Yesterday we saw that even with strong Administration and Congressional pressure for lenders to modify loans, and modest financial incentives to loan servicers achieving successful workouts (we’ll return to those below), as chronicled in this Wall Street Journal, many people – at least, the Journal had no trouble finding plenty – are waiting as impatiently as those who expected to get free Kentucky Fried Chicken some months back.

That’s a big oupsie, isn’t it?

Actually, despite the Journal’s chastisement of Saxon for ‘falling behind,’ an extraordinary number of loans have been dealt with:

This always presumes that you’re supposed to modify all these loans, doesn’t it?

Saxon so far has completed nearly 17,000 loan modifications where borrowers have submitted income verification and other documentation and made their first payment.

All of you have already been accommodated

In fact, Saxon’s been accelerating its procedures in a manner that, were it applied to new loans, would be accused of recklessness:

In total, it has given initial approval of 28,000 modifications where the borrower has provided spoken information about income, a process that underscores the government’s desire to move things along quickly.

Once upon a time, that approach was called a no-doc loan or a liar’s loan.

Trust me, the sign is lying, not me!

I presume Saxon’s smart enough not to convert an initial approval into a final without the borrower’s documentation.  Certainly Mr. Meola’s loaded with experience:

Charged with beefing up Saxon’s operations is Mr. Meola, an accountant who held senior mortgage positions at Citigroup Inc., PNC Bank, Washington Mutual Inc. and New Century Financial Corp.

Having been the EVP of home lending at a subprime lender that went massively bankrupt in April, 2007 is certainly experience, but is that of the comforting kind?

We’re experts, we have experience

Mr. Meola, 52, is the author of a how-to management guide, which offers tips on communications and staying positive.

I shouldn’t mock that, but how can a blogger resist?

“Always look on the bright side of life”

He joined Morgan Stanley in the spring of 2007 [After New Century's bankruptcy – Ed.] as chief operating officer of its residential mortgage business as the firm was in the midst of a massive spurt of loan originations and securitizations.

Despite the Journal’s understandable sympathy toward Mr. Meola, leaping from a bankrupt lender to another lender rapidly buying the same product, and in vintages that we now know were among the worst – well, that’s not what would lead my resume.

‘Massive spurt’?  Really?

That growth had enabled Morgan Stanley to climb up the rankings of subprime-mortgage sales. Within a few months, Mr. Meola and Morgan Stanley effectively stopped making subprime loans as the industry collapsed.

Perhaps Mr. Meola was the voice of caution.  That he is still at Morgan Stanley suggests so.

At the time it was purchased in 2006, Saxon’s portfolio totaled 165,000 loans for an unpaid balance of $26 billion. As of June 30, 2008, the portfolio had grown to 342,404 loans, the bulk of which were subprime, with a balance of $56.9 billion.

Even if Mr. Meola turned off the tap in September 2007, outstanding commitments would have taken some months to close, and the portfolio would swell. 

That swelling’s still hurting

The 2006 vintage averaged $157,500 apiece; the 2008 vintage $166,000, or 2.5% annual increase in loan size – basically keeping up with inflation. 

Another inference in Mr. Meola’s favor is this:

Part of the problem at Saxon is that it didn’t ramp up its ability to modify loans as early as other servicing companies. A spokeswoman for Saxon says that when Morgan Stanley purchased the company in 2006, it lacked enough employees and systems to undertake massive numbers of modifications. It wasn’t until the spring of 2007 – after its portfolio of subprime loans had already started to sour [And after New Century had gone bankrupt, and Mr. Meola had joined Morgan – Ed.] – that Saxon began to focus on modifying loans.  Not until the fourth quarter of 2008 did Saxon boost its capacity to handle a large flood of requests.

We’re under water

Nor would there have been a huge reason to do so, as until that time there was no Federal relief to change the workout equation.  The offers are generous:

Some Saxon borrowers have gotten swift modification approvals. Lorraine Rodriguez, a hospital worker in Anaheim, Calif., called Saxon in mid-May. Following an hour-long call, she says, Saxon told her she had been approved for a three-month trial modification starting June 1, cutting her mortgage rate to about 5% from 9.5%. Her monthly payment was cut 42%, to just below $1,900.

