From the Wall Street Journal:
More Borrowers With Risky Loans Are Falling Behind (no link)
Americans who have stretched themselves financially to buy a home or refinance a mortgage have been falling behind on their loan payments at an unexpectedly rapid pace.
The surge in mortgage delinquencies in the past few months is squeezing lenders and unsettling investors world-wide in the $10 trillion U.S. mortgage market. The pain is most apparent in subprime mortgages, though there are signs it is spreading to other parts of the mortgage market.
Subprime mortgages are loans made to borrowers who are considered to be higher credit risks because of past payment problems, high debt relative to income or other factors. Lenders typically charge them higher interest rates — as much as four percentage points more than more-credit-worthy borrowers pay — one reason subprime mortgages are among the most profitable segments of the industry.
They also have been among the fastest-growing segments. Subprime mortgage originations climbed to $625 billion in 2005 from $120 billion in 2001, according to Inside Mortgage Finance, a trade publication. Like other types of mortgages, subprime home loans are often packaged into securities and sold to investors, helping lenders limit their risks.
Until the past year or so, delinquency rates were low by historical standards, thanks to low interest rates and rising home prices, which made it easy for borrowers to refinance or sell their homes if they ran into trouble. But as the housing market peaked and loan volume leveled off, some lenders responded by relaxing their lending standards. Now, the downside of that strategy is becoming more apparent.
Based on current performance, 2006 is on track to be one of the worst ever for subprime loans, according to UBS AG. “We are a bit surprised by how fast this has unraveled,” says Thomas Zimmerman, head of asset-backed securities research at UBS. Roughly 80,000 subprime borrowers who took out mortgages packaged into securities this year are behind on their payments, the bank says.
Though delinquency rates on subprime mortgages originated in the past year have soared to the highest levels in a decade, economists don’t expect any significant harm to the nation’s economy or financial systems. But if late payments and foreclosures continue to rise at a faster-than-expected pace, the pain could extend beyond homeowners and lenders to the investors who buy mortgage-backed securities.
Soaring delinquencies are making some lenders more cautious, which is likely to put further pressure on the weak housing market. Yesterday, the National Association of Realtors said that its index for pending home sales for October fell a seasonally adjusted rate of 1.7% from September and was down 13.2% from a year earlier.
Delinquency rates have been rising steadily since the middle of 2005. But the trend has accelerated sharply in the past two to three months, according to an analysis by UBS. The figures don’t include loans that lenders were forced to repurchase because the borrower went into default in the first few months; such repurchases also have increased sharply this year.
In October, borrowers were 60 days or more behind in payments on 3.9% of the subprime home loans packaged into mortgage securities this year, UBS says. That’s nearly twice the delinquency rate on new subprime loans recorded a year earlier.
Predicting losses on these securities is a challenge because there’s little or no historical evidence to show how subprime loans will perform at a time when home prices are falling, says Thomas Lawler, a housing economist in Vienna, Va. An analysis by Merrill Lynch & Co. found that losses on recent subprime deals could be “in the 6% to 8% range” if home prices are flat next year and could rise to the “double digits” if home prices fall by 5%. Falling home prices could trigger losses not only for investors who bought riskier classes of mortgage-backed securities, but also for some holders of A-rated bonds, according to the report.