Friday, October 26, 2007

AHM v. LEH: The Revenge of Mark to Model

by Tanta on 10/26/2007 11:47:00 AM

This is killing me:

PHILADELPHIA (Dow Jones/AP) - Bankrupt lender American Home Mortgage Investment Corp. has sued Lehman Bros., accusing the investment bank of essentially stealing from the company as it struggled to stay on its feet.

The lawsuit, filed Wednesday in the U.S. Bankruptcy Court in Wilmington, Del., accuses Lehman Bros. of hitting American Home with improper margin calls in July and demanding money the company says it did not owe.

When the Melville, N.Y.-based lender couldn't meet Lehman's second margin call, for $7 million, Lehman foreclosed on $84 million worth of subordinated notes issued in American Home's structured-finance operation. . . .

American Home is relying in part on the frozen market for mortgage-industry paper to make its case against Lehman Bros. Without actual trades to show the value of the notes had declined, American Home argues that Lehman Bros. should have obtained an independent valuation before issuing the margin call.
That's an interesting theory of levering up your "assets": if the market says "no bid," you apparently get "no mark" and therefore "no call" and hence "no bankruptcy."

The thing is, in a nutshell, that AHM was using these borrowings to fund new mortgage origination operations. A "frozen market for mortgage-industry paper" means no money to make new loans with (proceeds from sales of commercial paper backed by the warehouse of held-for-sale loans) until you can sell the loans you've already made. But you can't sell the loans you've already made, unless you want to take a nasty hit on them, because nobody's buying decent whole loans in a "frozen market," and there is excellent reason to think AHM's warehouse held a boatload of not exactly decent loans. We know this because AHM was forced to visit the confessional about its massive number of buybacks of loans that didn't make the first three payments sucessfully.

So Lehman wanted out of its exposure to AHM's held for sale pipeline, as far as I can tell, because unlike your usual "pipeline," this one was a pipe to nowhere (kind of like the bridge to nowhere). It sounds like AHM is now saying that Lehman made up some ugly mark to model valuation instead of getting "independent" verification of the fact that there were no bids--or horrible ones--for the AHM loans. I guess the fact that AHM couldn't get 'em sold in the first place, which is the whole point of having a "held for sale pipeline," is insufficient evidence that the stuff was worthless.

I look forward to hearing about Lehman's response to this.

(Many thanks to the indefatiguable Clyde)