Tuesday, March 20, 2007

Sub-Prime lending: great candidates for Chapter 13

The following article recently appeared on Bloomberg.netregarding the recent trend in sub-prime mortgage lending, and its dire consequences. We have definitely seen a surge in Chapter 13 bankruptcies due to this practice. Take caution when biting off more than you can chew!

Foreclosures May Hit 1.5 Million in U.S. Housing Bust

By Bob Ivry

March 12 (Bloomberg) -- Hold on to your assets. The deepest housing decline in 16 years is about to get worse.

As many as 1.5 million more Americans may lose their homes, another 100,000 people in housing-related industries could be fired, and an estimated 100 additional subprime mortgage companies that lend money to people with bad or limited credit may go under, according to realtors, economists, analysts and a Federal Reserve governor. Financial stocks also could extend their declines over mortgage default worries.

The spring buying season, when more than half of all U.S. home sales are made, has been so disappointing that the National Association of Home Builders in Washington now expects purchases to fall for the sixth consecutive quarter after it predicted a gain just last month.

``The correction will last another year,'' said Mark Zandi, chief economist for Moody's in West Chester, Pennsylvania. ``Fewer people qualifying for mortgages means there will be less borrowers, and that will weigh on demand.''

A five-year housing boom that ended in 2006 expanded home- ownership to a record number of U.S. households. Now it has given way to mounting defaults, failing subprime mortgage companies and an increasing number of unsold homes.

Last Housing Slump

If this slump follows the same pattern as the last one, in 1991, it will persist for at least another year and may fuel a recession. New-home sales declined 45 percent from July 1989 to January 1991 and about 1 percent of all U.S. jobs, or 1.1 million, were lost in that recession, said Robert Kleinhenz, deputy chief economist of the California Association of Realtors.

This time around, new-home sales have declined 28 percent since September 2005, hitting a low in January, the last month for which data is available. And though the national jobless rate is near a five-year low this month, mortgage-related jobs fell by almost 2,000 in January alone. At least two dozen of the more than 8,000 mortgage lenders have been forced to close or sell operations since the start of 2006.

Subprime lenders Ameriquest Mortgage Co. in Irvine, California; Ownit Mortgage Solutions LLC and WMC Mortgage Corp., a subsidiary of General Electric Co., in Woodland Hills, California; Mortgage Lenders Network USA Inc. in Middletown, Connecticut and Fremont General Corp. together have fired more than 5,600 workers in the past year.

New Century

New Century Financial Corp., the second-largest subprime lender, said today it ran out of cash to pay back creditors who are demanding their money now. The Irvine, California-based company has lost 90 percent of its market value this year and stopped making new subprime loans, prompting speculation it will seek bankruptcy protection. New Century already has cut 300 jobs and its 7,000 remaining employees are waiting to see if the company will survive.

Fremont General, the Brea, California-based lender that is trying to sell its residential-mortgage unit, was ordered to stop making subprime loans by the U.S. Federal Deposit Insurance Corp. last week. Fremont was marketing and extending loans ``in a way that substantially increased the likelihood of borrower default or other loss to the bank,'' the FDIC said last week.

Doug Duncan, chief economist of the Washington-based Mortgage Bankers Association, predicted in January that more than 100 home lenders may fail this year.

The subprime crisis ``has taken the fuel out of the real estate market,'' said Edward Leamer, director of the UCLA Anderson Forecast in Los Angeles. ``The market needs new money in order to appreciate, and all of that money is gone for a very long time. The regulators are not going to allow it to happen again.''

Higher Rates

Subprime mortgages are given to people who wouldn't qualify for standard home loans and typically have rates at least 2 or 3 percentage points above safer prime loans. The portion of subprime loans that financed new mortgages rose to 20 percent last year from 5 percent in 2001, according to the Mortgage Bankers Association.

Subprime loans contributed to a home-ownership rate that reached a record 69.3 percent of U.S. households in the second quarter of 2004, up 5.4 percentage points from the same period in 1991, according to the U.S. Census Bureau.

``Probably the gain in home ownership over the last four, five years, is almost entirely due to looser lending standards,'' said James Fielding, a homebuilding credit analyst at Standard & Poor's in New York.

