The Continuing Challenge Of Distressed Residential Mortgages

The recession did not completely kill the secondary market, but it created a new landscape for lenders seeking the securitization of their mortgages. In the panel discussion entitled ‘Supporting the Secondary Market for Distressed Residential Mortgages,’ which was held during the recent Mortgage Bankers Association's Annual Convention, the main challenge of the current landscape relates to how the industry can move forward while still manacled to its excessive surplus of problematic mortgages.

For Stephen F. J. Ornstein, partner in the Washington, D.C., office of Sonnenschein, Nath & Rosenthal LLP, the only good news about this scenario is that the roughest stretch of the crisis is no longer ahead.

‘I think the hemorrhaging has stopped,’ he said. ‘You are starting to see the hints of a recovery. There is the beginning of a stabilization – many of the older players aren't around, but you have new players.’

But many of these new players are finding themselves dealing with the troubled loans originated by now-defunct lenders. Brien W. Hampton, senior vice president at Redbrick Partners LLC in Washington, D.C., noted that the Federal Deposit Insurance Corp. (FDIC) is ready, willing and able to find new homes for these less-than-sterling old loans.
‘On the government side, the FDIC is trying to liquidate distressed assets purchased from insolvent banks,’ he said. ‘What that tells us is the FDIC is looking for a non-Resolution Trust Corp.-style exit strategy so they can get that inventory back into the marketplace and share in the upside of that transaction.’

But slimming down – if not completely erasing – the market for distressed loans has been a problem. Jeffrey C. Taylor, co-founder of Digital Risk, based in Maitland, Fla., believes the secondary market cannot enjoy a full rebound to good health as long as delays are made to keep financially troubled homeowners in mortgages that they cannot pay.

‘It has to come down to the point [of asking], does that person really want to be in that house?’ Taylor said. ‘What sacrifices are they willing to make to stay in that house? If they don't want to be in that house, what is the best solution to help them move on?’

Taylor argued that modifications are a way of erasing mistakes that should never have been approved by originators.

‘This is the underwriting that was supposed to have been done the first time around,’ he continued. ‘You have to underwrite a loan and make sure the person is going to stay in the house for longer than 60 or 90 days.’

‘I think you have to let some people fail,’ Ornstein concurred. ‘You have to let these people get out of their homes and put people who can afford to be in homes with a properly underwritten product to be the homeowners.’

Ornstein further stated that today's underwriting standards are not helping matters. ‘Homeownership equals responsibility,’ he said. ‘We need to get back to the traditional standards of underwriting. People are struggling with traditional underwriting – where you look at the pay stub and tax returns and appraisals and you ferret out fraud. We've gotten away from this.’

For Hampton, the recovery of the secondary market is not helped by the continued presence of distressed loans – especially when investors are willing to take risks on them.

‘I am not seeing any pressure on institutions to liquidate their asset portfolios of distressed loans,’ Hampton said. ‘I've seen many buyers who have come into the marketplace to buy these assets.’

But even if lenders are eager to originate new, high-quality loans, the ongoing constriction of the warehouse lines of credit is making their efforts difficult. Ornstein argued that the only way for mortgage bankers to secure this financing is to open their quality-control efforts for full inspection by the warehouse lenders.

‘We have to get back to the traditional due diligence, where a warehouse lender works with an originator – and that means going to the shop and kicking the tires and understanding the underwriting process,’ he said. ‘We need to show how the underwriter works with a broker, how the loans are documented and how the applicant is placed into a product.’

Taylor added that the old school of warehouse lending is no longer applicable in today's environment.

‘When you consider warehouse lending in the past, you have to scrap 90 percent of it, because there were no analytics in place and no quality-control samplings of loans on the line,’ he said. ‘They have to be in place today.’

(Please address all comments regarding this article to Phil Hall, editor of Secondary Marketing Executive, at


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