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Arizona Daily Star
Tucson, Arizona | Published: 08.19.2007
First Magnus, one of Tucson's largest employers and one of the nation's largest mortgage lenders, grew astronomically right up until it suddenly stopped writing home loans and laid off most of its work force on Thursday.
How could the rising star that had never had an unprofitable month collapse overnight?
Analysts say easy credit fueled First Magnus' success — and buried the company when credit became hard to get.
In the months leading up to the meltdown, the 10-year-old company was writing $2.5 billion a month in home loans — three times the business it was doing just five years ago. First Magnus was setting new internal records for loan volume, opening dozens of new branches and hiring 300 new employees.
As recently as the beginning of July, CEO and co-founder G.S. Jaggi predicted in a letter to employees that "the next 18 months are going to be the most significant years in First Magnus' history in terms of gaining market share and firmly positioning ourselves as one of the top 10 mortgage companies in the United States."
Just six weeks later, the company laid off nearly all of its approximately 6,000 employees in 350 offices nationwide. The secondary market it relied on to buy its mortgages had evaporated when investors lost faith in the value of home loans due to rising delinquencies and defaults.
Now the company faces a new reality: a gutted operation and the looming threat of bankruptcy.
"First Magnus was riding a wave created by an enormous amount of liquidity," said Chris Lamoureux, head of the finance department at the University of Arizona's Eller College of Management. "They were staking a lot on the continuity of that wave."
The business model
First Magnus opened for business 10 years ago with a team of young executives with an idea for using Web-based technology to make mortgage lending more efficient, said Gary Baraff, company spokesman.
First Magnus, which did retail business through main retail arm Charter Funding and other affiliated brokers, didn't own the mortgages it wrote. Instead, it originated loans and then wholesaled them to secondary investors.
It was a cash-flow machine — acting as the go-between for people who need to borrow money and people who have money to invest. The company made money by charging fees for making these matches.
Brokers sent borrowers to First Magnus, which would evaluate credit risks.
The company originated few subprime loans, those to borrowers with shaky credit, Baraff said, but did some business in nonconforming mortgages, including jumbo loans, which exceed amounts allowed by Fannie Mae and Freddie Mac, and Alt-A loans, a category between prime and subprime that includes loans for which borrowers do not have to verify their incomes.
Most of its business was in conventional loans, Baraff said. Of those, many conformed to the strict guidelines of the Federal National Mortgage Association, known as Fannie Mae, and the Federal Home Loan Mortgage Corp., known as Freddie Mac. Some were insured by the Federal Housing Administration or guaranteed by the Department of Veteran Affairs.
Companies such as Countrywide Financial, Wells Fargo or Washington Mutual would pay to take First Magnus' customers. Some loans included a provision that if the homeowner couldn't pay, then the secondary buyer could send the loan back to First Magnus and ask for the principal amount back.
Normally the secondary buyer would sell the mortgages again — this time by dividing pools of debts into complex bonds with different maturities and ratings to cater to investor preferences in the global market. These are known as asset-backed securities, and the process is known as securitization.
The collapse
Everything was coming together for First Magnus, Baraff said.
There were record years for lending during the housing boom. Low interest rates made credit easy to get. Being privately held gave the company flexibility to ride economic ups and downs. A unified branding campaign and national-level industry awards were bringing new attention to the company. It was hiring new workers and opening new branches.
Until recent months, the company planned to open a federally chartered bank. Its plans for a 33,000-square-foot, three-story bank headquarters were set to be approved by the city of Tucson in the next month. But the bank plans were put on hold because of record business on the mortgage side, Baraff said.
"We had tremendous momentum going as recently as three weeks ago," he said. "Three weeks ago we were at the pinnacle."
Now there are no buyers. Investors aren't interested.
No new asset-backed securities of home loans were sold last week, and new issues for all asset-backed securities plunged 87 percent to $1.3 billion from a week prior, Bloomberg data show. Asset-backed mortgage bonds primarily consist of subprime and home-equity loans to borrowers with a higher credit risk.
