Home Loan Hot Potato: Banks Unload Risky, Bad Credit Mortgages

Bad credit mortgages can hurt more than just borrowers.

We’ve outlined various cases where efforts by major banks and Wall Street firms to unload bad U.S. housing loans are speeding up a shakeout in the subprime mortgage industry.

Here’s a summary of the problem.

As more Americans fall behind on mortgage payments, Merrill Lynch & Co., J.P. Morgan Chase & Co., HSBC Holdings PLC and others are trying to force mortgage originators to buy back the same high-risk, high-return loans that the big banks eagerly bought in 2005 and 2006.

Merrill demanded in December that ResMae Mortgage Corp. - which in 2006 sold $3.5 billion in subprime mortgage loans, or loans to borrowers with poor credit records - buy back $308 million of loans whose borrowers had defaulted. In a filing this week for bankruptcy law protection, ResMae said those demands “crippled” its operations. The Brea, Calif., company said that repurchase requests were “severe and unexpected.”

As more subprime lenders face losses or bankruptcy, big banks also face another problem:

• Many lent money to small firms like ResMae so that those firms could make more home mortgage loans to borrowers. It isn’t clear how much of these loans will be paid back to the banks. Wall Street firms also are increasing their own internal generation of subprime loans by acquiring smaller mortgage loan originators or processing companies.

In 2005 and 2006, banks such as HSBC and brokerage firms like Merrill Lynch went on a buying spree, snapping up subprime loans from typically small mortgage banks that had lent money to home buyers. At the same time, many lenders were loosening their credit standards and making riskier bad credit home loans.

HSBC kept many of the loans, while Wall Street firms chopped the loans into pools sold to investors as mortgage-backed securities.

In recent months, as home-price appreciation fell and borrowers faced rising interest rates, more people defaulted on their mortgages. That prompted Merrill Lynch and others to exercise their contractual right to demand the sellers buy back the loans.

Under mortgage contracts, mortgage originators must often repurchase loans that default very early in their term or that come with underwriting mistakes, such as flawed property appraisals.

“Following early payment defaults, we exercised our contractual rights to return loans to ResMae and protect our financial interests,” a Merrill spokesman said. HSBC declined to comment. J.P. Morgan declined to comment.

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