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III. HIGH RISK LENDING:
CASE STUDY OF WASHINGTON MUTUAL BANKE. Polluting the Financial System
Washington Mutual, as the nation's largest thrift, was a leading issuer of home loans. When many of those loans began to go bad, they caused significant damage to the financial system.
Washington Mutual originated or acquired billions of dollars of home loans through multiple channels, including loans originated by its own loan officers, loans brought to the bank by third party mortgage brokers, and loans purchased in bulk from other lenders or firms. Its subprime lender, Long Beach, originated billions of dollars in home loans brought to it by third party mortgage brokers across the country. According to a 2007 WaMu presentation, by 2006, Washington Mutual was the second largest nonagency issuer of mortgage backed securities in the United States, behind Countrywide. |416|
Washington Mutual and Long Beach sold or securitized the vast majority of their subprime home loans. Initially, Washington Mutual kept most of its Option ARMs in its proprietary investment portfolio, but eventually began selling or securitizing those loans as well. With respect to other loans, such as fixed rate 30-year, Alt A, home equity, and jumbo loans, WaMu kept a portion for its own investment portfolio, and sold the rest either to Wall Street investors, usually after securitizing them, or to Fannie Mae or Freddie Mac.
By securitizing billions of dollars in poor quality loans, WaMu and Long Beach were able to decrease their risk exposure while passing along risk to others in the financial system. They polluted the financial system with mortgage backed securities which later incurred high rates of delinquency and loss. At times, WaMu securitized loans that it had identified as likely to go delinquent, without disclosing its analysis to investors to whom it sold the securities, and also securitized loans tainted by fraudulent information, without notifying purchasers of the fraud that was discovered and known to the bank.
From 2000 to 2007, Washington Mutual and Long Beach securitized at least $77 billion in subprime and home equity loans. |417| WaMu also sold or securitized at least $115 billion in Option ARM loans. |418| Between 2000 and 2008, Washington Mutual sold over $500 billion in loans to Fannie Mae and Freddie Mac, accounting for more than a quarter of every dollar in loans WaMu originated. |419|
According to a 2007 WaMu presentation at a securities investor meeting in New York, in 2004, WaMu issued $37.2 billion in RMBS securitizations and was the sixth largest RMBS issuer in the United States. |420| In 2005, it doubled its production, issuing $73.8 billion in securitizations, and became the third largest issuer. In 2006, it issued $72.8 billion and was the second largest issuer, behind Countrywide. |421|
WaMu and Long Beach's securitizations produced only RMBS securities. Although WaMu considered issuing CDO securities as well, it never did so. |422| From 2004 to 2006, WaMu and Long Beach securitized dozens of pools of prime, subprime, Alt A, second lien, home equity, and Option ARM loans. |423| WaMu and Long Beach also sold "scratch and dent" pools of nonperforming loans, including nonperforming primary mortgages, second lien, and Option ARMs. |424|
At first, Washington Mutual worked with Wall Street firms to securitize its home loans, but later built up its own securitization arm, Washington Mutual Capital Corporation (WCC), which gradually took over the securitization of both WaMu and Long Beach loans. WCC was a private Washington State corporation that WaMu acquired from another bank in 2001, and renamed. |425| WCC became a wholly owned subsidiary of Washington Mutual Bank. In July 2002, WaMu announced that WCC would act as an institutional broker-dealer handling RMBS securities and would work with Wall Street investment banks to market and sell WaMu and Long Beach RMBS securities. |426|
WCC was initially based in Seattle, and by 2003, had between 30 and 40 employees. |427| In 2004, due to increasing securitizations, WaMu decided to move the headquarters of WCC to Manhattan. |428| In 2004, for the first time, WCC acted as the lead manager of a WaMu securitization. That same year, WCC initiated a "conduit program" to buy Alt A and subprime loans in bulk for securitization. |429| WCC issued its first Alt A securitization in 2005, and its first subprime securitization in 2006. |430| It also conducted whole loan sales and credit card securitizations. |431| At its peak, right before the collapse of the subprime securitization market, WCC had over 200 employees and offices in Seattle, New York, Los Angeles, and Chicago. The majority of WCC employees were based in New York. |432| WCC was headed by Tim Maimone, WCC President, who reported to David Beck, Executive Vice President in charge of WaMu's Capital Markets Division. Mr. Beck reported to the President of WaMu's Home Loans Division, David Schneider. |433|
At the Subcommittee hearing on April 13, 2010, Mr. Beck explained the role of WCC in WaMu and Long Beach securitizations as follows:
"WaMu Capital Corp. acted as an underwriter of securitization transactions generally involving Washington Mutual Mortgage Securities Corp. or WaMu Asset Acceptance Corp. Generally, one of the two entities would sell loans into a securitization trust in exchange for securities backed by the loans in question, and WaMu Capital Corp. would then underwrite the securities consistent with industry standards. As an underwriter, WaMu Capital Corp. sold mortgage-backed securities to a wide variety of institutional investors. |434|
WCC sold WaMu and Long Beach loans and RMBS securities to insurance companies, pension funds, hedge funds, other banks, and investment banks. |435| It also sold WaMu loans to Fannie Mae and Freddie Mac. WCC personnel marketed WaMu and Long Beach loans both in the United States and abroad.
Before WCC was able to act as a sole underwriter, WaMu and Long Beach worked with a variety of investment banks to arrange, underwrite, and sell its RMBS securitizations, including Bank of America, Credit Suisse, Deutsche Bank, Goldman Sachs, Lehman Brothers, Merrill Lynch, Royal Bank of Scotland, and UBS. To securitize its loans, WaMu typically assembled and sold a pool of loans to a qualifying special-purpose entity (QSPE) that it established for that purpose, typically a trust. |436| The QSPE then issued RMBS securities secured by future cash flows from the loan pool. Next, the QSPE—working with WCC and usually an investment bank—sold the RMBS securities to investors, and used the sale proceeds to repay WaMu for the cost of the loan pool. Washington Mutual Inc. generally retained the right to service the loans. WaMu or Long Beach might also retain a senior, subordinated, residual, or other interest in the loan pool.
The following two diagrams created for a 2005 Long Beach securitization, LBMC 2005- 2, demonstrate the complex structures created to issue the RMBS securities, as well as the "waterfall" constructed to determine how the mortgage payments being made into the securitization pool would be used. |437|
In that particular securitization, Goldman Sachs served as the lead underwriter, WCC served as the securities dealer, Deutsche Bank served as the trustee of the trust set up to hold the securities, and Long Beach served as the mortgage servicer.
Another document, prepared by Goldman Sachs, shows the variety of relationships that WaMu engaged in as part of its securitization efforts. |438| That document, which consists of a list of various loan pools and related matters, shows that WaMu worked with Goldman Sachs to make whole loan sales; securitize loans insured by the Federal Home Administration or Veterans Administration; and securitize prime, subprime, Alt A, second lien, and scratch and dent nonperforming loans. It also shows that Goldman Sachs asked WaMu and Long Beach to repurchase more than $19.7 million in loans it had purchased from the bank. |439|
Goldman Sachs handled a number of securitizations for Long Beach. At one point in 2006, Goldman Sachs made a pitch to also handle loans issued by WaMu. One Goldman Sachs broker explained to a colleague in an email: "They have possibly the largest subprime portfolio on the planet." |440|
Over the years, both Long Beach and Washington Mutual were repeatedly criticized by the bank's internal auditors and reviewers, as well as its regulators, OTS and the FDIC, for deficient lending and securitization practices. Their mortgage backed securities were among the worst performing in the marketplace due to poor quality loans that incurred early payment defaults, fraud, and high delinquency rates.
Long Beach Securitizations. In April 2005, an internal email sent by an OTS regulator recounted eight years of abysmal performance by Long Beach securities, noting that loan delinquencies and losses occurred in pools containing both fixed rate and adjustable rate mortgages:
"[Securitizations] prior to 2003 have horrible performance…. For FRM [fixed rate mortgage] losses, LBMC finished in the top 12 worst annual NCLs [net credit losses] in 1997 and 1999 thru 2003. LBMC nailed down the number 1 spot as top loser with an NCL of 14.1% in 2000 and placed 3rd in 2001 with 10.5% .... For ARM losses, LBMC really outdid themselves with finishes as one of the top 4 worst performers for 1999 thru 2003. For specific ARM deals, LBMC made the top 10 worst deal list from 2000 thru 2002. LBMC had an extraordinary year in 2001 when their securitizations had 4 of the top 6 worst NCLs (range: 11.2% to 13.2%).
