Opening Statement of David Beck April 13, 2010
Permanent Subcommittee on Investigations
Senate Committee on Homeland Security & Governmental Affairs
Chairman Levin, Doctor Coburn, and members of the Permanent Subcommittee, my name is
David Beck. From April 2003 through September 2008 I worked at Washington Mutual Bank,
which I will call WaMu for the purposes of my testimony today. I appreciate the Subcommittee’s invitation to appear to discuss my experiences at WaMu. I hope that I can provide information that will assist the Subcommittee in its investigation of the causes and consequences of the financial crisis.
I understand that the Subcommittee is interested in various topics related to my work in WaMu’s
capital markets organization and to my role and responsibilities with respect to three WaMu
subsidiaries: WaMu Capital Corp., which was called “WCC”; WaMu Asset Acceptance Corp.,
which was called “WAAC”; and Washington Mutual Mortgage Securities Corp., which was
called “WMMSC” (pronounced “WIM-zic”). I also understand that the Subcommittee is
interested in learning about my role and responsibilities with respect to Long Beach Mortgage
Corporation, which was a separate subsidiary, first of Washington Mutual, Inc., then of WaMu.
My comments are organized along the lines provided in the Committee’s invitation to me.
An Overview of WMMSC, WAAC, and WCC
Like most other banks that originated mortgage loans, WaMu originated substantially more loans
than it could keep on its balance sheet for investment purposes. And so WaMu’s capital markets
organization managed WaMu’s overall strategy for selling mortgage loans that WaMu did not
retain on its books.
During the time that I was head of capital markets for WaMu, people who reported to me were
responsible for overseeing the entities that purchased and held loans that were to be sold into the
secondary market (WMMSC and WAAC, depending on the time period). 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, WMSSC 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. These distributions are made
in accordance with the terms of the securitization documents, and each securitization has detailed
rules setting out how loan payments are to be distributed to securities holders. The distribution
rules can be referred to as the “waterfall.”
WCC’s Structure and Operations
Sales of Mortgage-Backed Securities
As I mentioned, WCC was a registered broker dealer and acted as underwriter of securitization
transactions generally involving WMMSC or WAAC. In such instances, WMMSC or WAAC
would sell, or “deposit,” loans into a securitization trust in exchange for securities backed by the
loans in question. WMMSC or WAAC would then sell these securities to WCC as underwriter,
and WCC would sell the securities in the secondary market. As part of the underwriting process,
WCC conducted due diligence on the loans in the securitization loan pool through the use of
third-party due diligence providers. WCC conducted this diligence regardless of whether the
loans in question had been originated by WaMu or a third-party originator. The diligence
process generally involved the review of loan files for a statistically appropriate number of loans
to be pooled in each securitization trust. A portion of the reviewed loan files were selected at
random, while some were adversely selected based on various negative traits.
WCC sold mortgage-backed securities to a large variety of institutional investors including
hedge funds, mutual funds, commercial banks, insurance companies, pension funds, and the like.
In many instances, the individuals making the investment decision had long-term, hands-on
experience creating and selling mortgage-backed securities. The buyers were thus in a position
to be selective about the types of securities they would purchase based on their judgment,
specific investment needs and objectives. As a result, mortgage-backed securitization deals were
customized transactions. The loans included in a pool to support the securities as well as the
actual securities themselves were constructed based in part on negotiations with the initial
buyers, which often would express a desire for securities with specific credit ratings or
maturities, for example, or for the loan pools to fall within certain credit parameters or
Not surprisingly, different buyers are interested in acquiring different types of mortgage-backed
securities, and each makes its own decisions about whether to participate in any given
transaction based, for example, on:
- Institutional investment guidelines. Some buyers’ guidelines (or indentures orprospectuses) might allow the purchase of only AAA-rated securities. Others might be specifically focused on higher risk, higher-returning securities.
