Analysis: Kitchen sink strategy dirties mortgage putback wars

NEW YORK (Reuters) - Mortgage investors trying to pry compensation from banks over bad loans are increasingly making frivolous claims among the legitimate ones, adding new stress to the test of wills and wallets, according to firms that review the cases.

Analysts say investors have taken on a kitchen sink strategy, in which they try to exploit any and all errors - even if they had nothing to do with a loan’s default.

With this tactic, investors are looking to expand their recovery on troubled loans they hold by forcing banks to repurchase them at face value. Others who bought distressed mortgages for pennies on the dollar would see a windfall if they can overwhelm banks with volume, and win settlements.

The more petty claims have grown to as much as 70 percent of a portfolio of loans whose quality is challenged, said Peter Kempf, president of American Mortgage Consultants, a loan due diligence firm,

“It’s overburdensome,” Kempf said of the investor strategy.

Kempf said AMC dug into a bolt of loans that an investor “put back” to a bank and saw an error but was taken aback by its irrelevance. The Brandon, Florida, refinance application from 2005 stated the borrower’s birth year as 1997, an obvious typographical error, he said.

“This gets a ‘Come on,’ type of response,” loaded with incredulity, said Kempf.

Firms like AMC are at the heart of the business, sought out by investors who see opportunity and banks that must defend against the so-called put-backs. AMC gets 40 percent of its revenue from that business, up from 10 percent in 2005, said Kempf, a former mortgage trader with PNC and Washington Mutual.

Ferreting out bogus claims is crucial for banks facing put-backs so often now that Wall Street researchers have been busy handicapping their success. FBR Capital Markets on Monday raised its estimates of bank costs to $54 billion to $106 billion.

“There are certainly things within the repurchase requests that we think are ridiculous,” said William Emerson, chief executive officer of Quicken Loans, a top 10 U.S. lender.

Errors by mortgage servicing units at Bank of America Corp and other financial firms have emboldened investors to try new angles on claims on which they had been stymied. As Pacific Investment Management Co and others took steps to draw put-backs or gain some financial relief over $16.5 billion in bonds, their target -- Bank of America -- dug in its heels.

Problems with foreclosure processing have led to an investigation by all U.S. states’ attorneys general and will be explored by the Senate Banking Committee on Wednesday.

As put-back requests grow, banks are steeling methods to scuttle investors’ strategies to seize on minor flaws. Investors must show errors led to defaults or expected defaults, and those ties are often loose, analysts say.

“The problem is that it becomes a pissing contest,” said Brian Coester, chief executive officer at Coester Appraisal Group, which reviews loans whose appraisals are challenged. “Whoever rebuts stronger, faster and provides more information” gains the upper hand, he said.

Put-back demands are laden with subjective calls, Coester said. But a big portion of those fly in the face of industry convention, and will not be successful, he added.

Among tactics, investors will compare a newly built home with older homes in a bid to show an inflated value. Or they will present new appraisals just below the original, enough to increase the loan-to-value ratio to a level ineligible for the uninsured funding it received from Fannie Mae or Freddie Mac.

“The (original) appraisal was $140,000 and theirs comes back at $132,000. They almost make it easy to fight because they are so unreasonable,” said Coester, who re-organized his business to deal with frivolous claims.

“We used to order the field review and then get that back and then rebut the claims letter,” he said. “We switched that to just rebutting the claims letter and ordering the field review only where necessary.”

Such put-backs are straining relationships between investors and sellers of loans. Costs to investors have also climbed so high that the smaller ones are not pursuing putbacks even if they find serious flaws.

While put-backs are growing, it’s “just going to stop” as many hit a wall, predicted Sue Allon, chief executive officer of Denver-based mortgage risk firm Allonhill, which does not accept put-back assignments.

“It’s short-term, it’s ambulance chasing and it’s not going to go anywhere,” Allon said.

Editing by Dan Grebler