Monthly payment cut from $3,275 to $1,900, saving you $1,375 a month.  Who can argue with that? 

The new rate “is still a high amount and is tough for us,” says Ms. Rodriguez, 57.

If a 42% debt service cut is still ‘tough,’ how ever did you buy the property in the first place?

Ambition, that’s how

If anything, Saxon’s been too generous:

Saxon’s borrowers’ rate of so-called re-defaulting — or defaulting on a loan after it’s been modified — has also been higher than most.

Translation: We promised you’d reform, we gave you a break, now you’re in the soup again.

Higher is not better

Of the loan modifications made by Saxon in the first quarter of 2008 where monthly payments were decreased by more than 20%, 34% of the amount owed was delinquent by 60 days or more 10 months after the modification, according to Credit Suisse Group.

The ‘20% drop’ is a shorthand for ‘modifications big enough to be meaningful.’  For every three borrowers to whom Saxon offered a concession – again, a free, no-cost concession – one out of those three went back in default.

One of those three balloons pops

That compares with an average of 27% delinquent for the 18 servicers Credit Suisse analyzed.

If Saxon’s having 1 in 3 redefault, while the average is 1 in 4, Saxon’s being too nice.

[Treasury Secretary Geithner] said the agency would begin publicly reporting each firms’ results starting in August –

Perfectly appropriate, but what statistics will be reported and what inferences will be drawn from them?

– and that Freddie Mac, the government-controlled mortgage buyer, would be auditing a sample of declined requests to make sure no borrowers were denied incorrectly.

An ex post facto audit with a standard of zero defects?  Why not just jail me now?

Do not collect $1,000 reunderwriting fee

Saxon is certainly trying:

Mr. Meola says in the fourth quarter of 2008 he had ordered Saxon to upgrade its call-center systems, improve training and make sure callers were routed to the right employees.

The company has retrained 659 employees on how to implement the government program. It has invested in a new, high-speed scanning software system, which can scan up to 125 documents a minute. Before the change, it took 20 minutes to upload the same amount of documents.

Mr. Meola reviews a sample of calls into the Saxon call center, including analyzing wait times. His checklist, which monitors customer dealings in 30-minute intervals, includes counting the number of denials and available agents.

Scoring based on how many agreements are reached is self-adjusting; you can always hit whatever ratio you want just by telling your people to be easier or tougher.

Just modify it, okay?

He’s been deflecting criticism from some watchdogs. In April, for example, Saxon executives convened at the Fort Worth unit of the Better Business Bureau. The agency, after receiving a spike in complaints from Saxon customers, had given the company an “F” based on the complaints.

Sitting in a small conference room, members of the bureau told Saxon executives of complaints about service, billing and miscommunications during refinancing, according to an agenda for the meeting. More than 300 people had lodged complaints in the year ending early 2009.

Sorry to be repetitive, but these people are asking for unilateral relief.  Patience is a virtue.

Won’t, can’t … or shouldn’t?

Mr. Meola says complaints spiked after Saxon took over a portfolio of 80,000 loans from a troubled rival in 2007.

No good deed goes unpunished. 

We’ll make your loan conform

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When you’re denied something, a chasm separates being told I won’t help you from I can’t help you.

It ought to be easy, oughtn’t it?  Hard-working people who suffer temporary setbacks deserve mercy from their lender.  For the lender, mercy will be good business, as those hard-working folks will gratefully repay their new obligations, saving the lender foreclosure expense, uncertainty, and loss on resale.  All will be well.

If only it were so …

We love fables and epics because they form neat narratives with right and wrong, triumph and tragedy, winners and losers, and those narratives reinforce our world views. 

Reality is more complex, especially when it comes not in spies but in battalions and, as revealed in this Wall Street Journal, it’s by no means clear who should be relieved, and what form that relief should take.  The Journal set it up in time-honored link-high-and-low fashion. 

Can they possibly be linked?

Start with the high:

Morgan Stanley chief John Mack recently made a new friend, he told shareholders in April — a Southern woman who had benefited from the big bank’s stepped-up efforts to modify loans under a new federal program aimed at keeping borrowers in their homes.

