Marketplace Scratch Pad

Mortgage lenders turn turtle

Paddy Hirsch May 1, 2009

The Senate may have tossed out Obama’s cramdown legislation, but too late for Thornburg Mortgage and Accredited Home Lenders.

Thornburg filed for bankruptcy protection in Baltimore. If you’re getting that sense of deja vu, it’s not because there’s a disturbance in the matrix. The Financial Times notes the company originally announced its decision to seek protection from its creditors on April 1. But the company didn’t actually do the business, leading many to hope it just might be an April Fool’s joke.

Some joke. And no such luck.

As for Accredited, Reuters reports the company was bought by private equity firm Lone Star in 2007 for $296 million. Accredited was one of the golden children of the mortgage boom, at one point producing as much as $2 billion in mortgages a month. But by the fall of ’07, the market had deteriorated to the point that the company actually stopped making loans altogether. Lone Star started the lending up again after the buyout, but the market went from bad to worse when the investment banks collapsed, and well, now here we are.

Santa Fe, NM-based Thornburg had an equally Icarian experience. In his excellent summary of the Wall Street meltdown, House of Cards, William Cohen calls Thornburg the canary in the coalmine of the financial services industry. The company specialized in making Alt-A loans, those greater than $417,000 to wealthy borrowers.

The rate of default on these mortgages, while still small, was growing at the same time that the value of the underlying collateral for the mortgage — people’s homes — was falling rapidly. [Bennet Sedacca, of Atlantic Advisors] could not help noticing that the effects of this double whammy were beginning to show up in other, smaller companies involved in the mortgage industry. He could watch the noose tighten in the credit markets. “Look at what is happening to Thornburg Mortgage,” he wrote … “It supposedly only has a 0.44% default rate on its [$24.7 billion] mortgage portfolio that it services but the bonds it owns are getting pounded. Result? Margin call. The worst part is that the company went to sell some bonds to settle the margin calls but couldn’t. The ultimate Roach Motel.”

In other words, even though Thornburg’s customers had a historically low default rate and high credit quality, Thornburg’s lenders decided those mortgages were no good as collateral for the loans that Thornburg needed to operate.

The problem at Thornburg was not that its customers could no longer pay the interest and principal on their mortgages; the problem was that the company could no longer fund its business on a day-to-day basis.

Sound familiar? Yup, Thornburg was stymied by a liquidity problem, which is exactly what happened to both Bear Stearns and Lehman Brothers.

Unlike a bank, which is able to use the cash from its depositors to fund most of its operations, financial institutions such as Thornburg as well as pure investment banks such as Lehman Brothers and Bear Stearns had no depositors’ money to use. Instead they funded their operations in a few ways: either by occasionally issuing long-term securities, such as debt or preferred stock, or most often by obtaining short-term, often overnight, borrowings in the unsecured commercial paper market or in the overnight “repo” market, where the borrowings are secured by the various securities and other assets on their balance sheets. These fairly routine borrowings have been repeated day after day for some thirty years and worked splendidly — until there was perceived to be a problem with either the securities or the institutions backing them up, and then the funding evaporated like rain in the Sahara.

Cohan’s has to be one of the best summaries of the specific cause of the collapse of the investment banks I’ve read.

Some of [Thornburg’s] mortgages were prime mortgages, money lent to the lowest-risk borrowers, and some were those Alt-A mortgages, which were marginally riskier than prime mortgages and offered investors higher yields. At Thornburg, 99.56 percent of these mortgages were performing just fine.
But that did not matter. What mattered was that the perception of these mortgage-related assets in the market was deteriorating rapidly. That perception spelled potential doom for firms such as Thornburg, Bear Stearns, and Lehman Brothers, which financed their businesses in the overnight repo market using mortgage-related assets as collateral.

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