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If you work or have worked in any capacity within a title company, a real estate company, for a lender, as a mortgage broker, or in any part of the mortgage loan and settlement industry, and have good information to share please email me: paularush@comcast.net Your name can be kept confidential if you don't want to reveal who you are.  

A FORMER BROKER POSTED THIS ON A INVESTMENT BLOG

There have been a couple of very interesting points made here. I have just recently left the mortgage business and used to use American Home Mortgage's wholesale channel ABC to place some loans. These were some of the worst credit quality highest risk loans I did as a loan officer. The perception of ALT-A loans being less risky than Subprime is a false one. AHM are one of the very few ALT-A lender that will make loans to borrowers with mortgage late payments over the previous 12 month period. They also originate a large portion of Option ARMs or neg-am mortgages.

Their underwriting guidelines for these complicated and risky loans are some of the worst out there. The first problem lies in the recast point associated with the loan. An Option ARM allows a borrower to pay less than the full interest due resulting in negative amortization, when the loan balance reaches a pre-determined percentage of the original balance the loan becomes a fully amortizing loan and the minimum payment goes away typically doubling the payment for the borrower. The recast point is also triggered after 5 years.

However the percentage of original value varies by lender. Countrywide use 115% which typically takes 3 years to reach. Washington Mutual use 110% which takes about 2 years. AHM use 125% which will take 4.5-5 years to reach but which will also almost guarantee that AHM and the borrower will be upside down when the loan recasts. The other bit of ridiculously lax underwriting has to do with how AHM compute the debt burden on their Option ARMs. The actual interest rate on an Option ARM is index+margin of 2.5 to 3.5. The most popular index is the 12month MTA or a 12 month rolling average of the treasury rate. Currently this index is at 5.013 so the fully indexed rate on an Option ARM is about 7.5-8.5%.

All other lender Option ARM guidelines state that the rate used for qualifying the borrower will be THE GREATER OF the fully indexed rate or 4.5%. AHM use 4.25% for primary residences and 4.5% for investment properties. They are using a rate 3 points or more below the actual note rate to qualify people who will be paying less than half of what should be due every month and who will owe more than the house is worth when their payment doubles on them. This is a recipe for disaster.

Wall Street has not priced in the incredibly high risk associated with Option ARMs (the lender does not get paid until the loan is paid off but is able to count new debt as revenue.) and AHM is heavily dependent on Option ARMs as a source of revenue. My opinion is that they are a short and will be in serious trouble when the Option ARMs they originated in 2005 and 2006 hit the recast point.

Their use of less than the fully indexed rate for qualifying borrowers can also be viewed as a violation of RESPA as it puts people into loans that they clearly can't afford. AHM also allow for higher LTVs on their Option ARMs than other lenders.

According to http://www.libertypost.org/cgi-bin/readart.cgi?ArtNum=155718 an option ARM yields about twice the profit of a subprime ARM which itself yields more than a fannie mae arm or fixed rate loan. "

"Option ARMs are the best-executing product in the market right now, despite the market noise," said Brad Morrice, chief executive officer at Irvine, California-based New Century Financial Corp.  The company is selling non-prime loans at about 102 1/2 cents on the dollar, compared with option ARMs "north of 104," he said."

Also please keep in mind that there is no doubt about the fact that qualifying a borrower at a rate of 4.25% when that borrower will be paying at a rate of 7.75% to 9% is a great example of AHM not doing due diligence. While I agree that there is nothing fundamentally wrong with the concept of the subprime or ALT-A mortgage business there is a whole lot wrong in how out of control that business got between 2003 and 2006. The point that I was trying to make is simply the fact that ALT-A mortgages are not that much less risky than Subprime.

The numerical credit score does not capture the entire scope of the risk and just like the subprime lenders the ALT A lenders have gotten way too aggressive and lax in their lending and underwriting standards during the recent housing boom. AHM, due to its overly aggressive and sometimes questionably legal lending practices (see above section about potential wide scale RESPA violations) is potentially headed for a meltdown similar to the meltdowns suffered by NEW and NFI.

While you are right about the stock having taken a 30% correction and potentially being able to recover somewhat in the short term, it's long term outlook is not good.

Take a look at this article, http://money.cnn.com/2007/03/19/news/economy/next_subprime/index.htm it is the first article to really talk about the mess brewing in the ALT A mortgage market and even this article only begins to touch on the tip of the iceberg. While the fundamental for AHM look good the nature of their business is not solid and will collapse with the housing bubble. Investing in AHM or any other residential mortgage REIT is essentially betting against a housing correction which is not a bet that I would make. The relatively high percentage of short positions further shows that this name is garbage.

Remember NEW, NFI and LEND also paid high dividends and had the risk of subprime loans "priced into the stock already." AHM does a majority of its business via the origination of exotic mortgage products (ALT-A, or ALT-A with high enough credit scores that they do not classify it as ALT-A despite the lax documentation, option ARMs and other Neg-Am products and high LTV reduced documentation loans.) that have exploded in popularity during 2004-2006 and which are now finally getting the scrutiny that they deserve. If you are not a real estate doom and gloom believer simply look at the financial performance of the company during 2002-2003 to get a gauge of where they are likely to end up after the housing boom fully winds down. To me this would indicate that this is a $10-18 stock when the dust settles. 1. They are not conservative, that is a fact based on their incredibly lax underwriting guidelines. They are the only lender who qualify borrowers for Option ARMs on less than the fully indexed payments. They allow for some of the highest LTVs and CLTVs on Investment properties and they are still offering 100% financing when many lenders have stopped. Subprime is not the issue here, lax guidelines are and ALT-A allows for equally if not more illogical and risky loans.