Economist.com article on subprime lending

[TheBreeze]

Please accept my apologies if this article from economist.com has already been discussed. Some interesting excerpts follow:

“But with rapid growth has come fragility. According to UBS, the rate of subprime-loan delinquencies of 60 days or more stood at around 8% in October, nearly double the rate of a year before. Foreclosures are also around twice as high as they were. Worse, loans are decaying remarkably quickly: the number of borrowers falling behind on payments in the first few months has leapt, to around 4% of the total.”

[Comments from TheBreeze:]It looks like the subprime lenders are getting more and more desperate. If 4% of the borrowers cannot even make the first few months’ payments, at what are likely to be much reduced rates compared to when their loan will reset, then the subprime lenders must be lending more and more to the least desirable subset of subprime borrowers.

…

“Dubious mortgages are now a growing share of the mortgage-backed market, so there is scope for more trouble. Of the $1.02 trillion of MBSs issued in the first half of this year, over 40% was linked to subprime loans, up from 6-8% in 2000-03, says CreditSights, a research boutique.

In a sign of how important the MBS market has become to Wall Street’s big securities firms, they are playing a lead role in consolidating the subprime business. Since the summer, Morgan Stanley, Merrill Lynch and Bear Stearns have all bought mortgage lenders; Lehman Brothers has acquired several in the past three years.”

[TheBreeze]This data point is very interesting to me — 40% ($400 billion) of MBSs issued in the first half of 2006 were linked to subprime loans. I wonder who is buying these risky MBSs? I’m thinking these must be coming back to the public in some manner, possibly hidden within bond funds or bought by pension funds, etc. The final bag holders may be denoted in Merrill’s, Morgan Stanley’s, and other big banks/brokers 10-Qs. I plan to look into these when I get a chance.

…

“Subprime’s woes do not—yet—amount to a financial crisis. However, there could be more pain ahead, for instance when some $475 billion-worth of adjustable-rate mortgages switch to higher rates next year. And the better-quality bits of the market are also running out of steam. HSBC, the world’s third-largest bank, has seen a deterioration across its American mortgage operations. Combined third-quarter profits for the country’s nine largest mortgage lenders were $991m, less than half the level for the same period last year.”

[TheBreeze]We know from Poway’s post that U.S. residential mortgages total $10 trillion. $2 trillion of those loans were/are schedule to reset in 2006 and 2007 beginning from March 2006. If the “$475 billion” number is correct, then $1.5 trillion in loans have reset from March 2006 to now.

How many of those borrowers were able to refinance? How many were not able to refinance and are now struggling under huge payments and will soon default? How many were able to refinance into another ARM, but need either rising home values or a reduction in interest rates to be able to refinance the next time their loans reset?

The economist tells us that subprime lending went from 6-8% in 2000-2003 to 40% today. It looks like it’s fair to say that subprime lending was the main driver of the housing bubble. Home prices may have been overvalued in the 2000-2003 timeframe, but not nearly to the extent they are today. It was all the subprime lending and exotic ARMs that got us to where we are today. As more and more subprime borrowers entered the housing market, the demand led to the run up in home prices.

However, I’m confused as to why so many loans reset last year and will be resetting this year. Aren’t most ARMs fixed for five years and then adjustable after that? So the ARMs that reset in 2006 and that will be resetting in 2007 were originated in 2001 and 2002, correct? According to The Economist, only 6-8% of MBSs were subprime in the 2000 to 2003 timeframe. Does this mean that the ARMs that are resetting in 2006/2007 were not made to subprime lenders? Would this explain the relatively low delinguency rate (~8%) for 2006’s $1.5 trillion in mortgage resets?

If I’m interpreting this data correctly, then subprime lending really took off in 2003 and was still going strong in the first half of 2006. So, should we expect the real market crash to begin 5 years from 2003 (2008) and continue until five years from 2006 (2011)?

