Consumer Law

Mortgage Foreclosures - What Are Tranches?

By M. Stan Herring

We are often asked by Alabama consumers who are facing foreclosures "What is all of this talk about securitization and tranches and trusts actually owning my house?"

Nicole Perlroth of Forbes has a fascinating article that lays out how the process works using a lady named Adama Kromah as the subject of her story.

Here is a nice overview:

At the peak of the housing boom, Wall Street had a saying: "A rolling loan gathers no loss." Loans were sliced, wrapped, pooled and sold to a seemingly endless chain of investors. This securitization process allowed banks to farm out debt to investors such as pension funds that otherwise couldn't stomach the underlying risk. It also meant that banks could create more mortgages and that Kromah could do the once unthinkable: own her own home.

We don't normally quote this much but this is critical to understand and Nicole has laid this out in a very easy to understand manner:

Countrywide had no intention of hanging on to this mortgage. Months before the closing, in fact the moment Countrywide quoted Ogbewele the $300,000, the two loans were entered into a database for Countrywide's securitization group to pool with other loans and sell to investors in the secondary market. The first buyer of her $240,000 mortgage was a shell company called Countrywide Alternative Loan Trust, or CWALT.

CWALT "sold" her loan again to CWALT 2004-36CB, a securitized trust that issued bonds to investors. At issuance, the trust held $884 million in mortgages. Kromah's mortgage made up less than .003% of the pool.

Countrywide hired Lehman Brothers and Greenwich Capital Markets to divide the trust into 13 slices and sell each to investors. Standard & Poor's and Moody's assigned credit ratings to each slice according to their underlying default risk. Top tranches were given a AAA rating and were to be paid out first. The lower, riskier tranches ranged from single A to B and came with higher yields but would be first to absorb any losses.

Greenwich coordinated the sale of senior tranches. Lehman found investors for the junkier slices, labeled B1 through B5, and paid in that order. The Bank of New York was hired as trustee to distribute principal and interest payments to bondholders.

Kromah's loan was melted into all of these tranches. The senior tranches were bought by insurers Genworth, Alfa Insurance, Ohio National and Investors Capital Research, a mutual fund company, as well as undisclosed private investors, such as hedge funds and sovereign wealth funds. The riskier tranches went to AIG, insurers Employers Reassurance, Country Life and Cotton States, and pension fund giant TIAA-CREF.

In April 2005, Cohen's hedge fund Ramius Capital bought the $4 million B4 tranche of the original Countrywide loan pool and tucked it into its newly created CDO, called Nautilus I. If Countrywide's trust is a pool of mortgages, Nautilus I is the gutter. Ramius essentially took the riskiest tranche of Countrywide's loan pool and folded it into its Nautilus I portfolio with mortgage-backed securities from other trusts for slicing, dicing, pooling, rating and selling anew.

Ramius hired UBS as underwriter to sell the CDO and cut it into even more slices. UBS hired Fitch to rate the slices from AAA to BB, magically turning what was once fairly shaky collateral into sterling-sounding securities. Ramius sold $413 million worth of this CDO to investors and injected a $97 million equity stake as well, in part to entice investors by signaling that it was putting its money at risk along with them.

Here's the ending to this story - at least for now - as foreclosure looms:

Kromah spends days on the phone with Countrywide, getting nowhere. Countrywide, now owned by Bank of America, is too far removed at this point. She hired a lawyer from the Financial Clinic, a nonprofit, to help work out a loan modification. Neither has a clue who really owns her mortgage.

If, or when, the B4 tranche folded into Nautilus I collapses, the next tranche in the CWALT trust to absorb losses will be B3. Then B2, a tranche wholly owned by AIG, the insurer now owned by American taxpayers. That leaves all of us with a little bit of interest in Adama Kromah's home.

We are preparing for our first Alabama Foreclosure Defense Seminar which we will hold in one of our conference rooms in our Birmingham, Alabama office. This will be in early October. Let us know if you are interested in attending as we will limit it to ten families at a time so we can have a good question and answer session to arm Alabama consumers with knowledge of how to fight back against wrongful foreclosures.

Full post as published by Alabama Consumer Blog on September 08, 2009 (boomark / email).