- A buyer’s current exposure to and appetite for different levels of credit risk. A buyer holding a significant amount of AAA-rated securities might be interested in taking on the additional credit risk, and the additional potential return, of lower-rated securities.
- The maturities of the securities being offered. Most buyers wanted to hold securities that provide cash flows matching their liabilities.
- The various risk concentrations of the loans in the securitization trust. A buyer with an investment strategy focused in low-FICO or high-LTV loans, for example, might not beinterested in a deal backed only by prime mortgages.
- The issuer involved in the transaction. Buyers often would seek to diversify their portfolio investments across the mortgage finance industry by holding mortgage-backed securities issued by different issuers off many different registration statements. Buyer interest in any given mortgage-backed securitization would also depend on the buyers’ existing leverage and capitalization; how the varying returns on equity different buyers could generate and were targeting might be affected by acquiring different types of assets; the buyers’ assessment of the market and economy; and other financial economic considerations. Given that buyers determine what to buy based on their unique interest in and assessment of a specific
securitization and of the market in general, the value of and interest in any given offering, and
the loans supporting that offering, would vary from buyer to buyer and from deal to deal. A deal supported by prime loans might be less valuable to a buyer with holdings already concentrated on lower risk loans than to other buyers. A security for a deal with very long final maturity might be less valuable to a buyer who needs shorter-term assets.
Potential buyers of mortgage-backed securities were given access to information about the
securities in question and about the characteristics of the loans underlying the securities. This
included not only the information in the prospectus supplement for each securitization (which
described the types of loans in the loan pool, the underwriting process, and the characteristics of
the borrowers and the security underlying the loans), but also a “loan tape” that included specific
information about the nature of each loan in the pool (borrower’s FICO score, loan-to-value
information, information about the loan type and terms, and the like). Investors also had access
to extensive information, released on a monthly basis, about the performance of prior
securitizations of loan pools made up of the same type of loan product. Investors could review
all of this information before deciding whether purchasing the particular offering would fit into
their overall investment strategy.
In general, WCC concentrated on underwriting securities backed by prime or Alt-A loans that
WaMu had originated or that WaMu or WMMSC had acquired from third-party originators. For
most of my time at WaMu, sales and securitizations of loans originated by Long Beach Mortgage
were done by Long Beach’s separate capital markets group. As a result, while WCC may have
participated as a “co-underwriter” in transactions involving the securitization of Long Beach
loans, any such deals generally would have been led by other underwriters such as RBS
Greenwich Capital, UBS Warburg, Credit Suisse First Boston and the like prior to mid to late
2006. WCC would have been the sole or lead underwriter of securities backed by Long Beach-
originated sub-prime loans only thereafter.
WCC also occasionally participated in whole loan transactions (in which a buyer would acquire
an entire group of loans rather than securities backed by a group of loans). WCC negotiated the
terms of and helped to close whole loan sales undertaken by whatever entity then owned the
loans in question. Typically, these were sales of WaMu-originated loans, though on occasion
WCC would participate in the sale of loans originated by third parties.
Whole loan purchasers were significant players in the financial services, real estate lending and
loan servicing industries. As a result, each bulk whole loan sale was in many ways a unique,
highly negotiated transaction. As with buyers of mortgage-backed securities, whole loan buyers
assess their needs based on their current portfolio of whole loans and target future risk profile.
Some may find themselves concentrated in certain product types or other risk characteristics and
want to buy different kinds of loans or loans to borrowers with different risk profiles (higher or
lower FICO scores or LTVs, for example). In any case, of course, buyers generally sought to
diversify their risk and maximize their risk-adjusted return.
As a natural part of considering whole loan sale transactions, WCC and others in the capital
markets organization were well positioned to help WaMu or WMMSC consider whether the best
execution of a loan sale involved a whole loan sale transaction or a securitization, with the
outcome depending on market demand, the needs and wants of interested buyers, and the like.