Sorry if I’ve butchered this data. Just trying to figure out what it all means and why we haven’t seen massive foreclosures given that $1.5 trillion in mortgage loans have reset since March 2006 and interest rates have increased considerably since those loans were originated (likely in 2001).

[powayseller]

I think the most popular ARM in early 2000’s was the 2yr and 3yr ARM; thus the big resets in 2006, more in 2007, and even more in 2008.

Mortgage data is very expensive, so I doubt I’ll be able to afford any of it. Check out this excellent mortgage publication website. Just scroll through the list of articles, :

For just $1797/year, you can subscribe to Inside MBS and ABS and read this article
“Citibank’s Heavy MBS Buy in 3rd Quarter Boosts Thrift Industry’s Mortgage Securities Holdings
Thrift industry MBS investment jumped sharply higher in the third quarter because one of the globe’s largest banking giants parked a huge volume of newly acquired mortgage securities in one of its thrift charters. Citibank (West) FSB, a… [Includes two charts]”

“Mortgage Brokers Drive a Sluggish Subprime Market Through 3Q 2006
Mortgage brokers have provided most of the muscle – such as it is – for the subprime market this year, a new snapshot of the business reveals. But brokers are clearly feeling some heat as the year comes to a close because the regulatory spotlight continues…”
to read more, pay Inside B&C Lending, $794/year

“OCC: Lenders not Obeying Guide as Expected
Federal regulators are about to get tougher on originators of nontraditional mortgage products for being slow to adopt underwriting practices recommended in federal interagency guidelines issued more than two months ago to protect consumers. Regulators, the Office of…”
to read more, you have to subscribe to Inside Regulatory Strategies for $571/year

For $50, you can read just one article. How many reporters, other than those backed by Business Week or the Economist, can afford those hefty fees? I bet the U-T isn’t going to let Dean Calbraith spend that kind of money. Would the Voice of San Diego? What is in those articles?

I believe if some bloggers had access to the data, they could paint a doomsday scenario of epic proportions.

[powayseller]

“…a large portion of the sub-prime loans are two-year adjustables, says Berson, the Fannie Mae chief economist.”

$2.5 trillion in adjustable loans is coming due over the next 2 years, according to Paul Kasriel, chief economist at Chicago-based Northern Trust. I think nobody really knows how much will come due. How many of the original borrowers refinanced, so that not all 3yr ARMs made in 2004 will come due in 2007.

“Berson offered a typical example of what the industry calls a “2-28,” an ARM in which the interest rate is fixed for the first two years and then adjusts regularly for the next 28 to whatever index the loan calls for. The average yearly cap on this loan is 2.3 percentage points per year.

Roughly speaking, a consumer’s monthly bill could rise from $330 to as much as $1,425 to $1,755.

Fannie Mae expects sub-prime loans to be reset en masse this year with that trend continuing into 2007.

But over at the Mortgage Bankers Association, senior economist Michael Fratantoni is more interested in the five-year adjustables that were issued during the refi craze of 2002-03. That’s a large crop that will sprout in 2007.

“The estimate is that in 2007, more than a trillion dollars worth of hybrids are going to hit their first reset date,” he said.

That one chunk of hybrid loans represents 12 percent of the $8.8 trillion in single-family home loans outstanding nationwide.” – Mish’s Site, from the HeraldTribune

We are reminded in the article that cheap and easy credit is not a given. People think they can always refinance, but when credit cycles contract, that is not the case.

[TheBreeze]

Thanks for the extra data points, Poway. Your posts always contain excellent info.

[PerryChase]

Thanks for the link to the article. I get the magazine but don’t have time to read everything.

The article makes me think of how China’s banking system is in bad shape and may not survive economic shock because they never developed a good risk/credit management system. In America we have a good credit reporting system but the lenders threw that out the window and lent money willy nilly to boost origination fees/income. By the time the FBs default the mortgage executives would have pocketed their bonuses and been long gone.

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