Subprime fallout may widen
NEW YORK — Investors are waiting to find out how just how bad their hangover will be as thousands of loans made to home buyers with spotty credit histories have begun to look dubious in the sobriety that followed the housing bubble.
Wall Street is roundly punishing companies whose business is making so-called subprime loans and analysts say a purge of such loan makers would not be unusual. Shares of companies such as Novastar Financial Inc. and New Century Financial Corp. have been hit hardest — their stock is down 80 percent and 90 percent for the year, respectively.
“When we see downturns it is very very common for large numbers of originators to no longer be around at the end of the cycle,” said Andrew Chow, a portfolio manager at SCM Advisors LLC.
“Even if conditions improve, I would think that we would continue to see turnover in who the originators are. It’s a way of life for that sector.”
Investors are concerned that New Century Financial Corp. might soon be felled by the credit restraints that are revisiting the market, and that they will take down similar companies faced with a growing number of defaults on home loans.
New Century, which traded at around $30 per share just over a month ago, closed at $3.22 on the New York Stock Exchange Friday after falling another 66 cents, or 17.6 percent.
Investors are fleeing on concerns of a possible bankruptcy.
Lenders may now find themselves holding deeds to homes in a flat real estate market as risky borrowers are overwhelmed by mortgage payments that ballooned when tempting teaser rates expired.
New Century, already the target of shareholder lawsuits, alarmed investors Thursday when it announced one of its financial backers had turned off the funding spigot. The company said last month it had failed to keep tabs on how frequently borrowers missed payments.
Wall Street is now looking for signs that the problems of New Century and other subprime lenders will branch outward as even more banks pull back on funding.
“We’re definitely going to see fewer small companies in this space,” said Bose George, an analyst at Keefe, Bruyette & Woods Inc. “I think that happens with a combination of mergers, probably some bankruptcies as well. We’ve already seen a lot of bankruptcies of smaller lenders,”
As the market for subprime loans has grown, so has the prevalence of subprime lenders, when compared with the overall mortgage industry. During the last perilous subprime market in 1998, George estimated the market for risky loans was about $100 billion per year.
Today, it’s a $600 billion-per-year business.
Subprime loans now account for around 20 percent of the entire mortgage market, compared with only 12 to 13 percent then, George estimates.
In recent years, the hot real estate market allowed subprime lenders to thrive because they could make loans to risky borrowers who, when faced with financial trouble, simply tapped into equity in their homes for cash. Those mortgage refinancings have slowed as the real estate market cools.
Banks have repackaged subprime loans and sold them on the market in a process known as securitization.
Strong demand on the market meant subprime lenders reaped huge profits, quickly bringing risky borrowers in the front door and selling their loans out the back.
Unlike the 1980s, when savings and loan banks flamed out due to the number of bad loans on their books, there is a much larger pool of investors holding loans that could go bad, Chow said.