U.S. urges caution on subprime loans

By Becky Yerak

March 3, 2007

The subprime mortgage business is starting to have the whiff of the troubled airline industry.

At least 20 U.S. subprime lenders in recent months have closed, retrenched, filed for bankruptcy, delayed earnings reports, taken financial hits, or been sold or downgraded amid a rise in delinquency rates.

And federal regulators have noticed.

Worried that "subprime borrowers may not fully understand the risks" of such lending products as adjustable-rate mortgages, the Federal Reserve, the Federal Deposit Insurance Corp. and three other regulators yesterday asked lenders to carefully evaluate borrowers’ ability to repay at the full rate.

The regulators don’t want marketers of subprime products to base their lending decisions on "teaser" rates that expire after a short period of time.

Putting out a call for public comments, the regulators also noted that the products "may pose an elevated credit risk to financial institutions."

Bad news continued to bubble up this week in the subprime mortgage industry, which serves homebuyers with poor or limited credit records and typically charges 2 or 3 percentage points above safer prime loans.

Shares of New Century Financial Corp. closed down 7.6 percent yesterday as the subprime lender announced plans to lay off 4 percent of its work force and postponed filing its year-end financial results.

General Motors Corp. said this week that it would again delay filing its annual report, triggering concerns about its possible exposure to the subprime lending market through its GMAC residential mortgage unit.

On Feb. 7, HSBC Holdings PLC, of London, disclosed that the impact of slowing growth in housing prices was contributing to a rise in delinquencies in U.S. subprime mortgages at its HSBC North America Holdings Inc. unit.

"The absence of equity appreciation is reducing refinancing options," HSBC explained.

On Feb. 22, Bobby Mehta stepped down as chief executive of HSBC North America Holdings.

On Thursday, Warren E. Buffett, head of Berkshire Hathaway, assailed "weakened" residential lending practices.

"The ’optional’ contracts and ’teaser’ rates that have been popular have allowed borrowers to make payments in the early years of their mortgages that fall far short of covering normal interest costs," the legendary stock picker wrote. "But payments not made add to principal, and borrowers who can’t afford normal monthly payments early on are hit later with above-normal monthly obligations."

Buffett calls it the "Scarlett O’Hara scenario."

" ’I’ll think about that tomorrow,’ " Buffett wrote, paraphrasing the final line from Gone with the Wind. "For many homeowners, ’tomorrow’ has now arrived."

From 1994 to 2006, the subprime industry’s share of total mortgage originations climbed from less than 5 percent to 16 percent, according to the Mortgage Bankers Association.

Malcolm Bush, president of the Woodstock Institute, a Chicago nonprofit that studies housing, said developments in the subprime mortgage industry come as no surprise.

In recent years, he said, there has been an explosion of "exotic mortgages with a variety of payment schemes that permit people with lesser resources and credit to buy homes."

Last year, "you began to see a softening in prices, and mortgage companies began to see a lot of mortgages move into defaults," Bush said.

On Tuesday, home loan funds provider Freddie Mac said it would stop buying subprime mortgages with a "high likelihood" of default.

About 2 percent of subprime mortgages made last year were more than 60 days late after five months, nearly twice the rate for ones made in 2005 and the worst rate in at least seven years, according to a Feb. 22 report from Barclays Capital.

Becky Yerak writes for the Chicago Tribune. Bloomberg News contributed to this article.

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