Foreclosure Detectives battle with the banks
the full story from the Walll Street Journal
By RUTH SIMON
URBANDALE, Iowa—In two squat, suburban office-park buildings here, Richard Barrent is digging through loan files that could help decide who pays for the mortgage-paperwork debacle.
The former Wells Fargo & Co. quality-assurance manager's two-year-old company is part of a cottage industry of loan detectives obsessed with detecting fraud, misrepresentations and violations of underwriting guidelines. Such discoveries can be used as ammunition to force banks and other lenders to buy back loans from bond insurers, holders of mortgage-backed securities and other customers of forensic loan-review firms.
"There is a growing interest across the board" for such reviews, says Charles Cacici, managing member of Risk Management Group, a Brooklyn, N.Y., company that also scours mortgage files for problems. Competitors include Digital Risk, Clayton Holdings and Allonhill.
NUMBERS GAME: Barrent Group Chairman Richard Levitt, at left, with President Richard Barrent at Barrent Group in Iowa on Monday.
The tedious business, usually involving hundreds of pages per loan, has taken on new urgency since the foreclosure problems erupted in mid-September. Losses to U.S. banks from loan repurchases could reach $40 billion to $90 billion, according to J.P. Morgan Securities. Previous estimates were much higher but have declined partly because it is so difficult to compel lenders to take back loans.
Loan files sometimes can be hard to get. And mortgage companies often dig in their heels when confronted with a demand to repurchase a loan. That can result in negotiations or lawsuits that can stretch for months or more—or a stalemate.
"It is a day-to-day, hand-to-hand combat," Bank of America Chief Executive Brian Moynihan said recently when describing the Charlotte, N.C., bank's resistance to loan-repurchase requests.
In the worst-case scenario for investors, months of effort can result in nothing. Those odds are likely to discourage some investors from pursuing loan repurchases, which could reduce overall losses for banks. The payoff for investors and bond insurers when a bank eats a shaky loan: The lender typically must pay the difference between the original loan amount and what was recovered in foreclosure, or unpaid principal plus accrued interest if the loan is outstanding.
Losses on troubled loans can sometimes hit 80% of the original loan amount, says Mr. Barrent, the 49-year-old president and chief operating officer of Barrent Group. He won't identify any of the company's clients, though he says the firm is talking with bond investors about how to recoup losses from sloppy mortgage servicing.
Among the companies trying to make banks eat shaky loans are Fannie Mae and Freddie Mac. Last month, a group of large investors objected to the handling of 115 bond deals issued by units of Countrywide Financial, now part of Bank of America.
In one typical example, Gayle Hanson, a senior loan auditor for the Barrent Group, sifted through 331 pages of loan documents as part of her autopsy of $165,000 home-equity line of credit on a Colorado Springs, Colo., home. The file included multiple copies of the mortgage and notes detailing efforts to contact the delinquent homeowner.
She also scours credit reports, property records, appraisals, telephone listings, photographs of the house for signs that it was an investment rather than a primary residence, and any indication that the borrower owned property not disclosed on the loan application or that the appraisal was inflated.
Ms. Hanson found that the Colorado Springs borrower had at least three undisclosed mortgages totaling $520,000 in addition to nine investment properties listed on the loan application.
The files contained little information to support the borrower's claim that he earned $13,500 a month, as well as $5,700 a month in income from rental properties. "The underwriter didn't do due diligence on this," she said. Barrent wouldn't identify the borrower or lender.
Barrent works with clients to select mortgages with a high probability of problems. Misrepresenting income is the most common defect in loan files reviewed by the company's 38 employees. That isn't surprising given that many loans it reviews didn't require borrowers to document their earnings.
One borrower whose loan was scrutinized claimed to be a shoe salesman earning $35,000 a month. A regional sales manager who cited earnings of $250,000 a year actually made $47,000 as a clerk for the same company.
About 65% of Barrent's reviews result in a loan-repurchase request. Banks have bought back about 1,100 loans, or about half, with clients of the loan-review firm recovering nearly $142 million in losses, according to the company. The figures reflect reviews for bond insurers and exclude loans for which negotiations are continuing.
Closely held Barrent gets paid an undisclosed fee for each loan it inspects or in some cases, a portion of the recovery. "You are going to have to pound the table and go the distance," Mr. Barrent says.
Investors in mortgage-backed securities face tougher obstacles than Fannie Mae, Freddie Mac or bond insurers, says Glenn Schorr, an analyst at Nomura Securities International Inc. Bond investors typically must prove that an underwriting breach, not tumbling home prices or rising unemployment, "materially and adversely" affected a loan's value, he says.
In addition, contracts on bond deals often require investors to win support from 25% of the voting rights in the trust before they can petition for access to loan files. Even then, "the servicer will, in many cases, refuse," says Talcott Franklin, a lawyer in Dallas who has been organizing bond investors to pursue such claims and represents investors with at least a 25% stake in more than 3,000 bond deals.
Some investors are using outside data to build their case. David Grais, a New York lawyer representing two Federal Home Loan banks in lawsuits against securities firms that sold mortgage-backed securities, recently hired CoreLogic, a Santa Ana, Calif., company, to supply public records data on 750,000 loans in more than 250 bond deals.
Mr. Grais used the information to look for signs of inflated appraisals, undisclosed liens and investment properties or second homes that had been listed as primary residences. Nearly half the loans had at least one material flaw, he says, adding that he is optimistic that the results will convince a judge to give him full access to the loan files.
"We have lined up a battalion of loan file reviewers," he says.
Write to Ruth Simon at firstname.lastname@example.org
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