Default Jitters Batter Shares Of Home Lenders
Risky Mortgages Spark Concerns, Uncertainty About Fallout on Bonds
By JAMES R. HAGERTY and RUTH SIMON
February 9, 2007; Page A1
Default worries are growing at the risky end of the mortgage market.
Those worries sent some home lenders' shares plunging yesterday and
highlighted uncertainties about how many investors in mortgage-backed
securities might be vulnerable.
New Century Financial Corp. shares dropped $10.92, or 36%, to $19.24
in 4 p.m. composite trading on the New York Stock Exchange after the
big Irvine, Calif., lender disclosed late Wednesday that it expects to
report a fourth-quarter loss and will restate results for the previous
three quarters to correct accounting errors.
New Century is one of the nation's biggest specialists in "subprime"
mortgage loans, or home loans for borrowers with weak credit
histories. The company blamed its woes on"the increasing industry
trend of early-payment defaults," those that occur within the first
few months after a loan is made.
Shares of other subprime lenders, including Fremont General Corp. and
NovaStar Financial Inc., also plummeted. The combined market value of
seven U.S.-based lenders active in the subprime market dropped more
than $3.7 billion yesterday.
Contributing to the selloff was an announcement, late Wednesday, by
British banking giant HSBC Holdings PLC that problems in its
subprime-mortgage business were worse than previously indicated.
Yesterday, shares of HSBC, whose operations extend well beyond the
subprime sector, fell $2.44, or 2.7%, to $89.78 in 4 p.m. Big Board
composite trading.
Many in the industry are wondering how well investors in
mortgage-backed securities will cope as delinquencies rise. Lenders
quickly sell most subprime mortgage loans to packagers of securities,
such as investments banks, or directly to investors. The riskiest of
those securities, those that absorb some of the first losses from
defaults, are typically sold to money managers and hedge funds in the
U.S. and abroad.
"The thing none of us know, including the [Federal Reserve], is who is
holding this stuff," Richard Kovacevich, chief executive of Wells
Fargo & Co., one of the nation's biggest mortgage lenders, said in a
recent interview."The assumption is that it is well-diversified. If
it's concentrated, it's going to be a disaster."
. . . . . . . . . . . . . . . . . . . .
A report issued by Credit Suisse on Wednesday found that nearly one in
four subprime mortgage deals issued in 2006 had a delinquency rate of
at least 8% as of December. The analysis looked at loans that were at
least 60 days past due.
. . . . . . . . . . . . . . . . . . . .
As a result [of accounting scandals], the two companies' [Fannie Mae
and Freddie Mac's] share of the market has plunged to about 40% at the
end of last year from 70% in 2003, according to Inside Mortgage
Finance, a trade publication.
When Fannie and Freddie dominated the market, Mr. Ranieri says, they
generally set the standards for what types of loans would be made.
Now, those standards are largely set by the risk appetites of
thousands of hedge funds, pension funds and other money managers
around the world. Emboldened by good returns on mortgage investments,
they have encouraged lenders to experiment with a profusion of loans.
Many subprime borrowers aren't required to prove their financial
health with tax forms or other documents. Lenders also sometimes rely
on computer programs, rather than human appraisers, to estimate the
value of homes.
. . . . . . . . . . . . . . . . . . . .
In November, payments were at least 60 days overdue on 12.9% of
subprime loans packaged into mortgage securities, up from 8.1% a year
earlier, according to First American LoanPerformance, a research firm
in San Francisco.
Another innovation of recent years -- the collateralized debt
obligation, or CDO -- has made it possible for far more investors to
make bets on U.S. mortgages. They are akin to mutual funds. By
investing in a single CDO, investors can gain exposure to hundreds of
different mortgage securities of varying quality.
CDOs buy the bulk of the lower-rated rungs of subprime-mortgage
securities, those that take some of the first hits if defaults are
higher than expected, says Kedran Garrison, a CDO analyst at J.P.
Morgan Chase& Co. CDOs are especially attractive to investors in
Europe and Asia, as well as many in the U.S. But there is no way to
identify the biggest holders of CDO notes and shares or to know how
well they understand the risks and have hedged themselves.
That could be a problem for regulators. In 1998, the Fed convened
investment banks and worked out a rescue plan for hedge fund Long Term
Capital Management LP, which was on the verge of collapse. But in
today's splintered mortgage-securities market, the Fed wouldn't be
able to"get the involved players into a room" to work out a plan to
help a distressed institution sell off assets in an orderly manner,
says Josh Rosner, managing director of Graham Fisher& Co., a New York
investment research firm.
A spokeswoman for the Fed declined to comment.
CDOs aren't the only ones on the hook. Hedge funds, mortgage
real-estate investment trusts and the trading desks of Wall Street
firms are among those that could be hurt if their bets on the mortgage
market don't turn out as planned.
Write to James R. Hagerty atbob.hagerty@wsj.com2and Ruth Simon
atruth.simon@wsj.com3
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