M Hanson Advisors Real Estate & Finance

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1 M Hanson Advisors Real Estate & Finance The Mortgage Pages - September 29 th BAC, JPM, C, PNC (NCC-Legacy) & WFC Second Mortgage Risk - Early Innings of Second Mortgage Losses Our mission is to provide our clients a significant edge. This is done by turning the daily, market-moving real estate and mortgage news flow and events into old news by the time it makes headlines. - Mark Hanson This report attempts to quantify real-time bank-specific second mortgage loss risk in large part based upon first mortgages that they unfortunately sit behind, which are moving down the Foreclosure path on a journey towards liquidation. As you are likely aware, only roughly a third of all distressed seconds are taken into official default or Foreclosure by the banks because after the first mortgage is paid from the proceeds of the Foreclosure, there would not be anything left. Sure, underwater lien holders can bluff the borrower into a callback or mortgage mod by filing a Notice-of-Default but the process is expensive and if the borrower is delinquent on their first mortgage as well, then it is generally a waste. Thus, a second mortgage s fate has a lot to do with the performance of the first mortgage and the aggressiveness of the first mortgage servicer. Through our proprietary default and Foreclosure data we can track not only each first mortgage in the default and Foreclosure pipe, but also subordinate liens and which bank originated and is presently servicing the loans. This provides a window into how seconds are being (mis)managed not available anywhere else. Just this week the OCC put out a statement attempting to discredit the presumption that bank s were refusing to take losses on second liens through perma can-kicking. The numbers the OCC citied seem awfully small at $293bb but perhaps they are categorizationally challenged, which I have seen often with respect to the two different types of second liens, HELOCs and HELOANS; the former a credit card and the latter being a true fixed-rate, fixed-term junior mortgage. If they are talking about only true junior mortgages and not HELOCs then $293bb sounds a little more accurate. For one thing, the volume of junior mortgages that are performing but

2 tied to troubled first liens "remains relatively small," the Office of the Comptroller of the Currency and the Office of Thrift Supervision said in a new report. The agencies estimated that of the $293 billion of second liens attached to first mortgages, 6%, or less than $18 billion, are current yet standing behind delinquent or modified firsts. Nevertheless, the agencies said they have stressed to banks and thrifts the need to properly reserve against potential losses on second liens that are in this situation or, where appropriate, to charge off the loans. The agencies also said national banks have recognized $43.5 billion of losses from nonperforming second mortgages over the past two years more than five times the losses recognized over the previous five years. It is well known the big banks carry most of the second lien (HELOC & HELOAN) risk, but what is not widely known is the real-time, bank-specific risk profile with respect to second mortgages being completely wiped-out, as the first mortgages they are unfortunate enough to be sitting behind move through the Foreclosure process. Nor, is each bank s willingness to take second mortgages -- with enough equity to Foreclose -- through the process. Both results may surprise you. The Data For this report I compiled proprietary bank-specific official default, Foreclosure and cancelled Foreclosure data on five high-profile second lien originators covering the past 2.5 years. I used CA data only, as it is by far the largest second s market for all of the lenders profiled, and easily grossed up for any minor exposure in other regions. Bottom line - the problem is getting worse and more losses are coming, as higher grade loans (Alt-A, Prime, Jumbo Prime, Pay Option) -- with many more second liens behind them than Subprime loans carried -- experience more stress, and as the mountain of loan modifications, which are nothing more than new-vintage Subprime loans offered to borrowers with second liens in place to a greater degree than those without, begin spewing an everincreasing number of re-defaults and subsequent Foreclosures.

3 Mark Hanson 1) CA Second Liens in the Distressed Pipeline or at Foreclosure (Aggregate) The chart below shows the monthly sum of all second mortgage liens behind first mortgages, as they hit each stage of Foreclosure. 1 st Stage - Notice-of-Default -- where cure rates drop considerably and when banks should be adding reserves. While off the highs, the recent trend is higher once again, as the bank s primary re-leveraging mechanism, mortgage mods, grows in impotence. 2 nd Stage Notice-of-Trustee Sale (Foreclosure imminent stage) -- remains elevated showing significant pent-up liquidation pressure due to perma cankicking. Foreclosure -- where the second is completely wiped-out, sits at record highs in August. Cancelled Foreclosure (likely loan mod involved) -- where the loss was kicked down the road are rolling over, as the impact of modifications wane. What is so interesting here is that seconds behind first mortgages at the Second Stage (Notice-of-Trustee Sale) are near record highs hit in June But, first mortgage volume at the NTS stage is off 40% from the highs achieved in May 2009 due to aggressive and pervasive mortgage mod initiatives. Bottom line - more first mortgage with seconds behind them are becoming distressed, as a percentage of total distressed loans, in recent months than ever before. It is important to note that this does not capture seconds with enough equity in the properties for the banks to Foreclose. This is only seconds that are going along for the wipe-out ride behind distressed first mortgages.