"Although underwriting changes were made from 2002 thru 2004, the older issues are still dragging down overall performance. Despite having only 8% of UPB [unpaid balances] in 1st lien FRM pools prior to 2002 and only 14.3% in 2002 jr. lien pools, LBMC still had third worst delinquencies and NCLs for most of [the] period graphed from 11/02 thru 2/05 and was 2nd worst in NCLs in 2005 out of 10 issuers graphed. … At 2/05, LBMC was #1 with a 12% delinquency rate. Industry was around 8.25%. At 3/05, LBMC had a historical NCL rate of 2% smoking their closest competitor by 70bp and tripling the industry average." |441|
This email, which is based upon a 2005 Fitch analysis of Long Beach, shows that, from 1997 to March 2005, due to loan delinquencies and losses, Long Beach securities were among the very worst performing in the entire subprime industry. |442|
Long Beach's performance did not improve after 2005. In April 2006, for example, Nomura Securities issued an analysis of the ABX Index that tracked a basket of 20 subprime RMBS securities and identified Long Beach as the worst performer:
"Long Beach Mortgage Loan Trust appears to be the poorest performing issuer, with its three deals averaging 15.67% in 60+ day delinquency and 12.75% in 90+ day delinquency. Unsurprisingly, all three deals issued by LBMLT have exceeded their delinquency trigger limits." |443|
In November 2006, while attending the Asset Backed Securities East Conference for the securitization industry, the head of WaMu's Capital Markets Division, David Beck, emailed WaMu's Home Loans President, David Schneider, that with respect to RMBS securities carrying noninvestment grade ratings, "LBMC [Long Beach] paper is among the worst performing paper in the mkt [market] in 2006. Subordinate buyers want answers." |444|
In March 2007, an analysis by JPMorgan Chase again singled out Long Beach securities for having the worst delinquency rates among the subprime securities tracked by the ABX Index:
"Washington Mutual Inc.'s subprime bonds are suffering from some of the worst rates of delinquency among securities in benchmark indexes, according to JPMorgan Chase & Co. research. … Delinquencies of 60 days or more on loans supporting WaMu's Long Beach LBMLT 2006-1 issue jumped … to 19.44 percent … the highest among the 20 bonds in the widely watched ABX-HE 06-2 index of bonds backed by residential loans to risky borrowers." |445|
In July 2007, Moody's and S&P downgraded the credit ratings of hundreds of subprime RMBS and CDO securities, due to rising mortgage delinquencies and defaults. Included were approximately 40 Long Beach securities. |446| A July 12, 2007 presentation prepared by Moody's to explain its ratings action shows that Long Beach was responsible for only 6% of all the subprime RMBS securities issued in 2006, but received 14% of the subprime RMBS ratings downgrades that day. |447| Only Fremont had a worse ratio.
Over time, even AAA rated Long Beach securities performed terribly. Of the 75 Long Beach mortgage backed security tranches rated AAA by Standard and Poor's in 2006, all 75 have been downgraded to junk status, defaulted, or been withdrawn. |448| In most of the 2006 Long Beach securitizations, the underlying loans have delinquency rates of 50% or more. |449|
The problems were not confined to Long Beach loans. In early 2008, for example, an investment adviser posted information on his personal blog about a WaMu-sponsored RMBS securitization known as WMALT 2007-OC1. Formed in May 2007, this pool contained about 1,700 Alt A loans with a total outstanding balance of about $515 million. WaMu was the sole underwriter. The credit rating agencies gave AAA and other investment grade ratings to more than 92% of the securitization, but within eight months, 15% of the pool was in foreclosure. The posting suggested that the poor performance of WaMu securities was systemic.
When informed by David Schneider of the complaint about the negative publicity surrounding the pool, David Beck responded:
"Yes (ughh!) we are doing some peer group performance and looking at the servicing data … and putting together an analysis. … The collateral is full of limited doc layered risk alt a paper and at least half is TPO [third party originated]. The performance is not great but my opinion is not a WaMu specific issue." |450|
Home Loans President David Schneider replied: "Ok – thanks .… Are we sure there isn't a reporting issue?" Today, those securities have all been downgraded to junk status and more than half of the underlying loans are delinquent or in foreclosure. |451|
Despite their poor performance, it is unclear that any investment bank refused to do business with either Long Beach or WaMu. As long as investors expressed interest in purchasing the securities, banks continued selling them until the entire subprime market collapsed. Before the market collapsed, WaMu earned hundreds of millions of dollars a year from its home loans sales and securitizations. |452|
Securitizing Fraudulent Loans. WaMu and Long Beach securitized not just poor quality loans, but also loans that its own personnel had flagged as containing fraudulent information. That fraudulent information included, for example, misrepresentations of the borrower's income and of the appraised value of the mortgaged property. In September 2008, WaMu's Corporate Credit Review team released a report which found that internal controls intended to prevent the sale of fraudulent loans to investors were ineffective:
"The controls that are intended to prevent the sale of loans that have been confirmed by Risk Mitigation to contain misrepresentations or fraud are not currently effective. There is not a systematic process to prevent a loan in the Risk Mitigation Inventory and/or confirmed to contain suspicious activity from being sold to an investor. ... Of the 25 loans tested, 11 reflected a sale date after the completion of the investigation which confirmed fraud. There is evidence that this control weakness has existed for some time." |453|
In other words, even loans marked with a red flag indicating fraud were being sold to investors. The review identified several factors contributing to the problem, including insufficient resources devoted to anti-fraud work, an absence of automated procedures to alert personnel to fraud indicators, and inadequate training on fraud awareness and prevention. The 2008 review warned: "Exposure is considerable and immediate corrective action is essential in order to limit or avoid considerable losses, reputation damage, or financial statement errors." |454|
The Subcommittee uncovered an instance in 2007 in which WaMu securitized certain types of loans that it had identified as most likely to go delinquent, but did not disclose its analysis to investors who bought the securities. Investors who purchased these securities without the benefit of that analysis quickly saw the value of their purchases fall.
WaMu securitization agreements prohibited the bank from using an "adverse selection" process when including loans within a securitized pool. On March 22, 2007, WaMu filed a prospectus for WMALT Series 2007-OA3, in which Washington Mutual Bank and Washington Mutual Mortgage Securities Corp. co-sponsored a securitization of a $2.3 billion pool of Option ARM loans. In the section entitled, "Representations and Warranties Regarding the Mortgage Loans," the prospectus stated:
"Washington Mutual Mortgage Securities Corp. and Washington Mutual Bank, as applicable, used no adverse selection procedures in selecting the mortgage loans from among the outstanding adjustable rate conventional mortgage loans owned by it which were available for sale and as to which the representations and warranties in the mortgage loan sale agreement could be made." |455|
On the following page of the prospectus, under the section heading, "Criteria for Selection of Mortgage Loans," it stated:
"Each co-sponsor selected the mortgage loans it sold to the depositor from among its portfolio of mortgage loans held for sale based on a variety of considerations, including type of mortgage loan, geographic concentration, range of mortgage interest rates, principle balance, credit scores and other characteristics described in Appendix B to this prospectus supplement, and taking into account investor preferences and the depositor's objective of obtaining the most favorable combination of ratings on the certificates." |456|
WaMu emails and memoranda obtained by the Subcommittee indicate that, prior to assembling the loan pool used in the WMALT 2007-OA3 securitization, WaMu identified delinquency-prone Option ARM mortgages in its "Held for Investment" loan portfolio and transferred those loans to its portfolio of mortgages available for sale or securitization. WaMu then used its "Held for Sale" loan portfolio to select the loans for the loan pool used in the WMALT 2007-OA3 securitization. The prospectus provides a list of criteria used to select the loans in the WMALT 2007-OA3 loan pool, but omits any mention of the fact that some of the loans were selected using statistical analysis designed to identify Option ARM loans likely to go delinquent quickly. The internal emails demonstrate that WaMu selected delinquency-prone loans for sale in order to move risk from the bank's books to the investors in WaMu securities, and profit from its internal analysis, which was not available to the market.
On Thursday, September 14, 2006, John Drastal, then Senior Managing Director of WCC, sent David Beck, head of WaMu's Capital Markets Division, with copies to others, an email regarding "Tom Casey visit," with the importance marked "high." Tom Casey was then the Chief Financial Officer of Washington Mutual Bank. In the email Mr. Drastal relayed Mr. Casey's concern about WaMu's exposure to Option ARM loans:
"David,
"Tom just stopped by after the Lehman investor conference. He says equity investors are totally freaking about housing now. He asked how we could prepare for this. A few items….
