American Home Mortgage: The Story Behind the Story

Mortgage and Lending with KJ Financial

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.

Comments (51)

Jim Bishop
Morgan Stanley - Dublin, OH
Jeff - 
You asked the question of bundling loans together and that is exactly where AHM hit the wall.  As I understand it (can not find it in print), Wells Fargo declined buying $2 Billion in packaged loans from AHM.  The created an immediate problem cash problem for AHM to fund new loans (perhaps existing commitments) and broke their back.

They then went to sell themselves to IndyMac (another top 10 lender) but had an injunction filed against them by Wells Fargo for misstating their financial position.  This halted the sale and they started the shut down process.

AHM's was a big buyer of no-doc and low-doc loans which meant that they were open to abuse by brokers who wanted to take advantage of them.  No-Docs are great programs, but if the buyer really should not buy.....

This in not a comment on the original post, just an aside I thought of with Jeff's question.  (Jeff I could put a simple post together on gnma, but I am in a regulated position and not allowed)
Aug 06, 2007 04:03 AM
Kaye Thomas
Real Estate West - Manhattan Beach, CA
e-PRO, Manhattan Beach CA
Kurt. You did a great job of explaining  how the market works .. I'm going to post a link to this post on my other blog. 
Aug 06, 2007 05:06 AM
Zach Dahl
Ameritime Mortgage Company, LLC. - Charlottesville, VA
Virginia Home Loans

Kurt - Very concise post.  Which is always hard to do when explaining the market.  So what do you think about the Class Action Lawsuit filed against AHM?  Seems like whenever someone big goes down a lawsuit is accompanied with it...

Aug 06, 2007 05:32 AM
James Hershiser
RELC, Inc. - East Irvine, CA
Loan Officer for RELC, Inc.
Thank you for the post: very insightful.  I think you and Mr. Habib are spot on in this analysis. 
Aug 06, 2007 05:51 AM
Tom Burris
NMLS# 335055 - Baton Rouge, LA
Texas/Louisiana Mortgage Pro - 13 YRS Experience

The 'Golden Rule' = The man with the gold makes the rules.

Everyone was running fast and loose with the investor's guidelines and the investor lost their appetite for the loans. Market forces at work......


Aug 06, 2007 06:21 AM
Tom Burris
NMLS# 335055 - Baton Rouge, LA
Texas/Louisiana Mortgage Pro - 13 YRS Experience

oh..... and you won't see this explanation on Bloomberg or any other news channel. It is ALL about the evil lenders.


Aug 06, 2007 06:23 AM
Alex Charfen
Charfen Institute - Austin, TX
Kurt - thanks for such an awesome post.
Aug 06, 2007 06:59 AM
Kurt Jackson
KJ Financial - Kansas City, MO


I'll tell you putting things into an easily understandable context can be very challenging in our business.


Great I hope it helps the readers of your blog.


The problem with those lawsuits in this situation is if any money is made it will only be made by the lawyers.


Glad you enjoyed it.


How correct you are.

Alex & Cadey,

You are welcome. Glad you enjoyed it.

Aug 06, 2007 07:13 AM
Freddie Castaneda
Beechwood Realty - San Jacinto, CA
San Jacinto Valley Real Estate
Kurt, great post.  Very informative.  I was always wondering how it worked and why wall street played a big role in the mortgage industry.  I will bookmark this post for future references.
Aug 06, 2007 07:28 AM
"The Lovely Wife" (Broker Bryantnulls Wife) The One And Only TLW.
President-Tutas Towne Realty, Inc. - Kissimmee, FL

Boy Kurt...

I really like the way you broke this down into layman's terms.

Thank you. Thank you. Thank you :)


Aug 06, 2007 08:03 AM
Kurt Jackson
KJ Financial - Kansas City, MO


Happy it could help in your understanding.


You're welcome, you're welcome, you're welcome. :D  Okay I am new to the board I figured out the TLW, what's the ROAR?  Just curious.