Of course, as I suggested earlier, in any given deal the assets in question are more attractive to
one of the parties than to the other, and that difference is in part what allows the deal to be done
in the first place. For example, a lender with a heavy investment concentration in one type of
loan product might be less interested in acquiring or holding loans of that type than a lender
without the same concentration. In such a case, the first lender might sell loans of that type to
the second and thus create opportunities for both.
Other Capital Markets Activities
WaMu engaged in hedging activities for various purposes. For example, WCC staff became
responsible in 2005 for hedging the interest rate risk associated with unsold mortgage-backed
security positions and with loans purchased in bulk for resale in the conduit program and held at
WMMSC. And personnel who worked for WaMu, not WCC, hedged (1) the interest rate risk on
loans that had not yet closed, but for which WaMu had made loan commitments; (2) closed loans
that were in a WaMu loan warehouse and awaiting sale; and (3) WaMu’s mortgage servicing
rights. These interest rate risks were hedged by purchasing various types of securities (including
mortgage-backed securities), swaps, options, and other derivatives. Importantly, neither WCC
nor WaMu was approved to trade in credit default swaps, and CDS were not used to bet against
the performance of mortgage-backed certificates that WCC sold.
Because WaMu’s capital markets organization was engaged in the secondary mortgage market, it
had ready access to information regarding how the market priced loan products on any given
day. Using this information, we determined the initial prices at which WaMu could offer loans
to consumers by adding to the then-applicable market prices for private or agency mortgage-
backed securities, the (1) cost to hedge the loan pipeline, (2) cost to sell to the secondary market
and (3) cost to service and value of servicing the loans. Home Loans personnel would develop
the prices at which they could offer loans to consumers by adding their own costs of origination
and a margin.
The Conduit Program
From time to time, WMMSC purchased from other loan originators loans that were then
included in WaMu-sponsored securitizations. The goal of this conduit program was to purchase
loans from various loan originators and pool them together to create a securitization that was
attractive to the secondary market. WCC’s role in such securitization transactions was the same
as in those WCC-underwritten deals involving WaMu-originated loans: it helped construct and
negotiate the loan pools, conducted due diligence (through independent third parties), created
securitization structures attractive to investors (including by meeting their rating requirements),
and sold the securities.
Repurchase & Recovery
Your invitation asked specifically about the Repurchase and Recovery Team. In general,
purchasers of loans, whether the buyer in a whole loan sale or the trustee of a trust holding loans
underlying a securitization, can under certain circumstances demand that the seller of the loans
repurchase a loan. While I do not have a lawyer’s understanding of repurchase rights, I do know
that, under appropriate circumstances, a purchaser may demand that the seller repurchase a loan
on which the borrower fails to make a specified number of monthly payments owed (an early
payment default), for example, or when there has been an a breach of a representation or
warranty contained in the transaction documents for the loan sale or securitization. Like most
other aspects of the sale and securitization of home loans, the repurchase and recovery process is
filled with negotiation: buyers often take a very aggressive and expansive view of when a seller
is obligated to repurchase a loan, and sellers often disagree. In some cases, the seller convinces
the buyer that the seller is not obligated to repurchase the loan. In others, the seller agrees to
make the repurchase. In still others, it is the seller that identifies problems with a loan in the first
instance and initiates the repurchase process without demand from the buyer. Often the issue is
resolved short of repurchase (through correction of documentation problems or the payment of a
“make whole” amount, for example).
At some point in 2007 or 2008, the group at Washington Mutual responsible for evaluating and
responding to repurchase requests was placed under me. That group reviewed repurchase
requests to determine if they presented valid grounds for repurchase of the loan at issue, and then
responded to the requests accordingly. When appropriate, the group was also responsible for
making repurchase demands to those financial institutions from which WaMu or WMMSC had
acquired loans. The group, which came to be called the Repurchase and Recovery Team, also
created a computer modeling process to identify loans that might present a repurchase obligation.