"2. On the portfolio side, he asked about exposure on option ARMs. We talked about looking to potentially sell '06 production Option ARMs in portfolio. He even said looking at this quarter. I don't think that this is possible but we should look at what the credit composition of this product is and see if we can sell quickly if it's the right thing to do (see Nagle's message). He doesn't for[e]see a tainting issue if we are doing it for credit issues. Youyi, can you get me a collateral strat from the portfolio?" |457|
Three months later, on Wednesday, February 14, 2007, a WaMu portfolio analyst and trader, Michael Liu, sent an email to a senior official in WaMu's portfolio management department, Richard W. Ellson, with the subject line: "Option ARM MTA and Option ARM MTA Delinquency." The email included the abbreviations "MTA," which stands for "Monthly Treasury Average," and "PPD," which stands for "Payment Past Due." The email provided a description of Option ARM loans in WaMu's investment portfolio that were delinquent in the fourth quarter of 2006:
"Hi Rick,
"Attached is the spreadsheet with the total Option ARM MTA … and Option ARM MTA >=1 PPD summary. Some points for the Option ARM MTA >=1PPD:
- $105mm in Nonaccrual is between FICO 501-540.
- $222mm in Nonaccrual between LTV 61-80.
- CA [California] represents the greatest amount of Delinquency (1PPD, 2PPD, 3PPD, nonaccrual)[.]
- Loans originated in 2004 and 2005 represent the highest amount of 3 PPD and nonaccrual [.]" |458|
On the same day, Mr. Ellson forwarded the email to the Division Executive for Portfolio Management and Research, Youyi Chen, with the following comments:
"Youyi – attached is a description of the Option ARMs that were delinquent in the 2006q4 [fourth quarter]. You can see that it is very much a function of FICOs and Low Doc loans. We are in the process of updating the optimum pricing matrix. Mike did the work. Your comments are appreciated." |459|
Mr. Chen, in turn, forwarded the email to the head of WaMu's Capital Markets Division, David Beck. Mr. Chen's introductory comments indicated that the research had been performed in response to a question from WaMu Home Loans President David Schneider and was intended to identify criteria for the loans driving delinquencies in the Option ARM portfolio:
"This answers partially [David] Schneider's questions on break down of the option arm delinquencies.
"The details (1PPD tab) shows Low fico, low doc, and newer vintages are where most of the delinquency comes from, not a surprise." |460|
On the same day, February 14, Mr. Beck forwarded the entire email chain to David Schneider and WaMu Home Loans Risk Officer Cheryl Feltgen, adding his own view:
"Please review. The performance of newly minted option arm loans is causing us problems. Cheryl can validate but my view is our alt a (high margin) option arms [are] not performing well.
"We should address selling 1Q [first quarter] as soon as we can before we loose [sic] the oppty. We should have a figure out how to get this feedback to underwriting and fulfillment." |461|
Mr. Beck's message indicated that recently issued Option ARM loans were not performing well, and suggested selling them before the bank lost the opportunity. WaMu would lose the opportunity to sell those loans if, for example, they went delinquent, or if the market realized what WaMu analysts had already determined about their likelihood of going delinquent. Mr. Beck's email proposed selling the loans during the first quarter of the year, already six weeks underway, and "as soon as we can."
Four days later, on Sunday, February 18, Mr. Schneider replied to the email chain by requesting Ms. Feltgen's thoughts. Later that day, Ms. Feltgen responded with additional analysis and an offer to help further analyze the Option ARM delinquencies:
"The results described below are similar to what my team has been observing. California, Option ARMs, large loan size ($1 to $2.5 million) have been the fastest increasing delinquency rates in the SFR [Single Family Residence] portfolio. Although the low FICO loans have … higher absolute delinquency rates, the higher FICOs have been increasing at a faster pace than the low FICOs. Our California concentration is getting close to 50% and many submarkets within California actually have declining house prices according to the most recent OFHEO [Office of Federal Housing Enterprise Oversight] data from third quarter of 2006. There is a meltdown in the subprime market which is creating a ‘flight to quality'. I was talking to Robert Williams just after his return from the Asia trip where he and Alan Magleby talked to potential investors for upcoming covered bond deals backed by our mortgages. There is still strong interest around the world in USA residential mortgages. Gain on sale margins for Option ARMs are attractive. This seems to me to be a great time to sell as many Option ARMs as we possibly can. Kerry Killinger was certainly encouraging us to think seriously about it at the MBR [Monthly Business Review] last week. What can I do to help? David, would your team like any help on determining the impact of selling certain groupings of Option ARMs on overall delinquencies? Let me know where we can help. Thanks." |462|
As Chief Risk Officer in WaMu's Home Loans division, Ms. Feltgen pointed out some counterintuitive features of the latest delinquencies, noting that the fastest increases in delinquencies occurred in large loans and loans with high FICO scores. She also noted that the subprime meltdown had led to a "flight to quality," and that foreign investors still had a strong interest in U.S. residential mortgages, suggesting that WaMu might be able to sell its likely-to-go delinquent Option ARMs to those foreign investors. From her perspective as a risk manager, she urged selling "as many Option ARMs as we can."
Her email also indicated that the topic of selling more Option ARMs had come up during the prior week at the monthly business review meeting, in which WaMu CEO Killinger expressed interest in exploring the idea. |463| Finally, Ms. Feltgen offered help in analyzing the impact of selling "certain groupings of Options ARMs" on overall delinquencies. Removing those problematic loans from the larger pool of Option ARM loans in the bank's investment portfolio would reduce loan delinquencies otherwise affecting the value of the portfolio as a whole.
Mr. Schneider sent a second email at 11:00 at night that same Sunday providing instructions for moving forward:
"Let[']s do the following:
1. db [David Beck] - please select the potential sample portfolios - along the lines we discussed at the mbr [Monthly Business Review]
2. cf [Cheryl Feltgen] - please run credit scenarios
3. db - coordinate with finance on buy/sell analysis
4. db/cf – recommendation" |464|On Tuesday morning, February 20, 2007, Mr. Beck replied with additional analysis:
"Here's how I see this going.
"From the MBR [Monthly Business Review], my notes indicate two portfolios we discussed for sale; the 2007 high margin production (Jan and Feb so far) and the seasoned COFI book. |465|
"I will supply to Cheryl the loan level detail on both pools and the pricing assumptions for losses. Cheryl, you need to run scenario analysis and on losses versus pricing AND reserving assumptions. I can supply pricing assumptions but would like you to pull the ALLL [Allowance for Loan and Lease Losses] against these pools." |466|Later that day, Ms. Feltgen forwarded the email chain to her team, changing the subject line to read: "URGENT NEED TO GET SOME WORK DONE IN THE NEXT COUPLE DAYS: Option ARM MTA and Option ARM MTA Delinquency." Clearly, time was of the essence:
"See the attached string of emails. We are contemplating selling a larger portion of our Option ARMs than we have in the recent past. Gain on sale is attractive and this could be a way to address California concentration, rising delinquencies, falling house prices in California with a favorable arbitrage given that the market seems not to be yet discounting a lot for those factors. David Schneider has set a meeting for Friday morning with David Beck and me to hear our conclusions and recommendations. See the comments below about the information that we need to provide for this analysis. We will get the pools by tomorrow at the latest. We will need to coordinate with Joe Mattey and get input from him in order to make a judgment regarding the ALLL impact. ...
"In addition to the specific information that David Beck asks for, I would like your input on portions of the Option ARM portfolio that we should be considering selling. We may have a different view than David Beck's team as to the most desirable to sell and we should provide that input. Our suggestion, for instance, might include loans in California markets where housing prices are declining. There may be other factors.
"I will need to get from you by Thursday, February 22 end of day a summary of our conclusions and recommendations." |467|
A WaMu risk analyst, Robert Shaw, replied the same day and identified eight specific factors that were driving delinquencies in the Option ARM portfolio:
"Cheryl,
"I reviewed the HFI [Hold for Investment] prime loan characteristics that contributed to rising 60+ delinquency rates |468| between 1/06 - 1/07 [January 6 and 7]. The results of this analysis show that seven combined factors contain $8.3 billion HFI Option ARM balances which experienced above-average increases in the 60+ delinquency rate during the last 12 months (a 821% increase, or 10 times faster than the average increase of 79%). I recommend that we select loans with some or all of these characteristics to develop a HFS [Hold for Sale] pool.
