Mortgage Daily

Published On: December 24, 2007

In prophetic comments delivered just over a year ago, Freddie Mac’s chairman and chief executive officer warned mortgage bankers that too much capital was chasing too little product. Since that time, the residential subprime sector has unraveled — destroying an industry that, during the past quarter century, had gone from the shadows of mortgage lending to the forefront. Losses, which have spread far beyond U.S. subprime lenders and have wiped billions of dollars off the balance sheets of international financial institutions, may continue into 2009.

With a base of players in the early 1990’s that included Associates First Capital Corp., Beneficial Inc. and Household Finance Corp., subprime lenders were largely detached from mainstream mortgage lending, which had developed standard documentation that enabled loans to easily pass from one investor to another.

But an increase in investor appetite for higher yielding fixed income investments with relatively high ratings fueled an increase in new subprime mortgage originators, both wholesale and retail, who began packaging loans for securitization. Investors bought chunks of highly rated residential mortgage-backed securities populated with pools of subprime loans.

While overall residential originations went from around $1 trillion in 1993 to approximately $3 trillion in 2005, subprime production soared from around $20 billion to more than $600 billion during that same period.

In the process of such rapid growth, banks, hedge funds and investment banking firms accumulated billions of dollars in subprime mortgage securities. Investors from around the globe acquired investments in the riskiest U.S. borrowers.

But as U.S. home appreciation slowed last year, the most recent batch of new subprime borrowers — who had riskier loan characteristics and little invested in their properties — started to see their loan balances exceed their property values. Some just stopped making their payments, seeing evaporating equity as a lender’s problem.

Others had regularly used the growing equity in their homes to re-fuel capital needs through home-equity loans. The ongoing access to such capital enabled such borrowers to pay off other debt, such as high-rate credit cards and high-payment auto loans, while even enabling retail purchases. But as appreciation and credit access evaporated, this segment of borrowers was left to face the music — helping drive delinquency even higher.

“Given what we’re going through, we’re all kidding ourselves about what’s likely to ensue when a lot of product rolls over [next year] and there are questions,” Richard Syron, chairman and CEO at Freddie, told mortgage bankers meeting in Chicago during October 2006.

“It’s going to be a fairly tough correction,” Syron said at the time. “The long and the short of it is that, in financial services as a whole, there’s too much capital chasing too little product. We’re all going to get squeezed out on the risk curve; many already have. We’ll have to pay a lot of attention to that now because we’re entering into a different period of time [when] everything is priced to perfection.”

One of the first subprime lenders to collapse last year was Meritage Mortgage. Parent NetBank Inc., which itself was shut down by the Office of Thrift Supervision in September, announced in November 2006 that it would close Meritage in a plan to “exit or spin off any underperforming or noncore businesses.”

Next was Sebring Capital Partners LP, which stopped accepting new business in December 2006. The Dallas-based wholesaler was initially capitalized with the help of legendary Dallas Cowboy quarterback Roger Staubach.

But the collapse of Ownit Mortgage Solutions one week later was the first real hint of the turmoil that would follow.

The Agoura Hills, Calif.-based company had touted earlier in the year that it had 11,500 approved mortgage brokers, was licensed in 41 states and employed 600 people. Its share of the subprime market was 1.5 percent and one of its investors was Merrill Lynch.

Within a few weeks of Ownit’s collapse, Alliance Home Funding LLC, Harbourton Capital Group Inc. and Preferred Advantage would shut down.

By the following month, Mortgage Lenders Network threw in the towel — raising the level of intensity another notch, followed by Popular Inc., Clear Choice Financial Inc. and Mandalay Mortgage.

Even with all the turmoil that was emerging in the subprime sector, Doug Duncan, the chief economist of the Mortgage Bankers Association, predicted in mid-January this year that the housing slowdown would end this past summer — though he did warn of some decline in the nonprime market.

But by the time subprime giant New Century Financial Corp. stopped taking new applications in March, dozens of mid-sized lenders ended operations as foreclosures steadily rose.

