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Countrywide: Mortgage Restructure Free-For-All?

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In the banking business, it is always preferable (from a cash flow and profits standpoint) to take your medicine all at once rather than delay it.

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Mr. Practical,

In the words of Forrest Gump, " I am not a smart man" and I was hoping you could take a swipe at explaining something to me?

I think on Monday, Countrywide (CFC) announced it had "restructured" about 35k loans to keep them from foreclosure. These loans were for folks that:

1. Were 6 months or more behind on their mortgage, but could afford to pay their monthly bill going forward.

2. Cannot pay a new fully indexed reset ARM rate, but could afford a lower rate payment.

I have two questions about this: 1. By "restructuring" in this fashion, obviously the loan parameters are changed in a negative fashion to earnings for banks, funds, etc. that own them. When do all these markdowns show up on balance sheets, ratings for paper, etc. and doesn't this really crimp the market for this stuff going forward? I mean, who wants to buy mortgage related paper, if in 6 months it will be "restructured" to some unknowable lower value?

2. If I were a regular Joe holding a mortgage, and scrimping to get by due to a huge ARM reset, or I am current on my mortgage, but am having a tough time, doesn't this move by CFC give the "all clear" to stop paying the mortgage and/or not pay the higher rate and demand a "restructured" lower rate? I know that is exactly what I would do!

Any thoughts on this under the radar process is greatly appreciated!

-Minyan J


Minyan J,

That's the issue. It is merely an attempt to delay the inevitable; restructuring can take many forms, and from CFC's perspective what it is attempting to do is essentially extend a life line to higher risk borrowers.

This of course has consequences, such as immediate cash flow/earnings impact, and the associated impact on ABX pools and CDOs as outlined below.

Further, it introduces perhaps the unintended consequences that the writer puts forth--that is a deliberate attempt to get one's mortgage restructured at terms favorable to the borrower; in a sense, by having a restructuring go through, it is another point of price discovery, and leads to mark downs of all assets associated with that price discovery, which necessitates secondary actions on the part of other financial market participants.

That is, as price discovery increasingly occurs, and assets are marked down, it widens the asset/liability gap and necessitates further asset liquidation and or reversions of credit extensions in order to manage one's balance sheet.

It is this issue of price discovery which the Fed probably seeks to forestall as long as possible, as it is a ticking time bomb. For example, when Hovnanian (HOV) recently held its big weekend home sales event, the homes that were sold at a 20% "discount" to original levels essentially marked down the entire neighborhood by levels approaching 20%, and hence an individual's asset side is suddenly worth a lot less, necessitating adjustments in spending habits to reflect such a price discovery in order to maintain similar asset/liability ratios prevailing prior to the sale.

When do these changes in cash flow dynamics start to impact (1) bank earnings, (2) ABX pools of securitized mortgages, and (3) CDOs of securitized mortgage-backed pools?

1. Immediately assuming the banks have not provisioned somehow against this in the past (which they have not).

2. ABX markets get updates each month about the cash flow dynamics associated with them (pre-payment speeds, foreclosures, etc) – so any changes in the aggregate pool will be reflected monthly.

3. With a slight delay, same as above, as the cash flow dynamics get updated monthly.

Why won't everyone simply stop paying and get "better terms" on their mortgages than they currently do?

The business of lending has been difficult from time immemorial because the worst credits tend to take the most money (they need it – see Countrywide's 12 bln credit line it took). Everyone won't be doing this – restructuring their mortgage to get better terms – for a host of reasons, such as the stigma attached with such a negative credit event on your record and the likelihood that CFC is attaching several pre-requisites to the pool of people they are willing to do this for, among others.

That said, the people that do get through the filter and are willing to restructure their mortgages are likely far worse credits – meaning that CFC's restructuring is likely to make matters worse by dragging out the inevitable (foreclosure) while providing the incentive (as you mentioned) for borrowers on the cusp to get better terms.

This is, like the Fed's 50 bps rate cut, an attempt to forestall the inevitable price discovery that will affect these pools of mortgages. In the banking business, it is always preferable (from a cash flow and profits standpoint) to take your medicine all at once rather than delay it, unless, as an institution, you are so close to actual bankruptcy/bank run conditions that you are forced to put off the medicine taking.

Sadly, almost the entirety of the banking industry forestalls anyway.

Position in CFC
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