The nation’s largest provider of due diligence reviews of mortgage loans packaged up for sale to Wall Street investors has agreed to cooperate with New York Attorney General Andrew Cuomo’s sweeping investigation of industry practices.

The agreement, first reported by the New York Times and confirmed by company officials, gives Clayton Holdings Inc. immunity from prosecution in New York.

The Connecticut-based company had previously disclosed to investors in a Nov. 9 regulatory filing that it was “cooperating fully” with a June 22 subpoena from Cuomo’s office.

Cuomo’s office is investigating whether investment banks and other companies that sold securities backed by mortgage loans failed to disclose to investors and rating agencies warnings from due diligence firms like Clayton that some loans did not meet minimum underwriting standards.

In a statement, Clayton Chief Executive Officer Frank Filipps said the company has provided Cuomo’s office with due diligence reports on pools of loans that the company had reviewed for issuers of mortgage-backed securities (MBS). Those reports included warnings that the loan pools included mortgages that did not meet underwriting guidelines, but which were sold to investors anyway.

“We have also been asked about loans that had exceptions to lenders/seller guidelines and were eventually purchased by MBS issuers,” Filipps said in a statement provided to Inman News. “This information that we provided to the attorney general is the same information that we provided to our clients.”

The New York attorney general’s office’s yearlong investigation into the methods used in packaging mortgages into securities sold to investors during the housing boom first made headlines on Nov. 1, when Cuomo’s office announced a lawsuit against First American Corp. and its subsidiary eAppraiseIT.

The lawsuit accused the companies of providing inflated property appraisals after they were allegedly pressured by Washington Mutual, which was not named in the lawsuit. All three companies deny wrongdoing.

A week later, the attorney general announced subpoenas of government-chartered mortgage repurchasers Fannie Mae and Freddie Mac, and since then has reportedly subpoenaed Merrill Lynch & Co., Bear Stearns, Deutsche Bank AG and other firms involved in bundling up mortgage loans as investments (see Inman News story).

Clayton Holdings has seen its due diligence business shrink dramatically since the secondary market for subprime, alt-A and nonconforming mortgages fell apart in August over worries over rising defaults and falling home prices.

In its last quarterly report to investors, Clayton said revenue from its transaction management services, including due diligence analysis of loans bundled up as mortgage-backed securities, fell 61.9 percent from the same quarter a year ago, to $18 million. Total revenue for the quarter fell 47.1 percent, to $31.3 million.

The company has said its business was heavily concentrated with investment banks including Deutsche Bank, Morgan Stanley and Lehman Brothers, which have cut back their securitization of mortgages. In the first nine months of 2007, nearly 20 percent of Clayton’s total revenue came from Morgan Stanley and Lehman Brothers alone.

“As a result of recent increased incidences of delinquencies, early payment defaults, first payment defaults and fraud in nonconforming mortgages, many participants in the nonprime MBS market, including originators and investors, have dramatically reduced and in some instances ceased activity in their nonprime MBS-related business units,” the company warned investors. “These participants, including some of the largest investment banks, have historically been the primary source of our revenue.”

In the Nov. 9 report, Clayton executives revealed the subpoena from the New York attorney general, seeking “information and documents relating to the transaction management services that Clayton provides to its clients in the subprime mortgage industry.”

The company said it was cooperating fully and had launched an internal investigation led by outside counsel into the business practices related to its transaction management services.

“We cannot predict the effect that the attorney general’s investigation will have on the subprime mortgage industry or our business, although negative publicity, fines, sanctions, penalties or increased regulations could have a material adverse effect on our business, results of operations and financial condition,” the company said.

Clayton has been publicly traded since a March 2006 initial public offering of stock at $17 per share that raised $131.8 million. Shares in the company hit a 52-week low of $3 on Jan. 11 and were trading below $5 Monday, down nearly 80 percent from an all-time high of $24.30 on Feb. 23, 2007.

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