"Below, I have listed the factors (layered), their percentage change in 60+ delinquency rate over the last 12 months, and HFI balances as of January 2007. |469|
"1) HFI Option ARMs – 79% increase (.56% to 1.0%), $60.6 billion
2) Above + Vintages 2004-2007 – 179% increase (.33% to .92%), $47.8 billion
3) Above + CA – 312% increase (.16 to .66%), $23.7 billion
4) Above + NY/NJ/CT – 254% increase (.21 to .76%), $29.3 billion
5) Above + $351k-1mil – 460% increase (.12 to .70%), $17.2 billion
6) Above + FICO 700-739 – 1197% increase (.03% to .40%), $4.2 billion
7) Above + FICO 780+ - 1484% increase (.02% to .38%), $5.2 billion
8) Above + FICO 620-659 – 821% increase (.07 to .67%), $8.3 billion[.]" |470|Essentially, the eight factors identified Option ARMs that were in certain states, like California, had certain FICO scores or certain loan amounts, or were issued during the period 2004-2007.
Later that same day, Ms. Feltgen forwarded Mr. Shaw's email to Mr. Beck, Mr. Chen, and Mr. Ellson. Her email carried the subject line: "Some thoughts on target population for potential Option ARM MTA loan sale." She wrote:
"David, Youyi and Rick:
"My team and I look forward to receiving the loan level detail on the pools of Option ARMs we are considering for sale. I thought it might be helpful insight to see the information Bob Shaw provides below about the components of the portfolio that have been the largest contributors to delinquency in recent times. I know this is mostly an exercise about gain on sale, but we might also be able to accomplish the other purpose of reducing risk and delinquency at the same time. Talk to you soon." |471|
A week later, on Sunday, February 25, 2007, Mr. Beck sent an email with the subject heading, "HFI Option Arms redirect to HFS," to much of WaMu's top management, including Mr. Schneider, Mr. Rotella, Mr. Casey, as well as the FDIC Examiner-In-Charge Steve Funaro, and others. The email indicated that a decision had been made to sell $3 billion in recent Option ARM loans, with as many as possible to be sold before the end of the quarter, which was four weeks away:
"David [Schneider] and I spoke today. He's instructed me to take actions to sell all marketable Option Arms that we intend to transfer to portfolio in 1Q[first quarter], 2007. That amounts to roughly 3B [$3 billion] option arms availab[l]e for sale. I would like to get these loans into HFS [the Hold for Sale portfolio] immediately so that [I] can sell as many as possible in Q1.
"John [Drastal], we are only targeting to sell Option Arms destined for portfolio since year end at this point. I'll need direction from you on any special accounting concerns or documentation you will need to get these loans in the warehouse without tainting the HFI [Hold for Investment] book. |472|
"Michelle, I believe this action requires MRC [Market Risk Committee] approval. Please advise.
"This week I'll work to get the necessary governance sign offs in place. Cheryl, please direct me on what form the approval request should take and what committees should review and authorize the request. I can pull all of the data.
"We continue to work with Cheryl and the credit risk team to analyze emerging credit risks in our prime portfolio and recommend actions to mitigate them.
"Thanks for your help,
DJB" |473|Two days later, on Tuesday, February 27, 2007, Mr. Chen sent an email with the subject line, "HFI selection criteria changes," to Michelle McCarthy, who was head of WaMu's Market Risk Management department |474| as well as chair of both its Market Risk Committee and Asset Liability Committee. |475| The email was copied to Mr. Beck, Ms. Feltgen and others, and showed that the implementation of the plan was underway:
"After careful review with David and the teams, David suggested me to make the following recommendations to MRC [Market Risk Committee] on the existing prime HFI/HFS selection criteria
"1. Effective March 7th 2007, modify the portfolio option ARM and COFI ARM retention criteria (see attached ‘existing HFI descriptions', ‘section 1.01 to 1.11 and section 2.01 to 2.08') to include only following loans for the portfolio (HFI)
a. Super jumbo of size greater or equal to $ 3 MM (Risk based pricing applied, but difficult to sale)
b. Advantage 90 (high LTV loans without MI, very little production as 80/10/10 gets popularity)
c. Foreign Nationals (Risk based pricing applied, but difficult to sale due to FICO problems)
d. FICO less than 620, except employee loans in which case FICO can be restated after closing.
e. 3-4 units (excessive S & P level hit calls for portfolio execution)"2. Further more, we would like to request, transferring from HFI to HFS, all the MTA option ARMs and COFI ARMs, funded or locked between January 1st, 2007 to Mach [sic] 7th, 2007, and DO NOT fit the criteria listed above, and DO NOT fit the criteria section 3.02 to 4.07 in the attached ‘existing HFI descriptions')
"As a result of this change, we expected to securitize and settle about $ 2 billion more option/COFI ARMs in Q1-07 (mostly margin greater than 295), and going forward $ 1 billion per month potential incremental volume into HFS. For your information, the impact to gain on sale for the year is estimated to be about $180 MM pretax based on current market, and the impacts to 2007 portfolio NII is estimated to be about - $ 80 MM pretax.
"Also included in the attachment, is a pool of $1.3 billion option/COFI ARMs funded to portfolio between January 1st and February 22nd that will be re-classified as HFS based on the above recommendations. We understand that this population of loans will be growing from now to March 7th until the portfolio selection criteria are officially modified.
"We expected to start marketing the deal on March 12th, your prompt response will be greatly appreciated as the TSG [Technology Solutions Group] and QRM [Quantitative Risk Management] teams also need time to implement the coding changes." |476|
This email proposed several significant changes to WaMu's treatment of its Option ARMs. First, WaMu decided to require most of its Option ARMs to go directly into its Hold for Sale portfolio instead of going into its Held for Investment portfolio. In light of its analysis that Option ARM loans were rapidly deteriorating, the bank no longer wanted to treat them as investments it would keep, but immediately sell them. Second, the only Option ARMs that it would automatically direct into its investment portfolio were those that the bank considered to be so obviously of poor quality that they were "non-salable," according to another internal email. |477| Third, WaMu proposed transferring all Option ARM loans originated in 2007 from the investment portfolio to the sale portfolio. Since these three changes in how WaMu would treat its Option ARMs had compliance, accounting, and tax consequences, they had to be approved by the Market Risk Committee. That Committee was composed of senior risk officers throughout the bank as well as senior managers in the bank's finance, treasury, and portfolio management departments. The email indicated that the changes needed to be implemented within about a week so that marketing of some of the Option ARMs could begin by March 12.
On March 9, 2007 the Market Risk Committee met and approved the Option ARM proposal. The minutes of that meeting describe the changes that had been proposed:
"- Change the Held for Investment (HFI) ARM and COFI ARM retention criteria to include only the following loans for HFI effective March 12, 2007; Super jumbo ≥ $3.0 million, Advantage 90, Foreign Nationals, FICO < 620 except employee loans in which case FICO can be re-stated after closing, and 3 to 4 units.
- Increase Prime Option ARM's (including Second Liens) from $26.0 billion to $37.0 billion.
- Transfer up to $3.0 billion of saleable Option ARM and COFI ARM loans originated between January 1, 2007 and March 12, 2007 from HFI to HFS (excluding HFI loans described above)." |478|The minutes also recorded an exchange between Ms. McCarthy and another Committee member, Mr. Woods, who was the Chief Financial Officer of WaMu's Home Loans division:
"A second part of the proposal requests approval to transfer up to $3.0 billion of saleable Option ARM and COFI ARM loans originated since January 1, 2007 from HFI to Held for Sale (HFS). In response to a question from Mr. Woods, Ms. McCarthy explained that there are other Option ARM loans not included in the criteria that we are retaining in portfolio. Ms. McCarthy noted that Ms. Feltgen ha[d] reviewed and approved this proposal. Mr. Woods noted that Deloitte has reviewed the proposal as well." |479|
This exchange acknowledges that not all of the saleable Option ARM loans were diverted from the HFI to the HFS portfolio. WaMu chose to keep some Option ARMs and make other Option ARMs available for sale. The internal WaMu documents and communications reviewed by the Subcommittee strongly suggest that the decision to transfer the most recently originated Option ARMs from the Held-for-Investment portfolio to the Held-for-Sale portfolio was part of an effort to sell loans thought to be prone to delinquency, before they became delinquent. None of the hearing witnesses recalled how these loans were specifically selected for securitization, nor did any deny that they may have been selected for their propensity toward delinquency. |480|
The Subcommittee investigation determined that WaMu carried out the plan as approved, and transferred at least $1.5 billion Option ARMs originated in the first quarter of 2007, from the HFI to HFS portfolio. Of these loans, about 1,900 with a total value of a little over $1 billion were assembled into a pool and used in the WMALT 2007-OA3 securitization in March 2007. |481| WMALT 2007-OA3 securities were issued with WaMu as the sole underwriter and sold to investors. |482|
None of the materials associated with the sale of the WMALT 2007-OA3 securities informed investors of the process used to select the delinquency-prone Option ARMs from WaMu's investment portfolio and include them in the securitization. |483| Nor did WaMu inform investors of the internal analysis it performed to identify the delinquency-prone loans. Senator Levin questioned Mr. Beck about this point at the April 13 Subcommittee hearing:
Senator Levin. When you said that investors were told of the characteristics of loans, they were told of all the characteristics of loans. Did they know, were they informed that loans with those or some of those characteristics had a greater propensity towards delinquency in WaMu's analysis? Were they told that?
