WaMu vulnerable on securitized mortgages
WaMu vulnerable on securitized mortgages?
Likely to set aside extra reserves if appraisals found fraudulent: analyst
By Alistair Barr, MarketWatch
Washington Mutual may have to set aside some $412 million to $2.1 billion in extra reserves if a lawsuit filed by New York state's attorney general against the mortgage lender succeeds, a Keefe Bruyette & Woods analyst estimated on Friday.
Attorney General Andrew Cuomo announced the suit on Thursday, alleging that First American Corp., also known as WaMu, to inflate the appraisal value of homes. See full story.
WaMu suspended its relationship with eAppraiseIT and said it has no incentive to have appraisers inflate home values. First American said the complaint "has no foundation in fact or law."
If Cuomo succeeds in proving eAppraiseIT's appraisals on WaMu home loans were fraudulent, that could create big problems for the Seattle-based lender, KBW's Frederick Cannon wrote in a note to clients.
After lenders like WaMu originate home loans, they are often packaged up into mortgage-backed securities and sold to institutional investors around the world. The process gets the loans off the lenders' books, freeing them from the risk that those loans may default and also providing fresh cash to make more new mortgages.
But if parts of the origination process are found to be fraudulent, investors can potentially force lenders to buy the mortgages back at the original price. If the assets have suffered delinquencies and have dropped in value, the lender takes a financial hit.
Shares of WaMu sank more than 6% to stand at $24.16 in midday trading, adding to big declines from Thursday. Meanwhile, First American shares traded down more than 1% at $30.09 after climbing in the Thursday session, leaving them roughly unchanged since the suit was filed.
'Considerable risk'
The lawsuit filed by Cuomo "raises an issue of considerable risk to Washington Mutual: that poorly performing securitized loans will be put back to WaMu from bondholders on the basis of fraudulent appraisals and WaMu would be forced to put bad loans back on its balance sheet," Cannon said.
"In such a scenario, WaMu would have to buy the loans back at par and then mark them to market on its balance sheet."
Cannon also questioned WaMu's assertion that it has no incentive to inflate the appraised value of homes that it lends against.
For mortgages that the company originates and then keeps on its balance sheet, the assertion is valid. But for home loans that WaMu sells as mortgage-backed securities, such an argument can be dubious, he said.
"For loans that a bank plans to sell, high appraisals support a greater amount of loans that can be sold, and loan officers are generally paid on volume," Cannon explained.
"Further, if a mortgage loan is sold it is generally accepted by the lender that they have passed on the default risk to the security holder," he added. "Therefore, it would seem that there indeed could be an incentive for loan officers and the bank to push for inflated home values in the case of sold loans."
Cuomo's suit claims that eAppraiseIT provided appraisals or appraisal reviews on roughly 262,000 properties for WaMu between April 2006 and October 2007. If the average loan size was $200,000 to $300,000, this would account for between $52.4 billion and $78.6 billion of loans, Cannon estimated.
During the period in question excluding October 2007, WaMu originated $275.4 billion of real-estate loans, selling $172.5 billion as mortgage-backed securities. As a result, the loans appraised by eAppraiseIT could account for 19% to 29% of loan production, the analyst wrote.
The value of mortgages that could be "put back" to WaMu may be about $33 billion, Cannon estimated. That may require additional reserves of $412 million, or the equivalent of 30 cents a share, he said.
In a worst-case scenario -- in which inflated appraisals were systemic throughout WaMu -- the lender might need to set aside an extra $2.1 billion, or $1.57 a share, of reserves, he added.
"Although we attempt to put this issue in perspective with these numbers, the issue is far too premature to include any estimated expense in our earnings estimates," Cannon cautioned
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posted by Victor Lloyd Smith @ 4:19 PM
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