Loan terms

In times of heightened emotion, uncertainty, and fear, it often helps to be particularly mindful of the power of language to frame an issue. With respect to the changed (tighter) conditions in the mortgage market for risky borrowers and jumbo mortgages, the unseemly and anti-capitalist clamor for Federal intervention of a fiscal or monetary nature by self-interested politicians of western states with significant housing overbuild, patrician presidential candidates running hopelessly behind southern populist (and wealthy!) trial attorney presidential candidates, ceo's of distressed manufacturing companies utterly dependent on the power of cheap financing to suck yet more future demand into the present, and fabulously wealthy left coast bond managers and their rabbit chatting sidekicks with a perverse fetish for deflationary fearmongering, has been aided and abetted by sloppy and sensational use of language in the "popular" (as they are anything but) press and tv.

m* offers the following clarification in terms.

Mortgage Lender: a profit seeking institution whose business is to earn the difference between its cost of funds (liabilities) and the return on mortgages held (assets) for investment.

Mortgage Originator: a profit seeking institution whose business is to collect fees for originating mortgages for mortgage lenders.

With the rise of asset backed securitization, note that mortgage lenders can now include pension and insurance funds, hedge funds, publicly traded mortgage reits, as well as banks, and via Fannie and Freddie and an implicit claim on the Federal government's power to tax its citizens, every one of you and m* too.

The key feature uniting these lenders is that their participation is rooted in a calculation of the loan eventually being repaid. In this their interests are aligned, at least somewhat, more closely with the borrowers than the interests of an originator are.

Moreover, after years and years of advertising from the likes of Fannie and Freddie, (especially Fannie), we have become conditioned to viewing lenders as good guys, as facilitators of the American Dream. And every time an originator is referred to as a lender, that sense of all-American-Mom's-apple-pie clouds our perception of the true nature of their business.

In our history, lenders were not always good guys of course. In the Great Depression and the agricultural poverty of the Great Plains droughts in the early part of the last century, mortgage holders, banks, lenders of all stripes were the enemy of the common man, the cruel hand of heartless capitalism at the root of the country's troubles.

It should be apparent that the entities that fall under the second definition are asset light middlemen, (think, um, call centers) whose comings and goings represent barely a ripple in the greater economy and whose demise presents no significant impediment to the realization of "the American Dream." The next time you hear or read about mortgage "lenders" in trouble, ask yourself if the subject of conversation is not in fact an "originator."

In the case of Countrywide, to take one example, for the six months ended June 30th, the company's income statement reported the following:

Gain on sale of loans 2.7 bn
Interest income 1.4 bn
less Bad loan provision (0.4) bn
Net interest income 1.0 bn

Loan servicing fees 2.8 bn
less actual srvc fees (1.9) bn
Change in value scrv rights 1.5 bn
Impaired scrv rights (0.7) bn
Srvc Hedges (1.5) bn

Insurance premiums 0.7 bn
Other 0.3 bn

Countrywide's gain on sale income, loan servicing business, and even "insurance + other" business is on par or far exceeds its interest income. Keep in mind also that while Gain on sale income is largely inclusive of net interest income that would have been earned over time had loans been retained at the firm, Countrywide does not have significant access to long term funding of the kind that would enable it to retain those assets.

In fact, their limited access to long term funding makes that well nigh impossible, and the inability to sell it's current originations and thus roll over its short term funding is what precipitated the fears of drastically reduced income as well as possible insolvency that led to them tapping credit lines and selling a stake to BoA. So what you have is a company acting very much like a bank, without a bank's capital base.

Is there something wrong with the banking system that companies like Countrywide need to exist for homebuyers to access mortgage loans? Hardly. But the firm has been extremely successful in marketing itself over time and as a result commands significant attention in the public eye. BTW Countrywide does have a recently acquired bank subsidiary, however the continued reliance by the firm as whole on short term financing for its primary business and the treatment of the firm's equity in the current turmoil points to its relative insignificance.