YIELD is the percentage or dollar return on investment. For example,

1. If you buy a bond for $1,000 and the interest rate is 5%, the yield is 5%.  Simple enough.
2. You are expecting to receive $50 per year in interest, (your yield) assuming the bond is repaid in full when it is due.
3. Imagine getting a deal, you buy the same bond for $900.
4. The interest rate is still 5% which means it still pays $50 per year in interest.  But instead of investing $1,000, you have invested $900 and you are still getting $50 per year in interest.  Good stuff.
5. Your yield has increased because $50 is more than 5% of $900.
6. In fact, it is a yield of 5.55% (yield base). You compute it by dividing the dollar amount of the interest paid ($50) by the dollar amount of the investment ($900). $50/$900=5.55%.
7. But you are also getting repaid the full $1,000 when the bond comes due so adding to the money you get in interest is the gain you made on the bond (assuming you hold it to maturity). That difference in our example is $100, which is the difference between $900 and $1,000.   Hang with me here.
8. If the bond is a ten year bond, for simplicity sake we will divide the extra $100 you are going to make by 10 years which means you will be getting an extra $10 per year.
9. If you divide that extra $10 by your investment of $900 you are getting an average annual gain of 1.1%. Adding the base yield of 5.5% to the extra yield on gain of 1.1%, you get a total yield of 6.6%.
10. The difference between the interest rate on the bond (5%) and the real yield to you as the investor (6.6%) is 1.6%, which could be expressed as a  yield spread.

YIELD SPREAD can be expressed in either principal dollar terms or in interest rate. In the above example the dollar value of the yield spread is $100, being the difference between the par value of the bond (the amount that you hope will be repaid in full) and the amount you actually invested.

For decades there has been an illegal trick played between originating lenders using yield spread that resulted in an additional commission or kickback paid to the mortgage broker, commonly referred to as a yield spread premium.  This occurs when the broker, with full consent of the “lender” steers the homeowner into a loan product that is more expensive than the one the homeowner would get from another more honest broker and lender.

1. So for example, if you qualify for a 5% (interest) thirty year fixed loan, but the broker convinces you that a different loan is the only one you can qualify for or that the different loan is “better” than the other one, we shall say in our example that he steers you into a loan for 7%.
2. The yield spread is 2% which may not sound like much, but it means everything to your loan broker and originating lender.
3. The kickback to the broker is often several hundred or evens several thousand dollars — which is the very thing consumers were intended to be protected against in TILA (Truth in Lending Act). – Typically moving a borrower up an entire point could mean a kickback to the loan officer of 3-4% of the loan value.
4. By not disclosing the yield spread premium he deprived you of the knowledge that you get get better terms elsewhere and he didn’t bother tell you that instead of working for you he was working for himself.
5. Sometimes this is discovered right on the HUD statement disguised amongst the myriad of numbers that you didn’t understand when you signed the closing papers. They were required by federal law to disclose this to you and they are required to send you back the money that was paid as the kickback and for a variety of reasons it is grounds to rescind the transaction, making the Deed of Trust or mortgage unenforceable or void.
6. The kickback is called a yield spread premium in the language of the industry. On this phase of the transaction we’ll call it Yield Spread Premium #1 or YSP1.

Now we get to the securitization part of the “loan.” If you will go back to the beginning of this article you will see that the investor was seeking and expecting $50 per year in interest. Buying the deal for $1,000 gives the investor the 5% YIELD he was seeking.

What Wall Street did was work backwards from the $50, and asked the following stupid and illegal question: What is the least amount of money we could fund in mortgages and still show the $50 in income? Answer: Anything we can get homeowners to sign.