“I’m now invited – if I ever visit Memphis, Tennessee – to drive two hours south to have dinner with her and her family,” Mr. Mack said.

How far south of Memphis?

Meet the low:

Steve Applegate of Lake Mary, Fla., has tried without success to modify his $750,000 home loan through Saxon Mortgage Services Inc.

Before you get out your handkerchiefs for Mr. Applegate, let’s see his home:

Mr. Applegate in front of his house

Saxon is Morgan’s single-family loan servicer.

An April Credit Suisse Group analysis of how quickly companies have renegotiated loans ranked Saxon last among 18 mortgage-servicing firms. Saxon has modified just 6% of the loans it oversees that originated between 2005 and 2007.  

Isn’t there a middle group here, Saxons?

By contrast, Litton Loan Servicing, a Goldman Sachs Group Inc. unit, modified 28% of its loans.

Is this a race?  Shouldn’t the number of loans needing modification vary based on how good one’s portfolio is?  Wouldn’t a better measure be “percentage of non-performing loans”?  Or “percentage of non-performing loans that are salvageable”?

Actually, that question invites another, deeper one.  A loan is a contract entered into by willing parties.  (We’re omitting from this discussion those who were defrauded or duped into loans, as there’s no suggestion that such happened to Mr. Applegate or anyone else referenced in the Journal article.)  If a loan is to be modified, what’s the justification for modifying the loan, and whose perspective(s) should decide? 

We all have standing!

The borrower.  We know why the borrower wants it – the borrower gains an unalloyed benefit, one to which he or she is not contractually entitled.

The lender.  Lenders should modify loans only if they think it is in their interest to do so, compared with their alternative of enforcing and foreclosing.

The government.  This is the wild card, because the government’s objectives are larger:

Such firms are at the center of a grand government experiment aimed at halting foreclosures and the collateral damage they cause neighboring homes.

New foreclosure notices will total 2.4 million this year, which could trigger price drops in 69.5 million nearby homes, estimates the Center for Responsible Lending, a financial-services research and policy firm.

Not all markets are equally at risk of collateral damage; they are highly concentrated in a few places, such as Mr. Applegate’s Florida, or marginal neighborhoods whose homeownership rates (and prices) were inflated.

Don’t be in the orange states

At an average decline of $7,200 a house, that translates to a potential drop of $502 billion in total U.S. property values.

As the old math joke goes, I’ve got one foot in boiling water, the other in ice, on average I’m comfortable.

The government plan, rolled out in February and called the Home Affordable Modification Program, or HAMP, will pay mortgage-servicing firms to modify mortgages and find other ways to keep people in their homes.

Another four-letter acronymic program, to follow TARP, TALF, HERA, ARRA, and PPIP.  Now with 33% more letters than previous TLAs!

But the program’s sheer scale and the speed with which it was rolled out has created a new set of problems for some of the 27 firms charged with carrying it out.

Hampered by scale?

I look great but I pose new problems, don’t I?

Are we surprised that the lenders are swamped?  There are two reasons.

“Now listen closely – you need a bailout”

1. Workouts are much more difficult, and slower, than underwriting new loans. 

Unless, that is, you simply want to give the money away without regard to whom is deserving and whether the restructuring will work.

Staff lacked the training and experience to modify so many sour loans.

During the housing boom, Saxon’s mortgage-servicing employees did little more than send monthly statements in the mail and track down delinquent borrowers.

Servicing means coupon-clipping and matching payments to loans.  It’s highly routine, algorithmic, scalable, and electronic.  Servicing platforms (the term of art these days for companies or business units) handle enormous volumes of transactions, all on an entirely automated and standardized basis.

Loan servicing, 1996-style: we use the same architecture, just faster hardware

Workouts are the antithesis of loan servicing – customized rather than standard, small-scale rather than aggregatable. 

Under HAMP, reworking a single loan can be a time-consuming process with many steps, from:

·         Calculating a borrower’s debt-to-income ratio

·         Figuring out which type of modification works best for each borrower

·         [Choosing the appropriate form of restructuring – lower interest, lower principal, or a combination]

·         [Sizing the new loan or loan payments]

·         Negotiating with investors who own different slices of the loan pool

[Rearranged from the Journal's jumbled list.]