Other big subprime lenders to subsequently shut down included Aegis Mortgage Corp., Ameriquest Mortgage Co., Option One Mortgage Corp. and WMC Mortgage.

The damage has spread well beyond subprime lenders.

Firms that invested in subprime RMBS have been taking write-offs by the billions. Among them are big U.S. banks.

Citigroup Inc. warned last month its subprime losses could reach $11 billion, ousting its chairman and CEO in the process. Wachovia Corp. said it anticipates that writedowns tied to securities backed by residential subprime mortgages and in collateralized debt obligations in October and November will equal the $1.34 billion pretax loss reported for the entire third quarter, while fourth quarter charges are estimated at $1 billion. Bank of America Corp.’s chairman and CEO said he sees about $3.3 billion in mostly mortgage-related fourth quarter charges. Washington Mutual Inc. disclosed it will take more than $5 billion in charges at its home loan unit.

Mortgage write-downs are taking a big toll on investment bankers too.

Merrill Lynch & Co. Inc. is expected to take $9 billion in mortgage charges this year, Bear Stearns & Co. Inc. reported a fiscal fourth quarter write-down $1.9 billion in mortgage-related investments, and Lehman Brothers Holdings Inc. reported in its fourth quarter earnings mortgage related charges of $3.5 billion. Just last week, Morgan Stanley reported it took a $9.4 billion writedown on U.S. subprime mortgages and other mortgage related exposures during the fiscal fourth quarter ended Nov. 30.

The write-downs on U.S. mortgage investments have not been limited to North America.

Switzerland-based UBS announced earlier this month a $10 billion write-down of its U.S. subprime mortgage investments. UBS’s disclosure followed Royal Bank of Scotland’s announcement it expects writedowns of over $2.4 billion during the second half of 2007. Barclays announced in November that it would write down by nearly $2.7 billion the value of notes Barclays Capital issued to reflect the impact of rating agency downgrades on collateralized debt obligations and the subsequent market downturn.

Freddie’s Syron said earlier this month that Wall Street sees as much as $17 billion in losses at the McLean, Va.-based secondary lender over the next two years, though Freddie’s internal estimates call for only up to $12 billion. And so far this quarter, credit deterioration has cost American International Group Inc. about $3.75 billion.

Syron sees the market getting worse before it improves, especially because of a possible shift in consumer confidence and the possibility of employment worsening.

As millions of subprime ARM borrowers face payment resets through next year, foreclosures are likely to impact real estate market at least until 2009.

Next year, subprime originations are projected to be just $200 billion — less than one-third the level in 2005.

More importantly, the dismemberment of subprime production and securitization facilities has ensured than any return to the troubled sector will be slow and devoid of the executives and culture that built it the first time around.

FREE CALCULATORS TO HELP YOU SUCCEED
Tools for Your Next Big Decision.

Amortization Calculator

Affordability Calculator

Mortgage Calculator

Refinance Calculator

FHA Mortgage Calculator

VA Mortgage Calculator

Real Estate Calculator

Tags

Pre-Approval Resources!

Making well educated decions in a matter of minutes and stay up to date on the latest news Mortgage Daily has to offer. Read our latest articles to stay up to date on what’s going on…

Resource Center

Since 1998, Mortgage Daily has helped millions of people such as yourself navigate the complicated hurdles of the mortgage industry. See our popular topics below, search our website. With over 300,000 articles, we are guaranteed to have something for you.

Your mortgages approval starts here.

Add 1-2 sentence here. Add 1-2 sentence here. Add 1-2 sentence here. Add 1-2 sentence here. Add 1-2 sentence here.

Stay Up To Days with Today’s Latest Rates

Mortgage

Today’s rates starting at

4.63%

5/1 ARM
$200,000 LOAN

Home Refinance

Today’s rates starting at

4.75%

30 YEAR FIXED
$200,000 LOAN

Home Equity

Today’s rates starting at

3.99%

3 YEAR
$200,000 LOAN

HELOC

Today’s rates starting at

2.24%

30 YEAR FIXED
$200,000 LOAN