Refinancing Option

As home prices steadily gained from 2001 to 2006, homeowners who fell behind on mortgage payments could sell their homes and pay off their loans or get better refinancing terms based on the higher value of their property. Now that home values are declining, many borrowers won't be able to refinance because they would have to come up with the difference between their new mortgage and what their home is now worth.

Defaults may dump more than 500,000 homes on a housing market already saturated with leftover inventory built during boom times, New York-based bond research firm CreditSights Inc. said in a March 1 report.

Mortgage defaults may climb to $225 billion over the next two years, compared with about $40 billion annually in 2005 and 2006, according to debt strategists at Lehman Brothers Holdings Inc.

Seven-Year High

The portion of subprime loans more than 60 days delinquent or in foreclosure rose to 10 percent as of Dec. 31, from 5.4 percent in May 2005, the highest in seven years, according to data compiled by Friedman Billings Ramsey Group Inc. of Arlington, Virginia.

Many of the delinquencies came from loans where borrowers didn't have to provide tax returns or other evidence of income, or where they financed 100 percent or more of the home's value, CreditSights analyst David Hendler wrote in a March 5 report. Other defaults came on adjustable-rate mortgages with artificially low introductory ``teaser'' rates, sometimes with ``option'' payment plans that allowed borrowers to defer interest.

Banks ought to be concerned about such loans and are likely to see more missed payments and foreclosures as consumers with weak credit histories begin to face higher monthly mortgage payments, Federal Reserve Governor Susan Bies said last week.

``What we're seeing in this narrow segment is the beginning of the wave,'' Bies said. ``This is not the end, this is the beginning.''

About 1.5 million U.S. homeowners out of a total of 80 million will lose their homes through foreclosure, University of California-Berkeley economist Ken Rosen said last week.

``The subprime borrowers paid too much for their homes, and all of a sudden, they'll see their house value drop by 10 to 15 percent,'' Rosen said.

Borrowers at Risk

The Center for Responsible Lending in Durham, North Carolina, said in a December study that as many as 2.2 million borrowers are at risk of losing their homes, at a potential cost of $164 billion, from subprime mortgages originated from 1998 through 2006.

The number of U.S. foreclosures rose 42 percent to 1.2 million last year from 2005, according to Irvine, California-based RealtyTrac, while delinquencies in the last three months of 2006 rose to the highest level in four years, the Federal Reserve said.

Housing and related industries, which account for about 23 percent of the U.S. economy -- including makers of everything from copper pipes to kitchen cabinets -- fired about 100,000 workers last year. The total will be higher this year, according to Amal Bendimerad of the Joint Center for Housing Studies at Harvard University in Cambridge, Massachusetts.

Job Cuts

By the end of this year, job cuts at companies including Benton Harbor, Michigan-based Whirlpool Corp., Masco Corp. of Taylor, Michigan, and St. Louis-based Emerson Electric Co. may exceed the fallout from the 1991 housing slump, said Paul Puryear, managing director at St. Petersburg, Florida-based Raymond James & Associates. The Bureau of Labor Statistics doesn't give data for housing-related job losses.

``The fallout in the early 1990s was much worse than what we've seen so far, but this downturn is not over,'' Puryear said. ``The full impact hasn't hit yet.''

U.S. House Financial Services Committee Chairman Barney Frank, a Massachusetts Democrat, said he may propose legislation to reign in ``inappropriate'' lending, and a House subcommittee is scheduled to consider subprime lending and foreclosures March 27.

``The standards got loosened so much, and there's always the pressure to make money that there was pressure to maybe make the questionable loans that shouldn't have been made,'' said Ohio Representative Paul Gillmor, the subcommittee's top Republican, in a March 9 interview. ``The major problem has been the overall deterioration in credit standards by lenders that's exacerbated by those who are unscrupulous.''

Fraud `Pervasive and Growing'

The Federal Bureau of Investigation says mortgage fraud is ``pervasive and growing'' and the incidence of such fraud has almost doubled in the past three years.

``There has been an increase in unscrupulous individuals in the market,'' said Arthur Prieston, chairman of the Prieston Group, a San Francisco-based company that investigates mortgage fraud. ``There's an unfair assumption of a connection between subprime failure and fraud. But there is a connection between early default and fraud.''

