Will 2006 be a subprime year?

Author:Schneider, Howard
Position:Broker Business

Subprime lending skyrocketed in 2004, even as rising rates slammed into the refinancing boom. Borrowing by credit-challenged consumers grew almost 60 percent that year, and accounted for 19 percent of total originations, according to trade publication Inside B & C Lending. Yet refinancing volume shrank in 2004 by more than 40 percent, according to the Mortgage Bankers Association (MBA).

Today, close to one in five home loans is subprime, reports bond analyst firm Fitch Ratings, New York. Ten years ago, sub-prime mortgages made up just 5 percent of all loans. Bonds backed by riskier loans have more than doubled since 2001, states the New York-based Bond Market Association. Aggressive lending practices--such as accepting interest-only payments on adjustable-rate loans made to sub-prime borrowers--have boosted concerns that these riskier mortgages could have unacceptably high default rates as rates go up. Rising mortgage rates have caused a recent slackening of investor demand that is translating into even higher rates and lower production for subprime lenders now.

Traditionally subprime lending has been viewed as being recession-proof. Many consumers who need to take cash out of their equity, the reasoning goes, will do so regardless of where rates are. Yet home-equity lending has begun reflecting industry cycles as it moves mainstream. Much of this is due to big lenders getting into the business, and managing for volume. Industry participants noted last year that national subprime lenders were cutting their margins thin in an effort to keep production levels up.

Yet Bloomberg.com, New York, reports that New York-based JPMorgan Chase & Co. expects subprime loan volume to drop by up to one-fourth in 2006. "Lenders that rushed to provide mortgages amid rising home prices are now stuck with loans worth less than they expected, because bond investors are demanding more protection," notes Bloomberg.com. "They are raising mortgage rates to make up the difference."

Profits fall

In 2004 New Century Financial Corporation, Irvine, California, a national subprime lender, earned 175 basis points on its originations. But it projected profit margins would fall to between 15 and 25 basis points in the fourth quarter of 2005, according to Bloomberg.com. However, New Century Chief Executive Officer Robert Cole recently told Bloomberg.com that the firm was increasing rates twice as fast for subprime borrowers as it was for other consumers.

Subprime production...

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