Mr. Beck. They were not told of the WaMu analysis. |484|
Predictably, the securitization performed badly. Approximately 87% of the securities received AAA ratings. |485| Within 9 months, by January 2008, those ratings began to be downgraded. |486| As of February 2010, more than half of the loans in WMALT Series 2007-OA3 were delinquent, and more than a quarter were in foreclosure. |487| All of the investment grade ratings have been downgraded to junk status, and the investors have incurred substantial losses.
Washington Mutual had longstanding relationships with a number of government sponsored enterprises (GSEs), including the Federal National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage Corporation (Freddie Mac). |488| Between 2000 and 2008, Washington Mutual sold over $500 billion in loans to Fannie Mae and Freddie Mac, accounting for more than a quarter of every dollar in loans WaMu originated. |489| While the majority of those loans involved lower risk, fixed rate mortgages, WaMu also sold Fannie and Freddie billions of dollars in higher risk Option ARMs.
Relationships with Fannie and Freddie. Fannie Mae and Freddie Mac purchase residential mortgages that meet specified underwriting standards and fall below a specified dollar threshold, so-called "conforming loans." They often enter into multi-year contracts with large mortgage issuers to purchase an agreed-upon volume of conforming loans at agreed-upon rates. Prior to 2005, Washington Mutual sold most of its conforming loans to Fannie Mae, with relatively little business going to Freddie Mac. |490| From at least 1999 through 2004, WaMu sold those loans to Fannie Mae through a long term "Alliance Agreement," |491| that resulted in its providing more than 85% of its conforming loans to Fannie Mae. |492| In 2004, WaMu calculated that it "contributed 15% of Fannie Mae's 2003 mortgage business," |493| and was "Fannie Mae's 2nd largest provider of business (behind Countrywide)." |494| Among the advantages that WaMu believed it gained from its relationship with Fannie Mae were help with balance sheet management, underwriting guidance, and support for WaMu's Community Reinvestment Act initiatives. |495|
The following slide, created by Washington Mutual in March 2004, provides an overview of the GSEs' impact on the mortgage market at the time as well as the status of WaMu's relationship with Fannie Mae in early 2004. |496|
Despite Fannie Mae's long history with WaMu, in 2005, the bank made a major change and shifted the majority of its conforming loan business to Freddie Mac. WaMu made the change in part because its long term contract with Fannie Mae was up for renegotiation, |497| and Freddie Mac offered better terms. According to WaMu, Freddie Mac had purchased $6 billion of its Option ARM loans in 2004, without a contract in place, and WaMu wanted to sell more of those loans. |498| WaMu conducted detailed negotiations with both firms that lasted more than six months. |499| Internally, it considered a number of issues related to switching the majority of its conforming loans to Freddie Mac. |500| The deciding factor was Freddie Mac's offer to purchase 100% of WaMu's conforming Option ARM mortgages which were among the bank's most profitable loans. |501| In January 2005, in a document comparing the proposals from Fannie and Freddie, WaMu wrote:
"The Freddie Mac Business Relationship [proposal] dated 12/21/2004 establishes another execution opportunity that diversifies WaMu's execution risk and confers material financial benefits for the Option ARM product. The key to the Freddie proposal is that it provides significant liquidity for our Option ARM originations, with more advantageous credit parameters, competitive g-fees and preferred access to their balance sheet relative to our current agreement with Fannie. Fannie has made it very clear to us that we should not expect to retain the same pricing and credit parameters for Option ARMs in our 2005 pricing agreement that we have enjoyed during 2004. For fixed rate loans and hybrids, gfe[ e]s adjusted for MAP Pricing and credit parameters are roughly equivalent to the Fannie Agreement." |502|
In April 2004, at the conclusion of its negotiations with Fannie and Freddie, WaMu entered into a one-year contract with Freddie Mac, switching the lion's share of the bank's conforming loans to that company and away from Fannie Mae. |503| According to WaMu, Freddie Mac's share of its conforming loans "went from 20% in Q1 [first quarter of 2005] to 81% in Q2 [second quarter of 2005]." |504| WaMu reported internally that, as a result of the new contract, it became the second largest seller of mortgages to Freddie Mac behind Wells Fargo, and that "[f]orty percent of FRE's [Freddie Mac's] portfolio growth in '05 can be attributed to WM's $8 billion sale of option ARMS." |505|
As the 2005 contract's expiration date neared, WaMu developed a list of issues to be negotiated with Freddie Mac for a new contract, noting that Freddie Mac "does not want to be a ‘one-year' wonder." |506| WaMu also observed that "FRE is not likely to outbid FNM by such a wide margin on option ARMS like in the current contract." |507| In a list of "asks … to cement our relationship" with Freddie Mac, WaMu indicated, among other issues, that it would press Freddie Mac to buy more subprime and "lower quality loans":
- Credit...
- WM [WaMu] wants FRE [Freddie Mac] to expand the eligibility of lower quality loans to ensure WM is ‘market competitive'. …
- Non-prime
- Potential securitization of SMF [Specialty Mortgage Finance] assets ($1.5 -$10 bil) that will create liquidity for WM and create a positive affordability profile for FRE;
- Expansion of credit profile into subprime; (Keith Johnson wants to keep this point very general); …
- Liquidity – we want to understand how we can best help the FRE portfolio w/Product.
- Longer term portfolio commitment on option ARMS;
- Broader deliverability guidelines w/respect to option ARMs." |508|
WaMu wrote that it also expected Freddie Mac to discuss trends related to accepting "lower documentation standards." |509|
In April 2006, WaMu signed a new, two-year contract with Freddie Mac, again agreeing to sell the majority of its conforming loans to that company. |510| WaMu President Steve Rotella wrote: "Congratulations to the team for getting this done and with terrific results for the company." |511| In a document describing the "highlights" of the new agreement, a Wamu employee wrote:
"Aligns WM with the stronger GSE over the next 12-18 months; we fully expect once FNM [Fannie Mae] gets its financial house in order to become a very aggressive competitor – just when this contract is coming up for renewal." |512|
WaMu's reference to the "stronger GSE" was in response to accounting scandals that, over the prior year, had weakened both Freddie Mac and Fannie Mae. In 2003, Freddie Mac announced that it had misstated its earnings by at least $4.5 billion, mostly by under-reporting its earnings in order to smooth the volatility of its quarterly earnings reports, and would be restating its earnings for the prior three years. |513| Later that year, Freddie Mac paid a $125 million civil fine to settle civil charges of accounting fraud brought by its regulator, the Office of Federal Housing Enterprise Oversight (OFHEO). |514| In September 2004, OFEHO issued a report finding that Fannie Mae had also violated accounting rules to smooth its earnings reports. |515| Fannie Mae later filed a $6.3 billion restatement of earnings and paid a $400 million fine. |516| Both GSEs also changed their senior management.