Sales of asset-backed mortgage bonds as recently as June averaged $5.1 billion a week. Sales of asset-backed bonds in the week ended Aug. 3 totaled $9.66 billion, including $3.36 billion in mortgage securities.
Early last week, First Magnus was laden with $100 million in funded mortgages that secondary buyers weren't buying, Baraff confirmed. Plus, First Magnus owed some secondary buyers principal payments on loan defaults, adding to the company's liabilities.
Board Chairman Tom Sullivan Sr. injected $10 million into the company a week ago to "give us some breathing room," he said, but it wasn't enough to keep the company from going under. He said he thought lenders would work with First Magnus, "but we never saw they would stop securitization."
Credit that once flowed freely had dried up and investors doubted the value of mortgage-backed securities. With no buyers, First Magnus couldn't make money selling bundles of debt.
For the past few days, company executives have been working out the next steps. If the company files for Chapter 11 bankruptcy, it has $160 million in equity to repay bondholders, Sullivan said.
One of the biggest buyers of First Magnus loans was Countrywide Financial Corp., the biggest U.S. mortgage company. Last week Countrywide tapped $11.5 billion in credit because the investors who normally provide financing for mortgage companies' loan operations have bolted from the credit markets as defaults and delinquencies by home-loan borrowers surged.
The problems began when homeowners stretched too far to buy homes with adjustable-rate mortgages, expecting they could later refinance or sell the homes at a profit. Rising home values and growing uncertainty in the credit market made that difficult.
American Home Mortgage Investment Corp., Aegis Mortgage Corp., HomeBanc Corp., and New Century Financial Corp. have filed for bankruptcy. At least 70 U.S. mortgage companies have closed operations or sought buyers since the start of 2006.
"When you start talking about bankruptcies at companies like Countrywide, you start wondering about the pillars of the industry," said Richard Beidl, a mortgage-industry analyst and consultant with Impact Partners Inc. in San Diego. "We have artificially allowed a considerable number of people into the home market to buy homes who shouldn't have been in the market."
At least some of those people got their home loans from First Magnus. Spot audits done in 2005 and 2006 by the U.S. Department of Housing and Urban Development and the Arizona Department of Financial Institutions revealed several problems with First Magnus loans:
● A Scottsdale branch manager made "false promises and misrepresentations" that "resulted in 10 fraudulent loan transactions," an Arizona Department of Financial Institutions report said.
● A loan was approved with false employment verification, pay stubs and tax forms.
● A loan was approved with a false lease form for a borrower's previous residence.
● Three loans were approved with overstated income and high debt-to-income ratios.
● A refinance loan was approved without information about debt carried by the borrower's spouse.
● "Insufficient justifications" were used in some loan approvals, including one case in which the borrower was listed as a "minimal user of credit." He had six accounts, and four had gone into collection.
Despite these few specifics, it's not easy to pinpoint the specific cause of First Magnus' problems, said Lamoureux, the UA finance professor.
"First Magnus is another symptom in what is broadly being called now a credit crunch," a structural change in credit markets, he said.
"Three months ago, mortgage-originating firms had no trouble finding buyers. In the last few weeks, there has been a structural change. We may never know what caused it. It may have been purely psychological."
It might turn out that 2005 and 2006 was the heyday, Lamoureux said. At least for the time being, no-money-down loan offers and easy approvals are a thing of the past.
The sudden economic shift has been devastating for the people who built and grew a company that last year ranked as Southern Arizona's 61st-largest employer and now has laid off at least 700 Tucsonans — about 90 percent of its local work force.
"I've taken my body blows but not a knockout punch," First Magnus founder Sullivan said. "This is a knockout punch. What you do is you get up off the canvas and say, 'Hey, I'm not out of the fight.' "
● Bloomberg News and Arizona Daily Star reporters Josh Brodesky, Tiana Velez and Shelley Shelton contributed to this report. ● Contact Star reporter Becky Pallack at 573-4224 or bpallack@azstarnet.com.
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