Reset Wave Coming

UBS, Lehman execs talk about subprime problems

May 23, 2007

By NEIL J. MORSE

In particular, they pointed to the building “reset wave” that will cause many adjustable-rate mortgages to rise an average of 200 basis points, exacerbating already stressed loan performance.

“We’ll be facing a hard time when the two-year reset comes along,” said Tom Zimmerman, managing director of ABS & Mortgage Credit Research for UBS Investment Bank. He was reffering to the leading edge of all the 2/28 mortgages originated in 2006.

Loan term modifications will not be the panacea that some suggest, the Wall Street executive said while speaking at a subprime conference last week in Las Vegas. “A lot of people in these loans lied about their income — they lied about everything,” thus precluding workouts based on real income or property value.

While modifications, in general, are “great,” Zimmerman said “they won’t solve the core problem of people who shouldn’t have been in these loans in the first place.”

A similar view was expressed by Karen Cornell, senior vice-president, Lehman Brothers, Carrollton, Texas, who is “hearing [that] when servicers try to modify some [loans], they still can’t perform.”

Cornell blamed today’s subprime problems on “massive amounts of fraud” that, she argued “couldn’t have been prevented by any [laws or guidance]. I’m not sure anyone foresaw what ended up collapsing the industry in the first quarter,” she said, referring to widespread misrepresentation, both benign and malicious.

Jeff DeMaso, senior regulatory compliance counsel for Clayton, a due diligence technology provider, acknowledged the virulent spread of fraud and the industry’s attempts to fight back.

“It wasn’t the focus a couple of years ago [but] now we’re seeing more targeted [loan] reviews and more attention to underwriting.” For example, he said originators now routinely ask whether a loan meets investor guidelines.

“The secondary market is imposing stricter guidelines on sellers,” said DeMaso, “and we’re seeing an expansion of’ tangible net benefit analysis by Wall Street.”

In the past, such scrutiny only was evident in states requiring it, according to DeMaso.

UBS’ Zimmerman believes large institutions that are subject to tougher regulatory and credit oversight now “will patrol the underwriting issue better.”

That’s where vertical integration will have a salutary effect, according to Lehman’s Cornell. “There are obvious economic benefits to it,” she remarks. “Vertical integration is a really good thing from the consumer [investor] standpoint [because] they have money to lose.”

In the meantime, there will be plenty of self-examination and even more accusations, according to Zimmerman, about “who is responsible for the big [subprime market] blowup.”

But, to find the culprits, “Look in mirror,” he said, adding “everyone loves a bull market and in a bull market underwriting standards always loosen.”

The UBS executive predicted “the CMBS market will be the next to go [down]” and said we have not yet seen a “fully corrected subprime market. Everyone is struggling to figure out the right mix now of term, downpayment, [how much] stated income [to permit]. No one knows what the right mix is.”

On the bright side, Zimmerman figures “we got rid of the weak lenders, but it will take awhile” to completely bounce back.