Summary

Alt-A Mortgage Sector Strategist (Robert Eng, CEO Strategist Network) says, “the Alt-A originate-to-sell mortgage business model might not be viable in a declining real estate market.”  There are three main reasons for this.  1) Alt-A (stated income) loans may tend to contain areas of inaccuracy or misrepresentation that could justify a repurchase demand if firmly pursued by the investor.   2) For loans which originators sold to Wall Street investors but are later asked to “repurchase” or “buy-back,” the loss severity grows essentially linearly and at the same magnitude with the fall in collateral value.   3) Current squeezed margins at 1% are potentially inadequate to cover origination costs, sales commissions (to brokers, correspondent lenders, and Account Executives), and especially, future repurchase claims from investors who purchased loans.  Please send an email or call for more detailed info & advice. Ultimately, this Alt-A originate-to-sell business model destroys value.

Analysis

 

About the Author

Robert Eng is CEO of Strategist Network, a strategic management consulting firm. Robert has 14 years of strategic management consulting experience in financial services was a leader in Michael Porter’s Monitor Group and also A.T. Kearney, both global consultancies. He has consulted extensively on bank competitive strategy and risk management for many of the largest and fastest growing financial institutions in the U.S. and Asia. Robert specializes in mortgage, home equity, credit cards, and insurance.  For more information, send an email to info@strategistnetwork.com

Why the Alt-A Originate-To-Sell Mortgage Business Model Could No Longer Be Viable in a Declining Real Estate Market

Mortgage Sector Strategist (Robert Eng, CEO Strategist Network) says, “the Alt-A originate-to-sell mortgage business model might not be viable in a declining real estate market.”

1. Alt-A (stated income) loans may tend to contain areas of inaccuracy or misrepresentation that could justify a repurchase demand if firmly pursued by the investor. Some examples are:
1. Stated income amount
2. Employer name
3. Job/Role
4. Owner occupancy (or tenant occupied)
5. Authenticity of proof of asset documents
6. Appraisal value accuracy
7. Non-arms length transaction (buying from a relative / friend; intentionally inflated price)
8. Using the name of an acquaintance who has a good credit score as buyer/borrower
9. Located in a neighborhood with high fraud/misrepresentation and/or manipulation of value through by churning home sales among a group of individuals¾ again, this puts in question property value
10. Etc.
2. For loans which originators sold to Wall Street investors but are later asked to “repurchase” or “buy-back,” the loss severity grows essentially linearly and at the same magnitude with the fall in collateral value.
1. Typical losses in 2006 on Alt-A stated income loans ranged from 9% for an average lender to 20% for an aggressive lenders (e.g., those which tended to structure higher risk deals such as first mortgages with piggy second position loans for no/low money down)
2. A 15% drop in property values will typically at least double the loss severity.
3. This same drop in property values will also likely trigger a wave of non-payment and bad loans as borrowers get “upside down” in their mortgage (owing more than the home is worth). This is exacerbated by negative amortization (“neg-am / Option ARM”) loans, and piggy back second position loans (no/low money down)
4. Were the typical default rate to move from 3% to 6%, then the occurrence of bad loans or repurchase (and make whole demand) incidence would likely double; incidence could triple or deteriorate faster under this same scenario if Wall Street investors scrub their portfolios for loans which are of a similar profile as a bad loan but which may be currently performing. Even these can be sent back in bulk for some claimed misrepresentation or disagreement on value
3. Current squeezed margins at 1% are potentially inadequate to cover origination costs, sales commissions (to brokers, correspondent lenders, and Account Executives), and especially, future repurchase claims from investors who purchased loans.
1. At the start of Alt-A (stated income) lending, several years ago, the held-for-sale originators earned about 3% commission on selling to Wall Street investors. Due to margin compression, the typical commission has been cut by about 67% to now about only 1%.
2. At a typical assumed loss rate of $80,000 ($200,000 average loan size, loss severity at 40% if real estate values fall 20% off the peak). Then, it takes 40 good loans to make up for one bad loan.
   

Ultimately, this Alt-A originate-to-sell business model destroys value.