Misrepresentations Usually Presage Loan Defaults.

Maitland, FL -- Risk mitigation firm Digital Risk has found 50% to 60% of the subprime and alternative-A mortgages from the last few years that it has examined due to contract breaches contain significant misrepresentation or fraud, according to Bruce Miller, who was recently named to head the company's New York-based structured finance consultancy practice.

Mr. Miller, the former founder of Credit Suisse's conduit and credit products group, said traditional methods of analyzing such loans have proved insufficient and he has come to believe that every subprime/alt-A loan originated in the past few years should get a third-party review. Information on original loan "tapes" for these mortgages cannot be counted on, he said, adding that he feels rating agencies, as well as other market participants, have largely been "defrauded" when it comes to this information.

Payment histories that were once commonly seen as a good way to size up loan quality are no longer enough because they may, for example, show a borrower has a fairly good track record and only one 30-day delinquency on its loan while hiding the fact that the same borrower owns five other properties he has been flipping, Mr. Miller said.

Automation valuation models at the ZIP code/metropolitan statistical area level also may be insufficient ways to size up such loans, which really need to be analyzed in terms of the individual property as well as in terms of whether a pattern of fraud has been detected in the region if one wants to derive any value from them, said Mr. Miller.

"Everything revolves around getting as granular as possible. Otherwise it's the classic 'garbage in, garbage out.'"

While it has been a challenge to find value in problematic alt-A and subprime loans, Mr. Miller said Digital Risk's clients have told the company that by using more granular analytic techniques they can produce higher internal rates of return on their whole loan investments. He said the firm's clients are typically "anyone who is long mortgage risk as a guarantor or cash owner."

While liquidity appears to be improving and resources have been lined up to buy assets, there is ...