholders and customers that its fiscal health was in solid shape.

A short time later, on July 11, the savings and loan collapsed at a cost of $9 billion to the federal deposit insurance fund.

Dochow has since been relived of his duties.

Our affiliation of securities lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses. 

Top executives of Fannie Mae and Freddie Mac faced intense questioning on Dec. 9 by members of the Committee on Oversight and Government Reform over their role in the collapse of the two mortgage giants. Lawmakers grilled former Fannie Mae CEOs Daniel Mudd and Franklin Raines and former Freddie Mac CEOs Richard Syron and Leland Brendsel on why the companies ignored previous warnings about the potential problems of subprime mortgages and continued to buy up risky subprime and Alt-A loans.

As expected, finger pointing was in full force. During the hearing, Henry Waxman, chairman of the Oversight and Government Reform Committee, quizzed Fannie Mae’s former CEO Mudd about a June 2005 document citing the company was at a “strategic crossroads” and could either delve into riskier loans or focus on more secure ones. According to the document, the real “revenue opportunity” was in buying subprime and other alternative mortgages.

The document went on to say that homes were “being utilized … like an ATM.” It also acknowledged that investing in subprime and alternative mortgages would mean “higher credit losses” and “increased exposure to unknown risks.”

Other documents presented during the hearing made it clear that both Fannie Mae and Freddie Mac knew what they were doing as they took on added risks. Their own risk managers repeatedly raised concerns about the dangers of investing heavily in the subprime and alternative mortgage market.

In 2004, Freddie Mac’s chief risk officer, David Andrukonis, sent an e-mail to CEO Richard Syron urging the company to stop purchasing loans with no income or asset requirements “as soon as practicable.” The risk officer further warned that mortgage lenders were targeting “borrowers who would have trouble qualifying for a mortgage if their financial position were adequately disclosed” and that the “potential for the perception and the reality of predatory lending with this product is great.”

Syron did not heed any of the recommendations. Instead, he fired Andrukonis.

Questioning of the CEOs and others lasted more than four hours. Besides finger pointing, little was resolved in the end. Rep. Darrell Issa of California offered perhaps the most fitting comment of the day when he chastised the former Fannie Mae and Freddie Mac CEOs with the following comment:

“All four of you seem to be in complete denial that Freddie and Fannie are in any way responsible for this. Your whole excuse for going to risky and unreasonable loans that are defaulting at an incredibly high rate is that everyone is doing it.”

Our affiliation of securities lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses. 

For many people, home ownership is equivalent to the American Dream. But in the past 12 months, the continuing downturn in the U.S. housing market - the worst since the Great Depression - has made that dream more and more elusive.

Now, with the financial health of housing finance giants Fannie Mae and Freddie Mac being called into question, an already bad situation for homeowners could deteriorate even further.

Shares of both Fannie Mae and Freddie Mac plunged to new lows on Friday, July 11, following a devastating crisis of confidence over concerns that rising mortgage defaults would drain the companies’ reserves and leave them unable to finance current operations. Reports of a forced government takeover only added to their troubles. If such a takeover were to occur, it would likely leave shareholders with nothing, and taxpayers footing the bill for the losses on the home loans owned or guaranteed by Fannie Mae and Freddie Mac.

Fannie Mae and Freddie Mac - which own or guarantee more than $5 trillion of the country’s mortgages - play a central role in the housing market because they provide a major source of funding for banks and home lenders. In the aftermath of the subprime crisis and the credit crunch, their role became even more imperative as they were the only major players to package pools of mortgage loans into securities for sale to investors.

As reported July 12 by CNNMoney.com senior writer Chris Isidore, if Freddie Mac and Fannie Mae were no longer able to perform this function, it could significantly raise the cost of mortgage loans, as well as restrict their availability. In turn, even more turmoil in the housing and credit markets would result.

Former U.S. Treasury Secretary John Snow had harsh words for the way in which Fannie Mae and Freddie Mac have funded their businesses over the years. As reported July 11 in an article by Brendan Murray on Bloomberg.com, Snow said the mortgage companies relied on leverage to fund their businesses in the same fashion as a hedge fund, and that the government should avoid taking them over.

“Congress ought to be embarrassed for years of delays in passing legislation aimed at strengthening regulation of the two companies,” said Snow, now chairman of New York-based buyout fund Cerberus Capital Management LP, in the Bloomberg.com article.

The next big hurdle in the Fannie Mae-Freddie Mac saga will be on July 14 when Freddie Mac is scheduled to sell $3 billion of short-term debt. An unsuccessful sale will strike yet another blow to already-bruised and battered investor confidence.

IndyMac Seized

Meanwhile, IndyMac Bancorp Inc., once one of the nation’s largest home lenders, has been seized by federal regulators.