Aug 06, 2007 08:25 AM
"The Lovely Wife" (Broker Bryantnulls Wife) The One And Only TLW.
President-Tutas Towne Realty, Inc. - Kissimmee, FL
Aug 06, 2007 08:41 AM
Lola Audu
Lola Audu~Audu Real Estate~Grand Rapids, MI Real Estate - Grand Rapids, MI
Audu Real Estate~Grand Rapids, MI ~Welcome Home!
Kurt, this was an excellent analysis and very deserving of a feature.  I have bookmarked it for further reference.  This information is sooooo very much needed.  Thanks for tackling it in a way which was understandable in layman's terms.
Aug 06, 2007 01:08 PM
Chris Lengquist
Ad Astra Realty - Olathe, KS
Kansas City Real Estate Investing
Kurt - first, welcome to AR.  Second, you need to give me a call.  We can discuss business. I'm very happy with your other blog.  But I found you here so I thought I would write you here.  Seriously, I'll wait for your call.
Aug 06, 2007 02:46 PM
Your English is Atrocious

Your english and writing skills are appalling. Your prose is nearly impossible to follow. I am just as shocked at all the positive comments in this post.



Aug 06, 2007 04:01 PM
Kurt Jackson
KJ Financial - Kansas City, MO


Thanks now I know.


I'm glad you liked it.


I'll catch up with you today.


Your English is Atrocious,

Mrs. Eitemiller is that you?  I wish I would have paid better attention in your 10th grade English class. Do I have to go to the Principal's office again? 

Boy am I lucky this isn't English class and the people here, that, aren't, afraid, to, post, their, names, appreciate the information given and not the manner it is written.  Oops did I incorrectly use commas in that last sentence?  "Sentence, wait that can't be a sentence- not with that that structure mister." 

Oh, how dare you try to follow my prose, look here I don't prose for just anyone ya know. :)

Aug 06, 2007 10:19 PM
Jeff Belonger
Social Media - Infinity Home Mortgage Company, Inc - Cherry Hill, NJ
The FHA Expert - FHA Loans - FHA mortgages - USDA loans - VA Loans

Okay Kurt..... I gave it a shot. I left some things out because I didn't want to make it long. I left the true history out. Meaning, when mortgage-backed securities came into play, in the 70's.....  The Explanation of Mortgages : From the beginning of time......    The bottom line is that this can be very hard to explain in such a short article.,...   I should have done a two part, but this can get boring... even for us money geeks... lol   If I left anything out or could make a change, please let me know.  thanks 

Aug 07, 2007 02:15 AM
Bill Gillhespy
16 Sunview Blvd - Fort Myers Beach, FL
Fort Myers Beach Realtor, Fort Myers Beach Agent - Homes & Condos
Kurt,  Thanks for a very detailed explanation of a tough subject.  Keep up the good work.
Aug 07, 2007 08:07 AM
Allison Stewart
St.Cloud Homes - Saint Cloud, FL
St. Cloud Fl Realtor, Osceola County Real Estate 407-616-9904
What an excellent post!  Being able to translate the mortgage crisis mess into simple language helps everyone get a handle on how it is impacting our various professions.  It will be very interesting to see what happens over the next few months.  Thank you for explaining it.
Aug 08, 2007 12:12 AM

Barry Habib is is credible and reliable???  When?  After the fact.

Go to his site and listen to what he said on Feb 20, 2007

CNBC spot from 2/20/07, "Will problems in the Subprime market spill over to the major lenders"


Watch the broadcast and tell me this guy knows what he is talking about.  Listen to his own words.   

I bet you he takes the segment down b/c he doesn't want to look like an idiot.  He said NO MAJOR lenders would be hurt by the Subprime problems.  WRONG!!! as usual

He also said there was no housing bubble back in 2006.

"Veteran mortgage analyst Barry Habib protests the idea of a housing bubble instead favoring the idea there is only a modest deceleration in appreciation occurring. Additionally, Barry suggests that builders have always offered the incentives that have been widely reported in the news lately."

Originally aired on: 9/27/2006 on CNBC

Wrong again! 

The best of all, the guy said back in 2001 that it was a great time to sell b/c the bubble was about to burst. (But Barry, I thought there wasn't a bubble in 2006??? But there was one in 2001 before the runup in prices???) Read it for yourself.  I am not making this up, here is the article. 

"But Habib, a student of history, says that only means the bubble is about to burst."

"If you are thinking about selling the stars are aligned perfectly for you. I say this last month was the peak because people always get into homes before school starts and we are seeing some softening right now," Habib said.

The guy told people in 2001 to sell before one of the largest runups in home prices ever.

What a genius!  Real reliable.

I do give him credit, he sure knows how to market himself, in that regard the guy is a MASTER! 



Aug 17, 2007 02:00 PM