Liz Moyer, Forbes.com, 03.14.07
News out of the subprime mortgage sector continues to worsen, as New Century Finance, already teetering toward bankruptcy, announced new regulatory probes and Massachusetts-issued subpoenas to two big securities companies for information on their research into the business.
A broad swath of investors shuddered on the news and continued uncertainty about just where the subprime shakeout was headed, and whether it would become a marketwide contagion.
Subprime mortgage originations made up 20% of all mortgages in the last two years. Last year alone, 40% of adjustable rate mortgages and interest-only loans were categorized as subprime. Historically, subprime loans have been just 10% to 12% of the overall market.
The Mortgage Bankers Association said Tuesday that subprime delinquencies rose to 13.3% in the fourth quarter from 12.5% in the third.
But from a bond market analyst's perspective, fears of a broader contagion are overblown. Just 1% of the mortgage bonds securitized so far this year and rated by Moody's Investor Service have been downgraded or put on watch, for example. That's out of $149 billion securitized since January.
Panic? What panic? "In view of how the laws of probability have yet to be repealed, a steep jump by subprime mortgage loans share of total mortgage originations from the 9% of 1996 to 2000 to the 21% of 2004 to 2006 practically assured an upward shift in mortgage delinquencies," wrote Moody's in a report Tuesday.
"The recent fallout in credit quality demonstrates that this market segment grew beyond its limits," said Standard & Poor's in a similar research note Tuesday.
As if to prove their point, the bond ratings agencies noted that delinquencies in the prime loan market had risen, but not by as much and not nearly at the magnitude of the subprime sector. Prime loan delinquencies were 2.57%, up from 2.44% in the third quarter, according to the Mortgage Bankers Association.
That's certainly not going to make employees of New Century feel better, however. New Century said Tuesday that several other lenders had reported it's in default of loan agreements, adding that the Securities and Exchange Commission has requested documents and was starting an investigation. The troubled Irvine, Calif., lender said previously that it is the subject of a criminal investigation by the Department of Justice.
Massachusetts securities regulator, William Galvin, said Tuesday he had demanded records of what went into analyst research at UBS and Bear Stearns on New Century and the subprime sector, citing a surge in foreclosures in his home state.
Galvin said in a television interview Tuesday afternoon that he was concerned there might have been conflicts at the brokerage companies that corrupted the analysis. UBS and Bear Stearns are active participants in the mortgage securitization business, and UBS was one of the lenders who said Tuesday that New Century was in default.
"We thought we put this kind of mistake behind us with the tech bubble," Galvin said.
He said on television Tuesday afternoon that he expected the companies would cooperate. A UBS spokeswoman said, "UBS just received the subpoena and is reviewing it. It is too early for us to comment. As a general matter, the firm is proud of its track record in research." A spokesman for Bear Stearns couldn't immediately be reached.
And two more lenders, GMAC (owned by General Motors and Cerberus) and Accredited Home Lenders, disclosed their own struggles on Tuesday. GMAC's Rescap unit announced a $651 million loss in the fourth quarter, compared with a $188 million profit last year. It said had curtailed new loans and stepped up "loss mitigation." Accredited Home Lenders said it was trying to raise capital.
Still, bond ratings agencies that assess the risks to the broader market said the damage seems to be relatively contained to a few subprime lenders, like New Century, with portfolios that are heavily concentrated in the subprime sector. The spike in delinquencies are coming off historically good credit quality in 2004, they note, and the levels of delinquencies aren't terribly higher than they were in the last subprime lending crisis of 1999 to 2000.
"The subprime mortgages experiencing the weakest credit performance are a small subsegment of this market and one with the highest layering of underwriting risk," S&P said Tuesday.
Layering of risk means the borrowers courted by these lenders had multiple characteristics that would put them at high risk for default, including no down payment, no documentation of income or assets, low credit scores and second mortgage in lieu of a down payment. In other words, the riskiest of the risky.
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