When asked at the Subcommittee hearing to define Washington Mutual's relationship with Fannie Mae and Freddie Mac, Mr. Rotella provided the following response:
"Well, like all big mortgage lenders, Senator, Fannie Mae and Freddie Mac were important .... [T]here was a substantial amount of production that was sold off to either Fannie or Freddie. ... [A]ny mortgage lender that is in the mortgage business, given the government advantages and the duopoly that Fannie and Freddie had, needed to do business with them. It would be very difficult to be a mortgage player without them." |517|
Loan Sales to Fannie and Freddie. During the years examined by the Subcommittee, WaMu sold a variety of loans to both Fannie Mae and Freddie Mac, including 15, 20, and 30- year fixed rate mortgages; Option ARMs; interest-only ARMs; and hybrid ARMs. |518|
A September 2005 chart prepared by WaMu, identifying the loans it sold to Fannie Mae and Freddie Mac during the first part of that year, details the types and volumes of loans involved. |519| The chart showed, for example, that the largest category of loans that WaMu sold to Fannie and Freddie at that point in 2005 was fixed rate loans, which together totaled nearly 140,000 loans with a collective, total loan amount of about $24.3 billion. |520| The next largest category of loans was Option ARMs, which WaMu sold only to Freddie Mac and which consisted of 35,421 loans with a total loan amount of about $7.9 billion. |521| The third largest category was interest-only ARMs, totaling about 8,400 loans with a total loan amount of about $2 billion. |522| The fourth largest category was hybrid ARMs, totaling 6,500 loans with a total loan amount of about $1.4 billion. |523| WaMu also sold other loans to Fannie and Freddie which included 6,020 loans of various types bearing a total loan amount of about $2 billion. |524|
The chart showed that, altogether by September 2005, WaMu had sold Fannie and Freddie about 196,000 loans with a total loan amount of $36.5 billion. |525| About 70% were fixed rate loans; |526| about 20% were Option ARMs; |527| and other types of loans made up the final 10%. In addition to those single family mortgages, WaMu had an active business with Fannie and Freddie regarding loans related to multifamily apartment buildings. |528| The 2005 loan data indicates that WaMu sold twice as many loans to Fannie and Freddie as it did to all other buyers combined. |529| Most of those loans were fixed rate mortgages, but they also included the higher risk Option ARMs. In 2005, for example, WaMu sold three times as many Option ARMs to Freddie Mac than to all of its other buyers combined. |530|
The amount and variety of the loans that WaMu sold to the GSEs fluctuated over time. For example, the following chart, which is taken from data compiled by Inside Mortgage Finance, presents the total dollar volume of loans sold by WaMu to Fannie and Freddie from 2000 until 2008 when WaMu was sold, as well as the percentage those loans represented compared to WaMu's total loan originations. |531|
Source: Inside Mortgage Finance
Year
Sold to Freddie Mac (in billions)
Sold to Fannie Mae (in billions)
Percent of Total WaMu Originiations Sold to GSEs
2000
$ 0
$ 7.1
14 %
2001
$ 1.4
$ 35.3
20 %
2002
$ 0.2
$ 95.7
29 %
2003
$ 2.2
$ 174.3
40 %
2004
$ 1.1
$ 25.9
10 %
2005
$ 34.6
$ 20.3
20 %
2006
$ 32.3
$ 11.2
23 %
2007
$ 31.8
$ 8.2
29 %
2008
$ 20.8
$ 2.1
70 %
TOTAL
$ 124.4
$ 380.1
27.3 %
The data indicates that, in total, WaMu sold more than half a trillion dollars in loans to the two GSEs in the nine years leading up to the bank's collapse, accounting for more than a quarter of all of the loans WaMu originated.
The documents obtained by the Subcommittee indicate that, from 2004 to 2008, Fannie Mae and Freddie Mac competed to purchase billions of dollars in WaMu's residential mortgage loans, and WaMu used that competition to negotiate better terms for its loan sales. Twice during that period, WaMu successfully played one GSE off the other to sell more high risk Option ARM loans under better terms to Freddie Mac.
Notes
416. See 6/11/2007 chart entitled, "Rate of Growth Exceeds the Industry," JPM_WM03409860, Hearing Exhibit 4/13- 47c. [Back]
417. 6/2008 "WaMu Wholesale Specialty Lending Securitization Performance Summary," JPM_WM02678980, Hearing Exhibit 4/13-45. [Back]
418. 10/17/2006 "Option ARM" draft presentation to the WaMu Board of Directors, JPM_WM02549027, Hearing Exhibit 4/13-38 (see chart at 2). See also 8/2006 "Option ARM Credit Risk," WaMu presentation, at JPM_WM00212644, Hearing Exhibit 4/13-37 (see chart at 5). [Back]
419. See chart in section E(4), below, using loan data from Inside Mortgage Finance. [Back]
. See 6/11/2007 chart entitled, "Rate of Growth Exceeds the Industry," JPM_WM03409860, Hearing Exhibit 4/13- 47c. [Back]
421. Id. WaMu attributed its rapid rise in the issuer rankings over the three-year period to its establishment of a Conduit Program, which began buying loans in bulk in 2004. Id. [Back]
422. See 12/15/2006 Enterprise Risk Management Committee, JPM_WM02656967. See also 10/25/2006 Asset- Liability Management Committee Meeting Agenda, JPM_WM02406624. [Back]
423. See 6/2008 "WaMu Wholesale Specialty Lending Securitization Performance Summary," JPM_WM02678980, Hearing Exhibits 4/13-45 and 46; 6/11/2007 chart entitled, "WaMu Capital Corp Sole/Lead Underwriter," JPM_WM03409861, Hearing Exhibit 4/13-47c. [Back]
424. See, e.g., undated "List of WaMu-Goldman Loans Sales and Securitizations," Hearing Exhibit 4/13-47b; 2/2007 internal WaMu email chain, JPM_WM00652762. [Back]
425. See 6/11/2007 chart entitled, "Capital Markets Division Growth," JPM_WM03409858, Hearing Exhibit 4/13- 47c. [Back]
427. Subcommittee interview of David Beck (3/2/2010). [Back]
429. See 6/11/2007 chart entitled, "Capital Markets Division Growth," JPM_WM03409858, Hearing Exhibit 4/13- 47c. [Back]
432. Subcommittee interview of David Beck (3/2/2010). [Back]
434. April 13, 2010 Subcommittee Hearing at 53. Washington Mutual Mortgage Securities Corp. (WMMSC) and WaMu Asset Acceptance Corp. (WAAC) served as warehouse entities that held WaMu loans intended for later securitization. Mr. Beck explained in his prepared statement: "WMMSC and WAAC purchased loans from WaMu, and from other mortgage originators, and held the loans until they were sold into the secondary market. WCC was a registered broker-dealer and acted as an underwriter of securitization deals for a period of time beginning in 2004 and ending in the middle of 2007. In addition to buying and selling mortgage loans, WMMSC acted as a ‘master servicer' of securitizations. The master servicer collects and aggregates the payments made on loans in a securitized pool and forwards those payments to the Trustee who, in turn, distributes those payments to the holders of the securities backed by that loan pool." Id. at 163. [Back]
435. See 6/11/2007 chart entitled, "Origination Through Distribution," JPM_WM03409859, Hearing Exhibit 4/13- 47c; Subcommittee interview of David Beck (3/2/2010). [Back]
436. See 3/2007 Washington Mutual Inc. 10-K filing with the SEC, at 45 (describing securitization process). [Back]
437. See "LBMC 2005-2 Structure" and "LBMC 2005-2 Cash Flow Waterfall," FDIC_WAMU_000012358-59, Hearing Exhibit 47a. [Back]
438. Undated "List of WaMu-Goldman Loans Sales and Securitizations," Hearing Exhibit 4/13-47b. [Back]
440. 3/24/2005 email from Kevin Gasvoda of Goldman Sachs to Christopher Gething, others, Hearing Exhibit 4/27- 167b. [Back]
441. 4/14/2005 email from Steve Blelik to David Henry, "Fitch – LBMC Review," Hearing Exhibit 4/13-8a. [Back]
443. 4/19/2006 "ABX Index – The Constituent Breakdown," prepared by Nomura Securities International Inc., http://www.scribd.com/doc/19606903/Nomura-ABX-Index-The-Constituent-Breakdown. [Back]
444. 11/7/2006 email from David Beck to David Schneider, Hearing Exhibit 4/13-50. See also 4/19/2006 "ABX Index – The Constituent Breakdown," prepared by Nomura Securities International Inc., http://www.scribd.com/doc/19606903/Nomura-ABX-Index-The-Constituent-Breakdown. [Back]