1. In our simple example, if they get a homeowner to sign a note calling for 10% interest, then all Wall Street needs to come up with is $500. Because 10% of $500 is $50 and $50 is what the investor was expecting.
2. Wall Street sells the bond for $1,000 and funds $500 leaving themselves with a YIELD SPREAD PREMIUM of 5%+ or a value of $500, which is just as illegal as the kickbacks described above. We will call this YIELD SPREAD PREMIUM #2.
3. They take $50 out of this $500 YIELD SPREAD PREMIUM and put into a reserve fund so they can pay the interest whether the homeowner pays or not. That is why they don’t want homeowners and investors to get together, because they will discover that the investor was paid the first year out of the reserve and payments from homeowners and then stopped receiving payment even though there was continued revenue.
4. But Wall Street also had another problem. Since they had siphoned off $450 and probably sent most of it off-shore in an off balance sheet transaction (to a Structured Investment vehicle [SIV]).  The time would eventually come when the investor would want his $1,000 repaid in full just like they said it would.  That would leave them $450 short and possibly criminally liable for taking $1,000 to fund a $500 mortgage.
5. So you can see that if the homeowner pays every cent owed, this is bad news to the people on Wall Street.  They would be required to give the investor $1,000 when all they received from the homeowner was $500. Therefore they had to make certain that they (a) had a method of covering the difference that would give them “cover” when demand was made for the $1,000 and (b) a method of triggering that coverage.
6. They also needed to make it as difficult as possible for investors to get together to fire the agent of the partnership (SPV) formed to issue the bonds they bought, which they did in the express terms of the bond indenture. So logistically they needed to keep investors away from other investors and keep investors away from borrowers so that none of them could compare notes.
7. To cover the money they took from the investor they purchased insurance contracts (credit default swaps is one form). They wrote the terms themselves so that when a certain percentage of the pool failed they could declare it a failure and stop paying the ivnestors anything. The failure of the pool would trigger the insurance contracts.
8. Let’s take an example: Under normal circumstances if you buy a car, you can insure it once and if it is wrecked you get the money for it. Imagine if you could buy insurance on it thirty times over at discounted rates. So you smash the car up and instead of receiving $30,000 for the car you receive $900,000. That is what Wall Street did with your mortgage. This was not risk taking much less excessive risk taking. It was fraud.
9. So IF THE LOAN FAILED or was declared a failure as being part of a pool that went into failure, the insurance paid off.
10. Hence the only way they could cover themselves for taking $1,000 on a $500 loan was by making absolutely certain the loan would fail.
11. It wasn’t enough to use predatory loan tactics to trick people into loans that resulted in resets that were higher than their annual income. Wall Street still had the problem of people somehow making the payments anyway or getting bailed out by parents or even the government.
12. They had to make sure the homeowner didn’t want the loan anymore and the only way to do that was to make certain that the homeowner would end up in a position wherein far more was owed on the loan than the house ever was worth and far more than it would ever be worth in the foreseeable future.
13. They had to make sure that the federal government didn’t step in and help the homeowners, so they created a scheme wherein the federal government used all its resources to bail out Wall Street which had created the myth of losses on loan defaults for notes and mortgages they never owned. It would then become politically and economically impossible for the government to bail out the homeowners.
14. This is why principal reduction has been off the table. If these loans become performing again, insurance might not be triggered and the investors might demand the full $1,000. With insurance on the $500 loan they stand to collect $15,000. without it, they stand to lose $1000. There is no middle ground.
15. So they needed a method to get the “market” to rise in values as much as possible to levels they were sure would be unsustainable. That was easy. They blacklisted the appraisers who wanted to practice honestly and paid appraisers, mortgage brokers and “originating lenders” (often owned by Wall Street firms) 3-10 times their normal fees to get these loans closed. They created “lenders” that were not banks or funding the loans that had no assets and then bankrupted them.
16. With the demand for the AAA rated and insured MBS at an all-time high the demand went out to mortgage brokers not to bring them a certain number of mortgages but to bring in a certain dollar amount of obligations because Wall Street had already sold the bonds “forward” (meaning they didn’t have the underlying loans yet).
17. With demand for loans exceeding the supply of houses, they successfully created the “market”conditions to inflate the market values on a broad scale thus giving them plausible deniability as to the appraisal fraud on any one particular house.

Whether you call it appraisal fraud or simply an undisclosed yield spread premium, the result is the same. That money is due back to the homeowner and there is a liability to the investors that they don’t know about. Why are the fund managers so timid about pressing the claims? Perhaps because they were not fooled.

Thanks again to Neil Garfield for this info.

- The Bank Slayer

HUD made the change to remain consistent with the Real Estate Settlement Procedures Act (RESPA), which will require mortgage lenders to disclose to borrowers a single origination fee on the Good Faith Estimate (GFE) and the HUD-1 Settlement Statement.   The regulations go into effect Jan. 1, 2010

Under RESPA, the single origination charge on the GFE and HUD-1 must include all administrative and processing fees related to the origination of the loans, including compensation for both the mortgage lender and broker. HUD recognized the bundled charge would exceed the 1% cap, according to a statement from the law firm K&L Gates.

To match the changes of FHA regulations, HUD will no longer limit the amount of the origination fee charged to FHA borrowers.

Great the new changes RESPA has rolled out allow the lenders/brokers to jack up the Origination Fee.  Now brokers can whack you a few points for origination AND pick up some Yield Spread kickbacks.  This makes me sick.

The FHA will expect lenders to charge “fair and reasonable” fees and will monitor them to ensure FHA borrowers are not overcharged, and FHA commissioner David Stevens intends to issue additional guidance on fee limitations, according to the letter.

Yeh right, fair and reasonable.  I have looked at well over 1,000 HUD settlements statements where brokers were supposed to be “fair and reasonable” but in fact they were limited by law to the amount they could charge for some types of loans.  You know what we found…they don’t care and many look for any angle to skirt the law.  Wow, no need for that anymore, now we don’t have a limit.

Thanks to Jon Prior @ HousingWire for this tip.

- The Bank Slayer

Want to see this in action?  Pull out your HUD from your closing.  The paper that shows all the money flowing.  Look on page 2 for items such as Origination Points, Discount Points, etc., and add up those fees you paid.  Now sniff around some more and look for items that say P.O.C. (paid outside of closing) and or YSP (yield spread premium).  If you find them they will typically have the amount in brackets OR off the main part of the calculation.  This amount is the “kicker” in commission for pointing you in the wrong direction.  

So he skews the facts and misdirects your attention until you come to “agree” that the worse the loan is the “better.”

The Bank Slayer