Saturday, February 10, 2007

Another Look at Sub-Prime Mortgages

From the Street.com

Nationwide, the subprime default rate soared to 10.09% in November 2006 -- it stood at only 6.62% a year earlier). Despite a growing economy in early 2007, November's industry default rate exceeded the level of November 2001, which was recorded at the bottom of the last recession. However, the problem runs deeper than 5 1/2 years ago because nearly 15% of the mortgages made in 2006 were subprime. That is almost triple the penetration of subprime compared to 2000-01.

* Subprime has never been more levered -- just as the housing cycle has peaked. Loan-to-value ratios have risen from about 78% in 2000 to 86% today.

* Subprime has never been more dependent on the candor of borrowers. Low-documented loans have doubled to 42% of subprime loans over the last six years.

* Creative loans -- non-interest paying, option ARMs, etc. -- represented nearly half of all loans made over the last 12 months. At the turn of the decade these loans represented less than 2% of total mortgage loans!


Notice the really large jump in sub-prime mortgage (SPM) delinquencies. This is not a simple statistical anomaly; it's a really big jump that should raise a lot of eyebrows.

Now combine that with the increased penetration of SPMs + the increase in low documentation loans and the problem looks worse.

Now add to that the fact that an economy growing at 3.5% has a default rate above the level recorded during a recession.

One of the stock boards I watch and participate in was speculating that yesterday's news from NEW and HSBC was the watershed event of this quarter, signaling the beginning of a downturn. I'm not sure I would go that far in my prognosis, but I do believe we are just seeing the beginning of this problem. Up until now housing has only damaged housing; we haven't seen the housing downturn bleed into consumer spending. Once we start to see that in a major way, we'll have serious problems.