445. "WaMu subprime ABS delinquencies top ABX components," Reuters (3/27/2007), Hearing Exhibit 4/13-52. [Back]
446. 7/10/2007-7/12/2007 excerpts from Standard & Poor's and Moody's Downgrades, Hearing Exhibit 4/23-99. [Back]
447. 7/12/2007 "Moody's Structured Finance Teleconference and Web Cast: RMBS and CDO Rating Actions," MOODYS-PSI2010-0046902, Hearing Exhibit 4/23-106. [Back]
448. See Standard and Poor's data at www.globalcreditportal.com. [Back]
449. See, e.g., wamusecurities.com (subscription website maintained by JPMorgan Chase with data on Long Beach and WaMu mortgage backed securities showing, as of March 2011, delinquency rates for particular mortgage backed securities, including LBMLT 2006-1 – 58.44%; LBMLT 2006-6 – 60.06%; and LBMLT 2005-11 – 54.32%). [Back]
450. 2/2/2008 email from David Beck to David Schneider and others, JPM_WM02445758, Hearing Exhibit 4/13-51. [Back]
451. As of December 2010, the total loan delinquency rate of the WMALT 2007-OC1 series was 57.37%. See wamusecurities.com. [Back]
452. See 3/1/2007 Washington Mutual Inc. 10-K filing with the SEC, at 82, 87. [Back]
453. 9/8/2008 "Risk Mitigation and Mortgage Fraud 2008 Targeted Review," WaMu Corporate Credit Review, JPM_WM00312502, Hearing Exhibit 4/13-34. [Back]
455. 3/22/2007 WaMu Prospectus Supplement, "Washington Mutual Mortgage Pass-Through Certificates, WMALT Series 2007-OA3," at S-102, Hearing Exhibit 4/13-86b. [Back]
457. 9/14/2006 email from John Drastal to David Beck, with Youyi Chen and Doug Potolsky copied, "Tom Casey visit," Hearing Exhibit 4/13-40a. [Back]
458. 2/2007 WaMu internal email chain, Hearing Exhibit 4/13-40b. [Back]
463. At the end of 2006, WaMu held about $63.5 billion in Option ARM mortgages, then comprising about 28% of its investment portfolio. See 3/2007 Washington Mutual Inc. 10-K filing with the SEC, at 52. [Back]
464. 2/2007 WaMu internal email chain, Hearing Exhibit 4/13-40b. [Back]
465. Option ARMs were considered a "high margin" product within WaMu, because they produced a relatively high gain on sale when sold. See 4/18/2006 Washington Mutual Home Loans Discussion Board of Directors Meeting, at JPM_WM00690894, Hearing Exhibit 4/13-3 (chart showing gain on sale margin by product). "COFI" stands for "Cost of Funds Index" which is an index used to set variable interest rates. "Seasoned" means the loans are older production. [Back]
466. 2/2007 WaMu internal email chain, Hearing Exhibit 4/13-40b. [Back]
468. A "60+ delinquency rate" applies to loans in which a payment is late by 60 days or more. [Back]
469. 2/2007 WaMu internal email chain, Hearing Exhibit 4/13-40b. [Back]
470. 2/20/2007 email from Robert Shaw to Cheryl Feltgen, Hearing Exhibit 4/13-41. [Back]
471. 2/20/2007 email from Cheryl Feltgen to David Beck, Youyi Chen, and Richard Ellson, Hearing Exhibit 4/13-41. [Back]
472. Loans in a bank's Hold for Investment portfolio receive different accounting treatment than loans in the bank's Hold for Sale portfolio, and generally accepted accounting principles (GAAP) frown upon frequent transfers between the two portfolios. The GAAP principles were a key reason for Mr. Beck's instruction that the transfer of the Option ARM loans from WaMu's HFI to HFS portfolios proceed "without tainting the HFI book." [Back]
473. 2/25/2007 email from David Beck to himself, David Schneider, Steve Rotella, Ron Cathcart, Tom Casey, Cheryl Feltgen, others, Hearing Exhibit 4/13-42b. [Back]
474. 12/28/2007 WaMu internal report, "Disclosure Management," JPM_WM02414318. [Back]
475. 3/9/2007 WaMu Market Risk Committee Meeting Minutes, Hearing Exhibit 4/13-43. [Back]
476. 2/27/2007 email from Youyi Chen to Michelle McCarthy, with copies to David Beck, Cheryl Feltgen, Steve Fortunato, and others, "HFI selection criteria changes," Hearing Exhibit 4/13-42a [emphasis in original]. [Back]
477. 2/27/2007 email from Youyi Chen to David Griffith, "Option ARM," JPM_WM03117796 ("David, we sell all 295+ margin and other OA and COFI, and KEEP the 4 categories going forward due mostly to non-salable reasons."). [Back]
478. 3/9/2007 WaMu Market Risk Committee Meeting Minutes, Hearing Exhibit 4/13-43. [Back]
480. Mr. Schneider and Mr. Beck were asked about this matter at the hearing. See April 13, 2010 Subcommittee Hearing at 75-82. [Back]
481. 4/10/2010 Subcommittee email from Brent McIntosh, Sullivan & Cromwell LLP, Counsel for JPMorgan Chase [Sealed Exhibit]. [Back]
482. 3/22/2007 WaMu Prospectus Supplement, "Washington Mutual Mortgage Pass-Through Certificates, WMALT Series 2007-OA3," at S-102, Hearing Exhibit 4/13-86b. [Back]
483. See, e.g., id. See also April 13, 2010 Subcommittee Hearing at 80. [Back]
484. April 13, 2010 Subcommittee Hearing at 82. [Back]
485. 4/11/2007 "New Issue: Washington Mutual Mortgage Pass-Through Certificates WMALT Series 2007-OA3 Trust," S&P's Global Credit Portal, www.globalcreditportal.com. [Back]
486. See 1/14/2008 "Moody's takes negative rating actions on certain WaMu Option Arm deals issued in 2007," Moody's, http://www.moodys.com/viewresearchdoc.aspx?lang=en&cy=global&docid=PR_147683. [Back]
487. "Select Delinquency and Loss Data for Washington Mutual Securitizations," chart prepared by the Subcommittee, Hearing Exhibit 4/13-1g. [Back]
488. See 9/29/2005 "GSE Forum," internal presentation prepared by WaMu, Hearing Exhibit 4/16-91 at JPM_WM02575608. As mentioned earlier, GSEs are Congressionally chartered, nongovernment owned financial institutions created for public policy purposes. At the time of the financial crisis, the GSEs included Fannie Mae, Freddie Mac, the Government National Mortgage Association (Ginnie Mae), and the Federal Home Loan Bank System (FHLBS), all of which were created by Congress to strengthen the availability of capital for home mortgage financing. [Back]
489. See chart, below, using loan data from Inside Mortgage Finance. [Back]
490. See 4/12/2004 "Pre-Meeting for Fannie Mae," internal presentation prepared by WaMu, at JPM_WM02405463, Hearing Exhibit 4/16-86 ("At current level, alternative executions, e.g., Freddie Mac, FHLB, and private investors, do not win a significant level of business."). [Back]
491. See 4/12/2004 "Pre-Meeting for Fannie Mae," internal presentation prepared by WaMu, at JPM_WM02405462, Hearing Exhibit 4/16-86 (chart entitled, "Timeline of the Alliance Agreement"). [Back]
492. See 4/12/2004 "Pre-Meeting for Fannie Mae," internal presentation prepared by WaMu, at JPM_WM02405461, Hearing Exhibit 4/16-86 ("Under this Alliance Agreement with Fannie Mae, WaMu has agreed to deliver no less than 75% of eligible, conforming loans to Fannie Mae."); 2/23/2005 email exchange between David Beck and WaMu executives, Hearing Exhibit 4/16-85 ("5 years of 85%+ share with Fannie"). [Back]
. 4/12/2004 "Pre-Meeting for Fannie Mae," internal presentation prepared by WaMu, at JPM_WM02405459, Hearing Exhibit 4/16-86. [Back]
494. Id. at JPM_WM02405467, Subcommittee Hearing Exhibit 4/16-86. [Back]
495. Id. at JPM_WM02405461, Subcommittee Hearing Exhibit 4/16-86. The Community Reinvestment Act (CRA) was passed by Congress to encourage banks to make loans in low- and moderate-income neighborhoods. See website of the Federal Financial Institutions Examination Council, "Community Reinvestment Act," http://www.ffiec.gov/cra/history.htm. Regulators, including the Office of Thrift Supervision, periodically reviewed banks' CRA activities and took them into account if a bank applied for deposit facilities or a merger or acquisition. Id. A 2005 presentation prepared by WaMu stated that its relationship with Freddie Mac helped the bank meet its CRA goals by purchasing more than $10 billion in qualifying loans. See 9/29/2005 "GSE Forum," presentation prepared by WaMu Capital Markets, at JPM_WM02575611, Hearing Exhibit 4/16-91. Between 1991 and 2006, WaMu was evaluated 20 times by OTS and the FDIC, achieving the highest possible CRA rating of "Outstanding" in each evaluation. See website of the Federal Financial Institutions Examination Council, ratings search for "Washington Mutual," http://www.ffiec.gov/craratings/default.aspx. Regulations state that an "outstanding" institution is one that not only meets the needs of its surrounding community, but utilizes "innovative or flexible lending practices." See 12 C.F.R. 345, Appendix A, http://www.fdic.gov/regulations/laws/rules/2000-6600.html#fdic2000appendixatopart345. [Back]