The shutdown means customers who have traditional bank accounts will be insured up to at least $100,000. Other accounts, however, such as annuities or mutual funds, are not insured.Â

Pasadena-based IndyMac specialized in Alt-A mortgages, a type of mortgage that required minimal documentation from borrowers regarding their incomes or assets. IndyMac was founded in 1985 by David Loeb and Angelo Mozilo, who also were the founders of Countrywide. Countrywide was taken over last week by Bank of America Corp.

The failure of IndyMac marks the largest collapse of an FDIC-insured institution since 1984, and is the fifth U.S. bank to fail this year. The demise of IndyMac and the apparent struggles of Freddie Mac and Fannie Mae, as well as those of nearly every major firm on Wall Street, highlights the new reality that’s been created by the nation’s ongoing credit crunch. Moreover, it serves as a grim but crystal-clear reminder to investors that regardless of how large the entity or how strong it is perceived to be, no one is 100 percent safe.

Our affiliation of lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses.

The past year hasn’t exactly been smooth sailing for the nation’s largest bank. In its first-quarter earnings report, Citigroup posted a record loss of $5.1 billion, following losses on assets tied to the subprime mortgage market that cut $14.1 billion in value from its investment portfolio.

The $14.1 billion in write-downs included $7 billion related to subprime and alt-A mortgages; $3.1 billion in leveraged loans; $1.5 billion related to bond insurers; $1.5 billion in auction-rate securities; and another $1 billion related to commercial real estate, a hedge fund and structured investment vehicles, or SIVs.

The losses stemming to subprime mortgages have forced the New York-based bank to bolster its capital by selling $6 billion of preferred shares in a public debt offering. The offering is in addition to the $37 billion of capital Citigroup has raised since November to replenish its balance sheets from credit losses and massive subprime-related write-downs.

Meanwhile, as Citigroup builds up its loan reserves for similar problems in the future, other investment banks have begun the process of writing down the value of auction-rate securities held by clients. UBS is reportedly lowering the values of its clients’ auction-rate securities by as much as 30 percent.

The problem is that auction-rate securities were, as the headlines report day after day, often sold to investors as cash-alternative investments. As UBS’ clients - and others to follow - are now discovering, the write-downs will yield them far less than “money in the bank.”

Our affiliation of lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses.Â

Still reeling from the assault of the subprime mortgage crisis, UBS has announced plans to write down another $19 billion in its mortgage-related assets, bringing the company’s total sub-prime losses to $37 billion. That is the largest write-down by any bank to date.

As a result of the write downs, UBS will sustain a first-quarter net loss of $12 billion.Â
UBS also is seeking approximately $15 billion in new capital, and plans to create a new unit for its illiquid U.S. real estate assets.

Still, even after the write-downs, UBS owns some $16 billion in Alt-A mortgage paper, as well as another $15 billion in various collateralized debt obligations (CDOs).Â

Like many banks, UBS took a major a hit in the wake of the subprime meltdown. And there may be still more to come. In the weeks ahead, analysts predict that other banks will join UBS in announcing substantial write downs of their own.

Recent comments by Federal Reserve Chairman Ben Bernanke seem to echo those predictions. Appearing before the congressional Joint Economic Committee, Bernanke warned that the future outlook for the economy was uncertain at best, adding that the housing and financial markets remained in a state of distress.Â

Bernanke also said the “R” word - recession - and that the economy could very well be headed down that path in the first half of the year.

Interesting - I think many of us thought we already were there.Â

Our affiliation of lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses.Â

What goes up must come down. But when it came to soaring home prices, Wall Street gambled that this adage wouldn’t apply.Â

Now, homeowners and investors in the subprime housing market are paying the price of lenders’ arrogance.

Amid rapidly rising home prices in 2005, irresponsible lenders took advantage of Americans eager to live the dream. With such come-ons as “No credit? No problem!” and “No down payment required,” lenders had no shortage of eager borrowers, especially when they didn’t require proof of income or even ask how long a potential borrower had held a job. A shocking number of subprime and Alt-A loans even financed 100% of the home’s purchase price.Â

Low teaser rates and interest-only payments made the deals irresistible, and if hesitant applicants dared to wonder aloud how they’d afford higher payments in the future, their lenders gave a breezy answer: With home prices soaring into the foreseeable future, their equity would rise more quickly than their debt.

Don’t worry; be happy!

With news stories daily about defaulting homeowners unable to sell, we know just how unhappy many of these homeowners are – and, by extension, those who invested in these mortgages, often unwittingly.Â

What if Wall Street had been right and home prices had continued upward? Were these loans and investments guaranteed to fail no matter what?

Default in less than a year

Yes. A bad loan is a bad loan.

Industry analysts are predicting record mortgage defaults and foreclosures this year, when teaser rates, interest-only payments and other introductory options expire. But the problem is not that homeowners won’t be able to afford the higher loan payments then.Â

The problem is that homeowners haven’t been able to afford their loans since the moment they signed the application.

