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Wednesday, April 11, 2007

Option ARMs: The Band Plays On

by Tanta on 4/11/2007 09:06:00 AM

Yesterday’s foray into bond market vigilantism was so fun, I’m tempted to try it again. This morning’s news item, via CNN (hat tip, Wayne!), “Risky loans - alive and well”:

NEW YORK (Money) -- Option ARMs remain an option. Despite problems in the mortgage market, brokers say lenders are still willing to make risky loans - including those that allow borrowers to make monthly payments that don't even cover the interest (so-called "option ARMs").

Also still widely available are "no-doc" loans, which require no income verification, and mortgages with no downpayment. . . .

In early March, rising delinquencies caused a dramatic sell off in the bonds backed by mortgages to the borrowers with poor credit quality. Analysts predicted that the investor distaste for those mortgages would spread into the Alt-A market as well. Indeed, in the past week two New York lenders American Home Mortgage and M&T Bank said they would pull back from making loans to the Alt-A market because investors were willing to pay less for those securities.

But mortgage bond traders say investors, who seemed nervous about the bonds a month ago, in the past few weeks have been coming back to the market. "We are seeing demand for these bonds picking up again," said a bond trader at one of the largest mortgage lenders in the country. He said yields, which rise with investor concerns, on most Alt-A bonds are up less than one tenth of a percent.
Does anyone else remember M&T and AHM announcing that they couldn’t get a bid for an Alt-A security? If so, could you direct me to the relevant press release? The ones I read seem to suggest that whole loan bids went away.

Of course there is a relationship between a whole loan bid—that’s the investment bank buying loans—and a security price—that’s the bond the investment bank created out of the whole loans it may have purchased, or just originated.

But we had some serious confusion in the comments to an earlier post about who knows what when—and whose rules are in effect—when whole loans are purchased from a loan originator, so it’s really best to be clear about this. The investment banks set their own whole-loan guidelines, which include product type, credit underwriting, documentation levels, maximum LTV, and so on. They put out rate sheets when they buy those loans on a flow basis (one by one, as some originator originates them). When they buy in bulk, from someone like M&T or American Home, they may or may not price each loan off of a rate sheet, although however bid price is calculated by the buyer, it uses the same math as the rate sheet. That bid price will include a spread somewhere (between the bid and the ask). A whole-loan market can start getting ugly if the bids are too low, or if the bids just aren’t there. My reading of what M&T and AHM reported recently was that both of those things happened: there were too few bids at too low a price. In this context, “too low a price” is relative to what M&T and AHM needed or wanted or expected.

It is in any case true that the guidelines of acceptability for this stuff are set by the investment banks, as is the bid price. Since the investment banks buy tons of whole loans on a flow basis—or from their wholly-owned origination outfit—they don’t actually have to buy whole loans from M&T or American Home or anyone else to keep a pipeline going. Two of the largest originators of Alt-A are EMC—owned by Bear Stearns—and Aurora Loan Services—owned by Lehman.

I also noted in the comments to an earlier thread that FED, a California thrift specializing in Option ARMs, just hired itself a new Wholesale Lending Manager. These loans do not have to be purchased by someone who intends to securitize them; there are portfolio lenders out there buying from correspondents and funding for brokers. It is not clear to me, at least, that the market for Option ARMs is exhausted by the appetite of securitizers for whole loans to securitize.

This has been a public service announcement on behalf of vigilant nerds everywhere.