Fannie and Freddie to tighten policies

The two GSEs announced that new lending policies will be effective as of September 13. These come as a response to a directive issued by the federal agency overseeing the mortgages giants. Fannie Mae and Freddie Mac will require that borrowers’ ability to repay loans be evaluated more carefully. Lenders will also have to improve their risk-management practices to keep pace with the increasing risk associated with the industry.

The Office of Federal Housing Enterprise Oversight (OFHEO) which regulates the two companies, called the new rules “a significant step”. Because Fannie and Freddie buy mortgages from both banks and other financial institutions that do not fall under federal regulation, the new policies will, “create market pressure for improved standards among non-banks” according to Sheila Bair, chairman of the Federal Deposit Insurance Corp. (FDIC).

All nontraditional mortgages issued on or after September 13 will be subject to the new rules.

Low bids for Bear Stearns Hedge Funds

Investors in the Bear Stearns High-Grade Structured Credit Strategies Enhanced Leveraged Fund, one of the two troubled hedge funds that have been making the news lately, are trying to sell their holdings at fire-sale prices. Unfortunately, the best bid so far is 5 cents on the dollar, much less than the 11 cents investors hoped to get.

The other, “less geared” fund, called High-Grade Structured Credit Strategies Fund is attracting bidders at 30 cents, compared to the asking price of 70 cents on the dollar. Both these funds are backed by subprime mortgages and highly leveraged, meaning that their market price was probably much lower than their estimated value. The low bids are indicative of the risk associated with the subprime business and all securities backed by mortgages. Looks like troubles in subprime are spilling over to other sectors after all.

And now, something economists feared is already happening. Another hedge fund seems to be heading the same way as the two Bear Stearns funds. United Capital Asset Management is suspending redemptions from its Horizon funds, without liquidating them – for the time being. The funds’ manager, John Devaney, predicted the current turmoil in the sector, but couldn’t avoid running into trouble.

NovaStar reports fourth-quarter loss

On Tuesday, February 20, NovaStar, a residential lender and mortgage real estate investment trust, announced loss of $14.4 million or 39 cents per share in the last quarter of 2006. A year earlier, the company reported earnings of $26.4 million, or 84 cents a share. In after-hour electronic trading NovaStar’s shares dropped 33% to $11.81.

Earnings for 2006 were $66.3 million, a remarkable 50% drop from $132.5 in 2005. Loan origination was up 20% in the fourth quarter of 2006, and 21% higher than 2005 levels for the entire year. NovaStar specializes in subprime mortgages and, as default rates increase, it is forced to repurchase the bad loans it sold to banks earlier. This type of problem is increasingly affecting subprime lenders, who loosened their underwriting guidelines in 2006, allowing the issuing of high-risk loans. Now that borrowers are defaulting, mortgage companies are forced to buy those loans back, suffering further loss and reducing earnings estimates.

So is NovaStar the next New Century? According to Scott Hartman, Chief Executive Officer at NovaStar, probably not. Even though the repurchase requests were at record levels in the fourth quarter of 2006, the company believes its cash and available liquidity of $154 million will cover the risk for all loans sold to date. To ensure better results in 2007, the company is tightening its underwriting guidelines, enhancing the appraisal review process and avoiding loans that carry “unacceptable levels of risk”

Nevertheless, next year’s dividend could fall to $4 from $5.60 in 2006. According to company officials, there may be little to no taxable income from 2007 through 2011. The management is currently evaluating whether it is in shareholders’ best interest to abandon the company’s REIT (real estate investment trust) status, given the restrictions it imposes on the company’s operations. For 2007, NovaStar believes it will meet the REIT distribution requirements of distributing at least 90% of undistributed 2006 taxable income.

This news may be a bitter pill to swallow for NovaStar investors, but it is not as bitter as the one New Century shareholders got. It seems the end of subprime lending, or at least a significant contraction, is near.