A Tough Week For the Home Loan Industry
The mortgage industry endured another difficult week, as two lenders said that sagging home prices and higher mortgage rates are pushing many more borrowers into delinquency.
HSBC Holdings PLC, Europe’s biggest bank and a major player in the home loan industry, said the market for “subprime” or bad credit mortgages is falling into trouble.
Analysts’ estimate for how much HSBC needs to sock away for problem home loans is shy by a fifth. The London-based bank estimates that it needs to set aside almost $10.6 billion to cover loans it can’t collect.
Shares of bad mortgage providers fell across the board Thursday, none hit as hard as New Century Financial Corp., a bad credit mortgage lender based in Irvine, Calif. The company said late Wednesday that accounting errors caused it to lose track of how drastically some of its mortgage loans are losing value.
During the housing boom, many lenders devised crafty home loans allowing people to borrow money with no down payment and pay low interest rates for the first few years on adjustable mortgages. Now, as interest-only mortgage lans reset, more borrowers are missing payments and many lenders are going out of business or putting themselves up for sale.
At one point in the not-so-distant past, bad credit home loans were once very attractive to some banks due to their higher interest rates.
But HSBC said that the weak housing market exacerbates credit problems in the subprime lending space.
Until a little more than a year ago, stretched borrowers who needed to raise cash could take out a second mortgage on their houses and use that money to pay off loans. With housing prices stagnant - and in some markets falling - consumers’ best source of financing has shriveled.
The problem for these types of lenders may not go away quickly.
“We expect poor subprime credit trends to continue at least through 2007 and into 2008,” Merrill Lynch analyst Kenneth Bruce wrote in a research report.
Another reason bad credit plagues mortgage lenders is that it shrinks appetite for mortgage loan purchases in the bond market. Most mortgage lenders don’t keep their loans; they package them into bonds and sell them to investors. Lenders’ profits are determined by how much the bonds sell for.
A home mortgage loan marred by a missed payment loses value because of higher risk the loan won’t be repaid. The price of a bond falls if it’s backed by home loan debt that has become riskier.
When mortgage lenders sell loans, deals normally include clauses allowing some investors to force a lender to buy back a loan if the borrower misses an early payment. Roth Capital Partners analyst Richard Eckert said missed payments on subprime loans have become “epidemic,” and investors are sending loans back to lenders with unusual frequency.
New Century made two accounting mistakes:
- It didn’t assume that more investors would sell back loans, even as loan repurchases surged throughout 2006 amid defaults.
- It didn’t assume that the repurchased loans would be worth less. Piper Jaffray analyst Robert Napoli estimated that a repurchased loan has typically lost 15-20 percent of its value.
New Century said it will restate results for the first three quarters of 2006 and expects to post a loss for the fourth quarter. The home mortgage company needs to set aside money anticipating more loan repurchases, and reflecting the lower value of those repurchased loans.
The lender also said that new loans this year will fall 20 percent, as the company becomes more selective about which borrowers it lends to.
Countrywide mortgage and IndyMac Bancorp., the two biggest independent U.S. mortgage lenders, each fell more than 2 percent. Another sector hurt by the troubled subprime mortgage market is mortgage insurance. If mortgage credit worsens, these companies pay out more in insurance claims.
SOURCE: North County Times