That Sinking Feeling

An article in BusinessWeek yesterday indicates that the fallout from subprime loan defaults could have implications for the overall economy.

The gathering storm clouds over the nation's housing and lending markets grow darker each day. Fueling the latest concerns is further fallout in the subprime mortgage loan market, where lenders offer financing to less-creditworthy buyers.

Global banking giant HSBC Holdings (HBC), the third largest subprime lender in the U.S., disclosed on Feb. 7 that full-year 2006 impairment charges at its U.S. mortgage unit would be 20% higher than the $8.8 billion or so that analysts had been projecting. On Feb. 8, New Century Financial (NEW), the nation's second largest lender to subprime borrowers, said it expected to report a loss for the fourth quarter, and that it would have to restate its financial results for the first three quarters of 2006 (see BusinessWeek.com, 2/9/07, "Subprime Time Bomb"). Another subprime lender, ResMAE, filed for bankruptcy on Feb. 13, bringing the total failures to 21 since December, according to www.ml-implode.com, reports Action Economics.

Wrong-footed by the rapid deterioration in subprime loans, primarily those originated in 2006, lenders such as New Century have had to buy back a growing portion of these loans, which they had sold to investors and other financial institutions, because of faster-than-expected defaults. HSBC particularly identified second-lien or "piggyback" loans (loans made above a first mortgage, generally to help buyers come up with downpayments) in its mortgage book as those that could be hurt by higher interest rates as adjustable-rate mortgages (ARMs) reset over the next few years. HSBC acknowledged that some borrowers face fewer refinancing options amid slowing growth in home prices, and limited if any appreciation in their home equity.