I was reading Bryant Tutas blog http://../../blogsview/165445/American-Home-Mortgage-what so there has been quite a bit of discussion on what happened to AHM and I haven't seen a description here of what actually happened.  So I thought I would try. This is pretty much how Barry Habib described it in his MMG minutes on Friday.

Investor means Wall Street, Lender is the funding source (my relationship with AHM was a wholesale lender so they were funding my loans and paying me the originator).

The way a mortgage lender gets paid is like this.  To keep this easy lets assume we have a client that needs a $100,000 loan.  If we deliver it at a rate of 6.75% the investor (remember wall street) will pay $101,000 for that loan at that rate.  So what that says is that 6.75% is a little better return than the investors were expecting and since they know they will receive payments on that $100,000 at 6.75% for a long enough period of time that the investor will make enough money to pay the $101,000. 

This also allows the originator to maybe give that loan to the client without the client having to pay extra fees to compensate the originator.  The originator has to make a profit right?  So in this scenario the originator makes $1,000.  Just to better understand the market typically then that same $100,000 at a 6.625% rate would get $100,500 from the investor, at 6.5% it would be $100,000. 

So if we as an originator wanted to actually make a profit we would have to charge the client an origination fee or POINT which is 1% of the loan amount or $1,000.  Now let's say the client wanted an even lower rate say they had a goal of having a 6.25% rate well the investor would only pay the lender $99,000 for that $100,000 loan so the originator would definitely have to have the client pay $1,000 just to have the $100,000 they needed for a loan those are called "Discount Points" and then if the originator needed to make money they would need to charge that origination fee.  So in this situation the client would have paid an additional $2,000 to get that 6.25% rate rather than not having to pay anything extra and get that 6.75% rate.

Well here's what happened last week.  See all the loans outside of the conforming loan market which are loans that are funded by Fannie, Freddie & Ginnie are in trouble.  So loans over $417,000, Option ARMs, Sub Prime, etc. are in trouble.  I am not saying they are all going away they are going through a repricing. 

See when an investor decides what type of return they want for a particular investment the return they want largely depends on the risk they deem.  They deem the risk based on historical analysis, so when history changes as it has in the last year or more with the number of foreclosures going up due to the overuse and improper use of these loan programs then the reward they want for risk they are assuming changes.

That is what is happening right now.  The end investor, the one with the gold is now saying that if they were paying $101,000 for a 6.75% loan the risk parameters have changed so maybe now for the investor to honor a 6.75% rate they are only going to pay $95,000.  Wow, that hurts. 

See the end investor doesn't care that the lender told me the originator that told you the client that we could do that loan at 6.75% with no points, they don't care that I locked that rate with the lender and the lender was expecting to deliver it to the market (wall street) at that price so everyone thought we'd be able to deliver that loan to you the consumer at 6.75% without charging points. 

The investor says "I am the one with the gold and we are not going to fund $101,000 for a 6.75% yield we are now going to fund $95,000 do you want it or not?"  Now, as the lender (the Mortgage Bank ABC for instance) now says ok, Kurt I know I told you I would deliver 6.75% to you and pay you $1,000, but now I can't. Because if I do that it will cost me $6,000 to do that.  Now I know Kurt that doesn't sound so bad but we are funding $100,000,000 per day and we have 60 days of those promises made.  So Kurt we are going to lose 6 Million a day for 60 days that is $360,000,000 in losses over two months.  We either don't have the resources to absorb that loss or we don't want to absorb those losses so we'll just file bankruptcy and walk away.  (Very simplified example.)

And to compound matters we have a billion dollars of loans that we haven't sold off on the market and our bank that lent us the billion dollars has given us that money on margin.  Very similar to the stock market.  Let me see if I can put this into laymen's terms.

Pretend you have a $100,000 house and you want to take out a margin loan on it and the bank will only lend you say 50% of the value of the house so if the house declines in value then you will have to readjust your margin account to 50% of the new value.  So you took out the $50,000 loan and all of a sudden the value of your asset the house drops 50% to $50,000 well the bank said you can only take out 50% of the value which is now $25,000 so you have a $25,000 margin call.  You either have to come up with the $25,000 or sell the asset-house.

So that billion dollars of borrowed money ABC has lent out that hasn't been sold to the investors is now getting a margin call that could be another $200 or $300 million or more so now they are talking about losing up to $600 million or more.  They can't afford to do that so they go under.  That is what has happened and been happening over the last 9 months to lenders.

People have asked about CW and other lenders going under.  Well they could.  Maybe their business decision is to eat these losses, maybe they say I know I promised you 6.75%, but now we can't deliver it if you want to close it will be 7.75% (a number arbitrarily chosen).  I don't know enough about those other companies, but the bigger they are the more money they are obligated on so I would think that would increase their risk.

It is estimated that as the credit market settles down we could likely see many products come back, but at MUCH higher rates.  For now this is impacting the non-conforming market only the conforming market is not being greatly impacted.  It was suggested that conforming 80/20's could see some impact in the conforming market so lenders should reacquaint themselves with their MI company reps.  I have seen some of the biggies taking away stand alone seconds so it makes sense that these 2nds could see some pull back.

One thing I am concerned with is Fannie's Flex 100 program they allow some ridiculous back end debt ratios if those start to under perform it could get ugly very fast.  For those of you in markets that have values within the FHA realm it is expected that FHA will become a very viable alternative for many loans that may be going away now.  It is also rumored that Congress is contemplating raising the FHA loan limits up closer to the conforming loan limit of $417,000.

I am by no means an expert on this subject, but I do think that Barry Habib is very knowledgeable on this stuff.  I hope this can shed some light on what is going on.