Storm Clouds A'Brewin

In September 2006 I joined Residential Funding Corporation (RFC) in Minneapolis, MN as a project analyst in the corporate financial planning and analysis group. I would spend the next seven years managing one crisis after another until my company finally filed bankruptcy in May of 2012. The drab courtroom which was packed to the gills that May stood in stark contrast to the company party I attended in October 2006 where balloons fell from the ceiling and party-goers meandered in and around a life-size Lego House in downtown Minneapolis. I’ve told this story many times, but I remember turning to my new colleague and asking “Is this Enron?”

I sometimes forget just how rare my knowledge is not only of mortgage finance, but also of its operations. There is literally no other time in history where I would have been afforded not only a front-row seat, but as a result of the nature of the crisis I was able to learn things in a very short amount of time due to my role as Girl Friday to the executive team.

One of my first projects was to catalogue all of the management reports across our various business segments to help educate our new private equity majority owners as they had just paid a hefty price. Seeing the storm clouds gathering in 2006, they quickly realized a purchase price adjustment was in order.

As I catalogued, I read and asked the questions I knew the executives would ask much to the annoyance of my business segment FP&A teams. After spending many years in graduate studies, research was second nature to me as well as learning about complicated financial transactions as a lot of my later graduate work centered around the International Monetary Fund (IMF) and its role in postcolonial nations. Anticipating executive questions and requests was also old hat as I had worked full-time throughout my graduate studies at companies such as the WSJ and Allen & Co. I spent all of my time at those companies on the executive floor as an executive assistant. If you know a famous businessperson or politician, I can guarantee you they have at least one very capable executive assistant behind them. When I worked for the Senator my job was also to read, read, read and distill what I was reading in digestible briefs. At Allen & Co, I read hundreds of proposals for funding on businesses that ranged from airplanes providing Wi-Fi to biotech. The Senator’s office was sandwiched between the Chairman of Coke’s office and that of Herb Allen himself. As a nobody, people often forgot I was there, and I learned a lot.

Those experiences made me very comfortable working with executives at my company, and I quickly rose through the ranks. I was in the GM Building in 2008 when our executives first figured out we could become a bank holding company which would make us eligible for TARP. I was sitting behind a closed door in a temporary office with the Investor Relations team as we were told not to mingle with anyone else. The following day on the Earnings call we were likely to be announcing the ResCap bankruptcy. It was then that I heard someone running down the hall yelling “Get me Person X’s number, now.” Person X was the CFO of a small bank we had in Utah. At the last minute, it was decided we would not announce the bankruptcy during the earnings call.

After receiving TARP funding, we spent the entirety of 2009 eating way too much Jimmy John’s and working on strategic alternatives while disposing of troubled assets. I had that asset sale schedule memorized due to how many times a day I was asked about that as well as our current tangible net worth as we triggered lending covenant after covenant. We sold assets, issued debt, we received parent capital contributions, we looked at NewCo/spinoff scenarios, potential platform sales….you name it. By the time I left Corporate FP&A for a strategy role where I would help manage our Consent Order and AG Settlement I was the person who signed off on our financials prior to earnings and 10Q filing.

While in the strategy role I was hoping to work on strategic initiatives to grow the business, but instead ended up compiling, with the help of the business heads and our lawyers - Morrison Foerster (MoFo) - our servicing motion. The bankruptcy was a complicated one as it was just our corporate entity which was filing and not our parent. This came after several conversations with the Fed. My CEO was aggressive, and he basically threatened the Fed with our bankruptcy to help negotiate the civil money penalty. Much maneuvering occurred to make sure that penalty got paid even though we did BK. We were the first company to enter bankruptcy while continuing to originate loans as there were many people interested in our portfolio and there were multiple transactions that transpired.

I would find those second liens in the portfolios of all the nonbank servicers and originators where I would work after leaving ResCap. But before leaving, my President tapped me to turnaround the foreclosure department which was reeling from the backlash of the robo-signing crisis. Fannie and Freddie were threatening to pull servicing (which would tank the auction) if we did not reduce our seriously delinquent population. At the time I oversaw 65K foreclosures. I had entered a new level of hell, but it gave me a lot of operational experience and taught me even more about the dirty, dirty, dirty underbelly of the business….and I’m not talking about the borrowers. I’m specifically talking about the government-sponsored and government agencies.