A review of the collateralized debt obligations (CDOs) and other subprime securities sold to investors in 2006 and 2007 – estimated at $362 billion – reveal that borrowers have been in default for some time, and investors would have lost millions even if home prices had lived up to Wall Street’s wishful thinking.

How do we know?

• On subprime mortgages issued in 2007, the November delinquency rate exceeded 11% — while the teaser rate was still in effect.

• This means 300,000 homeowners defaulted on loans they had for less than a year.

• Some homeowners defaulted within just a few months.Â

• Some failed to make even the first payment.

Investors fed lenders’ enthusiasm

Experts took notice in 2006 and 2007 when a reported 60% of subprime and Alt-A borrowers got loans without proving they could repay them. In light of a waning housing market in 2006, these experts urged lenders to tighten their underwriting practices.

Instead, lenders made more, not fewer, of these dubious loans. They made so many exceptions to their already lax rules that although they made up no more than 5% of subprime loans before 2006, “they represented the majority of these loans issued in 2006 and 2007,” said analyst Michael Youngblood in a CNNMoney.com article by Les Christie.

Lenders continued to make these loans because investors continued to buy them, according to Doug Duncan, chief economist of the Mortgage Bankers Association (CNNMoney.com). Merrill Lynch, Citigroup, UBS, Morgan Stanley, Bank of America and others eagerly bought the subprime loans, packaged them with other assets into mortgage-backed securities and collateralized debt obligations (CDOs) and earned huge profits from investors lured by the promise of high yields and AA or AAA ratings.

The worst is yet to come

Investors can expect the worst as the bulk of these loans move to their higher interest rates and new repayment terms this year. Investors who believed they purchased low-risk mutual funds but actually invested in CDOs and other securities backed by subprime mortgages will be shocked by significant losses resulting from a dramatic rise in already-high default rates.

Our affiliation of lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage related investment losses.Â

The latest casualties in the credit crisis are investors in Alt-A residential mortgage loans – referred to as “liar loans” by industry insiders because borrowers don’t have to prove their net worth. As more and more of these mortgages go into default, the value of the securities backing these mortgages plummets, causing significant losses to investors.

Standard & Poor’s announced in late February it may drop its ratings on $13 billion in Alt-A mortgage-backed securities, including 1,887 debt classes issued in 2006 and early 2007, a direct result of loan delinquencies. This would come on top of a downgrade of more than 400 Alt-A securities issued in 2005, about 1,000 from 2006 and 900 issued last year. A sharp decline in valuations for securities forces investment funds to unwind or meet margin calls.

Meanwhile, investors in Alt-A mortgages may be at more risk than they realize.

Mortgage-backed securities head south

In the beginning, Alt-A mortgages attracted investors because of their diversity. While some lenders issued Alt-A mortgages to borrowers with less-than-desirable credit histories, others made the loans available to more creditworthy individuals, diversifying the Alt-A market as a whole. That made the market more attractive in terms of risk: Alt-A loans generally have fallen somewhere between prime and subprime. In addition, the market includes a good mix of fixed-rate and adjust-rate mortgages, or ARMs, which carry lower minimum payments for borrowers – and thus are more likely to be repaid.

In today’s economy, though, default rates have increased even among more creditworthy borrowers, putting more investors’ funds at greater risk.Â
Valentine’s Day 2008 may have marked the start of the current decline in Alt-A mortgage-backed securities. It’s when rumors that UBS would sell a significant portion of its Alt-A holdings began to spread.  One week later, AAA-rated securities backed by 30-year fixed-rate Alt-A loans exceeding $417,000 were valued at 12 cents less per dollar of principal than similar securities – more than double the 5.5-cent dip of just a few weeks earlier.Â

Firms act now to stem losses

Some firms already are trying to minimize their losses. London-based Peloton Partners LLP is liquidating a $1.8 billion hedge fund. Expect UBS and Merrill Lynch to take action soon. Merrill Lynch owns $2.7 billion of Alt-A debt, primarily securities. UBS, which owned more than $21 billion of top-rated Alt-A securities at the end of 2007, already has discounted them by $800 million.Â

With $950 billion of Alt-A mortgage-back securities outstanding in the market, these moves may be just the first of many.Â

Stuart Goldberg, a managing director at Marathon Asset Management LLC, cautions investors not to take too much comfort in the past performance of mortgage-backed securities. Today’s Alt-A securities are a riskier investment than securities backed by subprime debt because the latter may have more investor protection built in.Â

Investors in mutual funds and other investments backed by Alt-A mortgages would do well to take note of larger, like-minded investors such as Peloton. Unless they can afford significant losses, investors may want to consider taking steps now to protect their funds.

Our affiliation of lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage related investment losses. Â