Friday, February 23, 2007

Shares of subprime lenders tumble

On Wednesday, February 21st, a number of subprime lenders saw their shares tumble in response to news of financial instability at NovaStar, the 19th largest subprime lender. NovaStar stocks dropped 39% since the news came out, to reach $10.68, as shares of New Century Financial declined 7% to $17.45 and those of Countrywide Financial went down 2.4% to $40.66.

Stocks of nearly all subprime mortgage lenders have been falling sharply during the past few months, as a response to deteriorating market conditions, but they are not the only sign of trouble in subprime lending. Approximately 1 out of 10 sub-prime mortgages has defaulted by the end of 2006, and banks are forcing mortgage companies to repurchase the bad loans. Since a large percentage of mortgages originated in 2006 are either “stated income” (which means that borrowers don’t have to provide proof of their income) or “interest-only” (where borrowers can pay the interest alone for a certain initial period), the risk of delinquencies is incredibly high and investors are pulling their funds out of the subprime mortgage market.

Now that lenders are tightening their underwriting standards, origination numbers are slowing down, but so are loan purchases by banks. HSBC announced it would have to spend more than expected on loan repurchase, New Century reported 4th quarter loss and said it would have to restate its income for the previous 3 quarters due to accounting mistakes, Accredited and NovaStar posted loss in the 4th quarter as well. Countrywide is stronger financially but high numbers of delinquencies will affect its stability too.

This is yet another installment in the wave of bad news that flooded the subprime market since the end of 2006. As lenders adhere to higher standards, loan origination volumes drop but loan quality increases. Loan providers predicted a tough 2007, but for some it proved tougher than expected. Several dozen smaller lenders have closed down or been sold recently in the challenging market environment. LoanCity closed seven branches, leaving 5 still operating, due to a “softer market”. Wells Fargo is cutting 250 jobs at its Fort Mill, S.C., offices, because lower origination volumes are expected due to tightening of policies.

The current situation is a challenge for subprime lenders, but it will eventually lead to improvements in the industry sector altogether. As the housing market shrinks, so does the demand for mortgage loans and some companies find themselves with little or no work to do. By the end of the year, we’ll probably see stricter mortgage standards and fewer lenders still operating in the new market realities.

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