I spent almost a year traveling all over the country to local law firms to go over our portfolios loan-by-loan to resolve issues. As our parent, newly dubbed Ally, was going purple, there was not a ton of money to sweeten the pot at the law firms like B of A did, so we had to resort to sheer elbow grease. That last year was the worst as an unwanted buyer known for offshoring and not paying vendors had upset the auction and bid higher than the stalking horse bidder. Although we had spent months in due diligence with the stalking horse bidder, this new entrant who had little experience with the GSEs and FHA/VA formed their bid with back-of-the-napkin math that failed to consider that servicing agency and government loans was a whole different ball of wax.

How it started:

How the early chapters ended:

I say early chapters, because the story is not completely over, but we will get to that a bit later.

We all tried to warn them that agency servicing was a tricky and costly game, but they thought the agencies would let them offshore everything. Back then, though the agencies kept a tight lid on those types of things mostly behind closed doors. When you service for the agencies, you are their b*&ch. There is no other way to say it. If you are big enough you can fight back, and we often did. Dealing with them was like a game of Whac-a-mole, but the government game was the only game in town.

A good example is when we agreed to settle with both Fannie and Freddie on repurchases. What is a repurchase? When you sell to the agencies you agree that you have followed certain guidelines. If they find you have not, you have to repurchase the loan from the securitization pool. The amount of administrative support it took to respond to these requests was massive, and we decided to just pay a large sum if they agreed that would cover our repurchases due to origination issues.

However, that was not enough for the GSEs. They soon came up with a new type of repurchase called a servicing repurchase. The funny thing about it though was that most of the servicing repurchases were title issues at time of origination. But what of that title insurance we are hearing so much about in the press these days? We filed those claims, but almost never got paid. Many of the companies were going under and those that weren’t took their sweet time resolving the issues as our liquidity continued to burn.

What I’ve heard around the industry is that the payout rate is about 3%. According to an industry trade group, in 2022, “title insurers brought in $17.6 billion in premiums during the first nine months of 2022, paying out $438.7 million in claims during that time.” 2.49% of overall premiums were paid out in 2022, but I can tell you that many people I know don’t even bother to file the claims because they know the outcome. I recently worked on a fraud case where that is exactly what happened.

I remember conducting a week-long training for some of my agents on common title issues and resolution. We were soon resolving them at multiples of the speed of the title companies. I hired newly graduated attorneys to review and ultimately through elbow grease again, we cleaned up the portfolio so much that my Fannie Mae rep won an award that year as if the rep was somehow responsible for our efforts.

Those servicing repurchases were never settled as we filed our bankruptcy instead. You may be asking yourself why the history lesson? I have often told you that the credit quality gospel singing from the industry due to Dodd Frank is based on many faulty assumptions, including inflated credit scores. Thankfully, Mark Calabria, the former director of the Federal Housing Finance Agency (FHFA) who may be vying for a job in the Trump administration, has finally joined me in airing the concern.

It has been lonely on this side, but more and more I’m seeing industry participants start to share concerns as they relied heavily on the Fannie and Freddie automated underwriting systems (AUS). For loans that were originated in 2024, according to Black Knight data, early payment defaults, or defaults where the loan goes delinquent soon after origination increased by 27% MOM, and early payoffs increased by 43%. The definition of early payment defaults varies, but one standard is if it defaults in the first six months. Some define it as the first three months. However you define it, we knew to shout Danger! Danger! if you saw loans originated in the past 12 months were increasing in delinquency. Both categories are areas of concern and can trigger a repurchase or prepayment penalty.

Despite all my efforts on social media to educate, the prevailing notion out there is that the banks largely do most of the origination. That is simply not the case anymore and this is very, very important for what’s to come.

As I would learn after I left GMAC, we went into bankruptcy because we truly tried to do things right unlike many nonbanks who never experienced the pain we did. Luckily for the banks and new entrants to the market all those Wall Street investors came and bought up those homes so the nonbanks got a fresh start without many of the default headaches as they had much smaller portfolios. Those portfolios are much larger now and gone are many of the industry experts that managed the last crisis.

Below I will discuss what’s ahead for the industry, why it matters and why your confidence in the industry’s ability to weather this upcoming storm based on delinquency numbers at big banks could be fatally flawed. Did you know Chase excludes those GNMA loans that are guaranteed by the government from its delinquency numbers? They claim it is because they are fully guaranteed. How does that work in practice? Do those claims get paid in full? Additionally, I will share my deep-dive into Redfin and inventory results for the cities I track as well as some analysis as to why California is suddenly starting to look very wobbly to me. People have largely acknowledged that Florida and parts of Texas are a dumpster fire, but if California goes, that is game over from a sentiment perspective.

Remember the refrain “defaults are regional and subprime is contained”?

Let’s dig in…