496. Id. at JPM_WM02405459, Subcommittee Hearing Exhibit 4/16-86. [Back]
497. See 4/12/2004 "Pre-Meeting for Fannie Mae," internal presentation prepared by WaMu, at JPM_WM02405468, Hearing Exhibit 4/16-86. [Back]
498. See, e.g., 2/23/2005 email exchange between David Beck and WaMu executives, Hearing Exhibit 4/16-85 (reporting that Freddie Mac was "very aggressive in 2004 buying 6B of option arm without a share agreement in place."). [Back]
499. See, e.g., 4/12/2004 "Pre-Meeting for Fannie Mae," internal presentation prepared by WaMu, Hearing Exhibit 4/16-86; 12/17/2004 email exchange among WaMu executives, "Risks/Costs to Moving GSE Share to FH [Freddie Mac]," JPM_WM05501399, Hearing Exhibit 4/16-88; 1/5/2005 "Business Relationship Proposal Issues," document prepared by WaMu, Hearing Exhibit 4/16-90 (describing multiple issues negotiated with both firms); 2/23/2005 email exchange between David Beck and WaMu executives, Hearing Exhibit 4/16-85 (David Beck wrote: "Fannie negotiated hard for our business especially in the 11th hour." CEO Killinger responded: "Good work David. It appears we got a good economic outcome and haven't burnt any bridges for the future."). [Back]
500. See 12/17/2004 email exchange among WaMu executives, "Risks/Costs to Moving GSE Share to FH [Freddie Mac]," at JPM_WM05501401, Hearing Exhibit 4/16-88 (listing multiple issues including whether Fannie Mae would "be less supportative [sic] of using their balance sheet to support our quarter-end liquidity needs"). [Back]
501. Id. at JPM_WM05501399 (describing Fannie Mae's offer to purchase two-thirds of WaMu's Option ARM production); 2/23/2005 email exchange between David Beck and WaMu executives, Hearing Exhibit 4/16-85 ("I reviewed the most recent proposals from Freddie and Fannie today with Steve. We agreed that the Freddie 65% minimum share (100% of option arms) proposal offers us between 26MM and 37MM of benefit depending on volume… 39% of our 2005 home loans gain on sale comes from conforming option arm sales. FH [Freddie Mac] stepped up with 21B of committed balance sheet and aggressive forward pricing for OA [Option ARMs] that result in the financial benefit over FN [Fannie Mae]."). WaMu originated both conforming and nonconforming Option ARMs, depending upon whether the loan exceeded the GSEs' dollar limit for the loans they would purchase. [Back]
502. 1/5/2005 "Business Relationship Proposal Issues," document prepared by WaMu, Hearing Exhibit 4/16-90. [Back]
503. See 7/5/2006 "Freddie Mac – WaMu Meeting," document prepared by WaMu, JPM_WM03200453, Hearing Exhibit 4/16-87 ("WM executed a majority share arrangement w/FRE [Freddie Mac], effective 4/1/05 thru 3/31/06; included in that arrangement was a market-leading opportunity to sell up to $21 billion of option ARMs to the FRE portfolio."). [Back]
507. Id. at JPM_WM03200453. [Back]
508. Id. at JPM_WM03200452-453 [italics in original omitted]. [Back]
509. Id. at JPM_WM03200454. [Back]
510. See 4/28/2006 email exchange between WaMu executives, JPM_WM02521921, Hearing Exhibit 4/16-89 (celebrating contract that "David Schneider signed today"). [Back]
513. See "Freddie Mac Raises its Estimate of Errors," Associated Press (9/26/2003). [Back]
514. See "Freddie to Settle with Fat Civil Fine," Associated Press (12/11/2003). In 2007, Freddie Mac paid an additional $50 million civil fine to the SEC to settle civil charges of securities fraud, without admitting or denying wrongdoing. "Freddie Mac to Pay $50 million," Associated Press (9/28/2007). [Back]
515. 9/17/2004 Office of Federal Housing Enterprise Oversight Report of Findings to Date, "Special Examination of Fannie Mae," available at http://www.fhfa.gov/Preview-FHFAWWW/webfiles/748/FNMfindingstodate17sept04.pdf. [Back]
516. See 2004 10-K filing with the SEC. Fannie Mae paid the $400 million civil fine in May 2006, to settle accounting fraud charges brought by OFHEO and SEC. See also "Fannie Settles Fraud Charges," National Mortgage News (5/29/2006). [Back]
517. April 13, 2010 Subcommittee Hearing at 105, Senator Coburn question to Mr. Rotella. [Back]
518. See 9/29/2005 "GSE Forum," internal presentation prepared by WaMu, at JPM_WM02575611, Hearing Exhibit 4/16-91 (chart entitled, "WaMu's Deliveries – Contract to Date 2005"). For more information on these types of loans, see Chapter II, above. WaMu did not sell loans directly to Ginnie Mae which, instead, guaranteed certain government backed mortgages when they were securitized by one of its approved securitizers. The WaMu chart showed that, in 2005, WaMu originated 35,291 loans with a total loan amount of about $4.6 billion that were securitized with Ginnie Mae guarantees. Id. [Back]
520. Id. The WaMu chart showed that WaMu sold 31,460 fixed rate loans with a total loan amount of about $5.2 billion to Fannie Mae, and 108,246 loans with a total loan amount of about $19.1 billion to Freddie Mac. [Back]
522. Id. The WaMu chart showed that WaMu sold 5,350 interest-only ARMs with a total loan amount of about $1.3 billion to Fannie Mae, and 3,016 interest-only ARMs with a total loan amount of $724 million to Freddie Mac. [Back]
523. Id. The WaMu chart showed that WaMu sold 3,250 hybrid ARMs with with a total loan amount of nearly $700 million to Fannie Mae, and 3,303 hybrid ARMs with a total loan amount of nearly $700 million to Freddie Mac. [Back]
524. Id. See chart for more detail. [Back]
525. Id. The chart showed that, altogether, WaMu sold about 45,000 loans with a total loan amount of $7.9 billion to Fannie Mae and 151,000 loans with a total loan amount of about $28.6 billion to Freddie Mac. [Back]
526. By loan number, the percentage is 71%; by loan amount, the percentage is 67%. [Back]
527. By loan number, the percentage is 18%; by loan amount, the percentage is 22%. [Back]
528. See, e.g., 4/12/2004 "Pre-Meeting for Fannie Mae," internal presentation prepared by WaMu, at JPM_WM02405461, JPM_WM02405467, Hearing Exhibit 4/16-86 (chart entitled, "Overview of the Alliance," and "WaMu was responsible for 34.7% of Fannie Mae's Multifamily business"). [Back]
529. See 9/29/2005 "GSE Forum," internal presentation prepared by WaMu, at JPM_WM02575611, Hearing Exhibit 4/16-91 (chart entitled, "WaMu's Deliveries – Contract to Date 2005"). During the same time period in 2005, WaMu sold about 99,000 loans with a total loan amount of about $35 billion to buyers other than Fannie and Freddie. The two largest categories of loans sold to buyers other than Fannie or Freddie were jumbo loans (43,758 loans with a total loan amount of $26.9 billion) and government backed loans sold to Ginnie Mae (35,291 loans with a total loan amount of $4.6 billion). Id. [Back]
530. Id. The chart indicates that WaMu sold over 17,000 loans with a total loan amount of nearly $4 billion to Freddie Mac, but only 5,841 Option ARMs with a total loan amount of $1.2 billion to all other buyers. It is possible, however, that the data on Option ARMs sold to other buyers is understated if some portion of the loans categorized on the chart as "jumbo" loans were, in fact, also Option ARMs. See, e.g., Id. at JPM_WM02575611, Hearing Exhibit 4/16-91 (interpretive note below chart); 8/2006 WaMu chart entitled, "WaMu Originations Product Mix," at JPM_WM00212644, Hearing Exhibit 4/13-37 (showing that WaMu used Option ARMs in both conforming and jumbo loans). In addition to selling Option ARMs to Freddie Mac and others, WaMu kept a portion of the Option ARMs it originated in its investment portfolio and securitized still others. [Back]
531. "Historical Data from Inside Mortgage Finance, Inside Mortgage Finance, www.imfpubs.com/data. [Back]
Back to Contents D. Shoddy Lending Practices F. Destructive Compensation Practices
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