That means many employees need to be trained in an entirely new set of skills.

Loan specialists need to study multiple guidelines, online tutorials and a HAMP data dictionary with terms such as “underlying trust identifier.”

This is more than simply training, it’s a whole new type of activity, one that usually requires more brain power, and therefore a higher-grade executive. 

Yes, you’ll be able to write on a whiteboard

Now, firms like Saxon are under pressure to stem foreclosures at all costs.

Saxon also has a financial incentive: The government is paying servicers:

$1,000 for each loan they modify

Another $1,000 annually for up to three years if borrowers stay current.

At $4,000 per modified loan, only about 2.5% of the unpaid principal balance (based on Saxon’s a$166,000 average loan) – not enough to encourage profligacy, particularly as three-quarters of it is paid only if the borrower stays current.  Rather, it’s a token of recompense to Saxon for upgrading their infrastructure and bringing in modification specialists to replace mindless servicing.

In all, the U.S. could provide as much as $18.6 billion to the mortgage industry, investors and borrowers.

Add to that the conflicting objectives – help the borrower, get a good loan, avoid being ambush-profiled in the Wall Street Journal or New York Times – and you have a high-stress job.

In May, shortly after the government program kicked off, Anthony Meola, Saxon’s chief executive, gave his employees a call to arms.

Mr. Meola was previously EVP of Home Lending at New Century, whose April, 2007 bankruptcy [featured at the time on the blog – Ed.] was an enormous early-warning indicator of trouble ahead. 

Sir, we’re picking up a subprime lender’s bankruptcy

He then spent a few years as a motivational speaker (he was certainly motivated J ) before landing this post.

Standing atop a makeshift stage in the middle of Saxon’s call center in Fort Worth, Texas, Mr. Meola barked into a microphone: “You are getting a chance to help preserve the American dream. Think about what you could do — you can save someone’s home!”

A man with a mission:

Mr. Meola, outside the firm’s New York headquarters

2.  Relief is free, so everybody wants some.

As so often happens, the vaporware outruns the fulfillment.  As we saw with the Free Kentucky Fried Chicken fiasco, offer something at no cost and everybody wants one – and many become irate and litigious if they are not satisfied.  All that uprush of demand sweeps the undeserving and the hangers-on along with the desperately worthy.

By the time the Obama administration and Treasury Department launched HAMP, Saxon was having trouble keeping up with requests for modifications, even as it attempted to get up to speed.

The company, based in Irving, Texas, has hired or expanded contracts with four outside companies to help handle the influx, and it recently added a late shift from 4 pm to 11 pm to manage the extra work.  

Systems designed for one load level cannot handle a peak load a full order of magnitude larger:

Even the volume of paperwork at one point grew unwieldy — an internal audit in mid-May found that Saxon’s scanning equipment was overloaded with materials sent in by borrowers, leading to delays and lost documents.

Any time load increases torrentially, the system can temporarily crash.

Here come the applications

Yet there is growing concern among some lawmakers that loan modifications aren’t moving fast enough.

I doubt that lawmakers have ever tried modifying a loan. 

[I have, and it's serious negotiating, made harder when the counterparty – the borrower – is unsophisticated, because you spend what seems eternities explaining the basics, the simplest principles, even the lexicon. – Ed.]

In late June, 20 Democratic senators wrote to Treasury Secretary Timothy Geithner, whose agency is the architect of the housing program, to ask him to put more pressure on mortgage-servicing firms.

“Close your hands around the sensitive parts, and squeeze”

The group cited a recent report from a foreclosure program administered by NeighborWorks America, a Washington network of affordable-housing organizations, that found homeowners still were being forced to wait, on average, 45 to 60 days for help.

NeighborWorks is a great group, so I trust their data, which nevertheless invites the question, what’s a reasonable interval?

On July 9, Mr. Geithner sent a message to the mortgage-servicing firms that have signed up for the modification program and told them to ramp up their efforts. “We believe there is a general need for servicers to devote substantially more resources to this program,” Mr. Geithner wrote, including adding staff and call centers.

Tell me something I don’t already know.

“Today’s lesson is mighty important, remember?”

[Continued tomorrow in Part 2.]

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