Mortgage fraud is committed when a borrower misrepresents himself or his finances to a lender. Some of that fraud involved speculators. They drove up prices during the boom by ordering new homes with the intent of selling them immediately after taking possession.

That ``flipping'' inflated demand and put the speculators in competition with the homebuilders, propelling the median U.S. home price to $276,000 last June from $177,000 in February 2001.

Housing Bubble

``A lot of the housing bubble was speculation,'' said Mike Inselmann of the Houston-based research firm Metrostudy.

When home prices got so high that speculators could no longer turn a profit, they canceled their contracts and walked away from their down payments.

Cancellation rates for new homes have surged to almost 40 percent of home contracts, Margaret Whelan, a New York-based analyst at UBS AG, said in a report on March 2.

That forced the top five U.S. homebuilders -- D.R. Horton Inc., Pulte Homes Inc., Lennar Corp., Centex Corp. and Toll Brothers Inc. -- to write off a combined $1.47 billion on abandoned land in the fourth quarter of 2006.

On top of that, new home sales plunged 17 percent last year from 2005, the biggest decline since 1990, according to the Chicago-based National Association of Home Builders. Existing home sales fell 8.4 percent in 2006 from a record in 2005, according to the National Association of Realtors.

`All 12 Months'

Donald Tomnitz, D.R. Horton's chief executive officer, said last week that his Fort Worth, Texas-based company would miss its projections for this year and that ``2007 is going to suck, all 12 months of the calendar year.''

A Standard and Poor's index of 16 homebuilders tumbled 4.1 percent today, its biggest decline since August, on concerns over increasing inventory and subprime defaults. The index has fallen 12 percent since Jan. 1.

D.R. Horton shares fell 5.1 percent today in New York Stock Exchange composite trading. Bloomfield Hills, Michigan-based Pulte dropped 4.8 percent; Lennar, based in Miami, dropped 4.9 percent; Dallas-based Centex lost 3.7 percent and Toll, based in Horsham, Pennsylvania, fell 3 percent.

Concern that the housing slump and defaults in the subprime mortgage industry will affect earnings at the largest banks and lenders has hurt financial stocks. They are the worst performers in the Standard & Poor's 500 Index since the benchmark reached a six- year high on Feb. 20. The group lost 5.6 percent, outpacing the broader index's 3.9 percent drop.

Investment banks including Merrill Lynch & Co., Deutsche Bank AG and Morgan Stanley have spent more than $4 billion over the past year to buy home-loan companies as add-ons to their mortgage-bond trading businesses. They needed loans to repackage into securities to sell to investors. Demand for higher yields led them into the subprime market. As that business flourished, financial firms either invested in subprime lenders of bought them.

`Too Early to Tell'

The number of U.S. financial institutions in the mortgage business jumped 16 percent to 8,848 in the past four years, according to the Federal Financial Institutions Examination Council.

``It's a little too early to tell how it shakes out for investment banks,'' said Andrew Davidson, president of New York- based Andrew Davidson & Co., which advises fixed-income investors on mortgage bonds. ``If it turns out that they have large losses, the investment banks tend not to be very forgiving and usually terminate businesses that haven't worked for them.''

Dale Westhoff, a senior managing director at New York-based Bear Stearns Cos., the largest underwriter of mortgage bonds, said last week that failing subprime lenders ``are going to be absorbed very quickly.''

``Hedge funds and private equity are going to play a very important role in buying distressed assets,'' Westhoff said.


In contrast to the 1991 housing skid, worker productivity is increasing, consumer confidence is expanding, interest rates remain within 1 percentage point of the 40-year low and the jobless rate fell to a five-year low last month. Last month, 7.4 million new and existing homes were sold at an annualized pace, more than twice the 1991 bottom.

And real estate people tend to be the world's most optimistic, said Bryce Bowman, director of development for Randolph Equities LLC in Chicago.

``There's a lot of capital chasing real estate and that has not ceased with this bust,'' Bowman said. ``Developers have stopped building crazy speculative housing developments and are burning off their inventory, so we're excited about the end of '07, and we want to be ready to go when business picks up in '08.''

To contact the reporter on this story: Bob Ivry in New York at .
Last Updated: March 12, 2007 16:37 EDT
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