“Creative financing” – the new way

Not so long ago Bank of America launched its “no fee” loan, which virtually waived mortgage insurance and fees for application, appraisal, loan origination, flood determination and several others. Borrowers are still required to pay some of the costs, and the interest rate is slightly higher than the average, but nevertheless Bank of Americas' terms are very, very competitive and officials claim that theirs is the best deal available.

Competitors, it seems, will follow the example. Washington Mutual now offers a flexible mortgage that allows borrowers to switch between fixed or adjustable rates without refinancing – at little or no cost. Credit unions are joining with a “home loan payment relief” loan, or HLPR. Like an adjustable-rate mortgage, it offers a reduced interest rate for the first two or three years, and then adjusts to a higher rate. Unlike an ARM, however, an HLPR is predictable, because the new rate is determined at the closing of the loan. The new rate equals the national average at the time of the initial loan, so borrowers know exactly what their payments will be long before their rate adjusts.

Eligibility for the new products is usually restricted to low- and moderate-income households and first-time homebuyers. Nevertheless, these products might at last offer the solution to subprime-lending troubles and a sensible way to finance home purchases. No more double-digit profits for lenders, but sound, smart loans that don’t take advantage of borrowers. More than 50 loan providers are out of business already, the rest are learning what it takes to survive a housing downturn.

Subprime lenders worried by high default rates

Last week some serious problems in the subprime mortgage business became evident, as a number of lenders announced higher-than-expected losses. HSBC officials said the company’s US division reported rising defaults, and New Century declared its financial results for 2006 contained accounting errors and overestimated the company’s earnings. Shares of subprime lenders saw serious declines throughout the week, exacerbating the situation for mortgage companies.

The subprime sector has been especially productive recently, with lenders looking to close as many loans as possible and allowing for lower mortgage quality. As delinquency rates begin to rise, they’re likely to start tightening their standards and raising interest rates on high-risk loans. This means that many borrowers will be unable to access credit, which may lower housing sales.

An estimated 17% of home purchases are now made using subprime loans. If these consumers are left out of the housing market, the effect will certainly be felt throughout the industry, but it’s hard to quantify the impact. The overall delinquency rate was 4.7% in 2006, up from the historic low of 4.4% in 2005. Probably not all subprime borrowers will leave the market, and economists say the reduction shouldn’t be a big problem for the industry.

Experts are optimistic in their forecasts and believe that the economy will remain stable throughout 2007, and the housing market will start to improve later in the year. Freddie Mac forecasters say the economy won’t be dragged down by the slumping Real Estate industry.

More trouble for New Century

After disclosing accounting errors on Wednesday, February 7th, New Century Financial Corporation lost nearly half its market value, as its shares dropped from a little more than $29 on Wednesday to $16.61 two days later. The company announced that it would have to restate its financial results for the first three quarters of 2006. The results had not accounted for loans returned by New Century’s investors and for their depreciation, due to the higher risk they present.

Like many lenders, New Century sells its loans to banks, to be packed into mortgage-backed bonds. The investors can send the loans back if a borrower is delinquent on his/her payments. In 2006, the company failed to account for the increasing number of payment defaults and the depreciation of returned loans. It announced that a 20% decrease in loan production is expected in 2007, in contrast to its earlier predictions of flat growth.

Since New Century shocked its investors with the news of its bad financial situation, a number of law firms filed shareholder securities class action lawsuits on behalf of investors who purchased the company’s shares between April/May 2006 and February 2007. These complaints allege that the company issued misleading statements regarding its business activity and overstated its earnings. One of the law firms will be appointed by court to prosecute the securities fraud action on behalf of the shareholders.

Countrywide Foresees a Tough 2007

Countrywide Financial, one of the US leading mortgage lenders, announced its financial results for 2006. While the overall annual results indicate a successful year, the 4th quarter performance was worse than predicted. The company Chairman Angelo Mozilo said he expects a tough 2007 “as mortgage origination volumes decline and industry capacity is rationalized”. The management is also preparing for higher delinquency levels and credit deterioration.

Nevertheless, Countrywide officials hope the company will continue to profit as smaller players leave the market or merge with larger businesses in the tough environment. The company predicts a better 2008, which should mark the beginning of an upward trend for the housing and mortgage market.

In spite of the reports, Countrywide shares went up as rumors of possible merge or acquisition by Bank of America spread late last week.

Countrywide is one of the largest residential mortgage originators in the U.S., holding a 15% market share.