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5 2) CA Second Lien Specific Default & Foreclosure Activity Unlike the report above showing seconds going along for the ride behind distressed first mortgages, this report below shows second liens where this is enough equity to Foreclose on which the servicers did in fact file a NOD or NTS, took the property to Foreclosure, or Cancelled the Foreclosure. Bottom line - This chart represents seconds on properties with enough equity to Foreclose and all stages are pinging on record highs in August.

6 3) CA Second Liens at the Notice-of-Default Stage by Bank-Owner

7 This report is a drill down from the aggregate reports shown previously and identifies the banks that currently hold the most distressed second mortgages. It is obvious here that second mortgage losses will not follow some sort of credit trend based on 30, 60, 90-day losses etc. They will occur as the servicers make the conscious decision to advance loans through the Foreclosure process, which we track in real-time. At the NOD stage shown below, cure rates drop considerably and if they haven t done it yet, reserves should be set aside. Again, because of aggressive mortgage mod activity over the past year, which is now waning, and because the bulk of the Subprime implosion is behind us, loans at the NOD stage are off their peak. But, I maintain that due to the modification volume ramp and typical redefault timelines, NOD s reached their lows in Q210. In this chart, Bank of America is the stand-out with second mortgages that hit the NOD stage and got in-line for liquidation in August at absolute record highs. Chase, who has the market cornered in the can-kicking division, would be a lot higher in recent months if not for a Foreclosure Cancellation spree they went on beginning in June whereby billions in Pay Option first mortgage Foreclosures were kicked down the road for some reason. I suspect they hope to refinance many of them through the new FHA short refi program throwing the risk onto the tax-payer, which was exactly why the program was designed. What is so appealing to note owners about the new FHA short-refi is that it allows for second mortgages to stay in place to 115% CLTV.

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9 4) CA Seconds at the Notice-of-Trustee Sale Stage (about to be Wiped-Out) Unlike the previous chart of the NOD (first) stage, which saw volume come down off record highs at all but BofA, at the NTS stage (Foreclosure imminent) shown below most banks are still seeing a growing risk of being completely wiped-out when the first mortgages they are behind are liquidated. From this stage, liquidation can occur as soon as three weeks, but the average is roughly two months.

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11 5) CA Monthly Second Mortgage Wipe-Outs through Foreclosure by Bank - At Record Highs As you can see, high second mortgage wipe-out volume are a relatively new phenomenon, as in the past most Foreclosures were Subprime first mortgages, which had fewer second liens second liens were offered to a much greater degree to stronger credits. Bottom line - as evidenced by the increase in Notice-of-Trustee Sales shown previously, which feed Foreclosures, and as mortgage mods re-default at an ever greater pace creating an entirely new default and Foreclosure channel, second liens completely wiped-out through Foreclosure will continue to increase.

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13 6) CA Seconds Spared (kicked down the road) by Foreclosure Cancellation (likely loan mod) -- Loan Mods Losing their Effect The Cancelled Foreclosure stage represents loans that were spared liquidation most of the time due to a loan mod. Over the past year, mortgage Foreclosure cancellations were the only real growth sector for the big banks. This stealing of present day losses and moving them into the future will come back to bite, as these new-vintage, high-leverage Subprime loans redefault creating an entirely new default and Foreclosure channel few are even considering. As you can see here, Chase went hog wild beginning in June when it cancelled Foreclosures on billions in Pay Option ARM first mortgages, which prevented roughly $350mm in second mortgage losses in CA alone. The rest of the banks are also seeing Foreclosure cancellation volume roll over as mods have outlived their usefulness.

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15 7) CA Distressed Second Mortgage Loan Amounts by Bank For the data junkies, this report shows the monthly average second mortgage original loan amount at the time of origination. The larger the second mortgage, generally the larger the first mortgage it sits behind. For example, this report indicates that BofA -- with a $73k average loan amount in August -- is sitting behind more lower loan amount first mortgages, which makes sense with Countrywide deals. Chase, on the other hand, with an average second mortgage amount at $97k sits behind larger number of higher end deals, which makes sense given their greater number of Jumbo loans as a percentage of total loan volume Chase originated during the bubble years. Citi, National City and Wells all catered to the mid-to-upper end second mortgage borrowers as well and competed heatedly with each other, which is why their average loan amounts are all similar at approximately $87k.

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17 Best Regards, Mark Hanson This document is for your private information only. In publishing research, Mark Hanson and M Hanson Advisors are not soliciting any action based upon it. Mark Hanson and M Hanson Advisors publications contain material based upon publicly available information, obtained from sources that we consider reliable. However, Mark Hanson and M Hanson Advisors does not represent that it is accurate and it should not be relied on as such. Opinions expressed are current opinions as of the date appearing on Mark Hanson and M Hanson Advisors publications only. Mark Hanson and M Hanson Advisors are not liable for any loss.