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Mortgage Market Woes March 15, 2007

Posted by newyorkscot in Markets.
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The Subprime and Alt-A markets have been taking a beating recently. Many borrowers took on a lot more risk and have stretched themselves too far such that when interest rates rose, payments increased driving up defaults and delinquencies and high-than-expected repurchases by mortgage lenders.

Not only has this damaged credit ratings of the borrowers and left some without a house, it has hurt the mortgage lenders revenues and cash reserves (which they need to buy back the loans). While originators are trying to sell these loans, they often pass the loan to warehouse lenders such as the big banks. In return they get cash equal to the value of the asset, minus a fee, known as a haircut, which helps to smooth out and cushion against late payments and delinquencies.  These banks are now asking for a larger haircut, also hurting the originators cash reserves.

Statistics

Subprime mortgages are loans taken out by homebuyers with poor or limited credit histories, where the mortgage lender charges rates 2-3% above the “safer” prime-loans. Last year, 13.5% of mortgages in the US were sub-prime (against 2.6% in 200). Overall the subprime market in 2006 was about $600billion, 20% of the $3trillion mortgage market. By the end of 2006, subprime delinquencies more than 60 days jumped to 13% (from 8% in 2005).

Additionally, the “Alt-A” market is adding to the woes of mortgage lenders and investors. Alt-A borrowers are “medium risk” borrowers that fall between the subprime and prime loan markets. Specifically, they meet Fannie Mae and Freddie Mac standards for credit scores but might not meet standard guidelines for documentation requirements, property type, debt ratio or loan-to-value ratio. Of course, they too pay a premium for their loans. “Alt-A”s  defaults are on the rise (now 2%). It is expected that 5% of the 2 million Alt-A mortgages issued in 2006 will foreclose.

Developments

Recently, the Fed has urged Congress to bolster regulation of Fannie Mae and Freddie Mac, the No.1 and No.2 US buyers of home mortgages, by suggesting they limit their holdings to guard against their debt poses to the economy. Freddie Mac correspondingly announced that it would no longer buy certain risky subprime mortgages.

This has forced subprime lenders to either tighten their lending standards or assume the higher risk of keeping these loans on their books. This will include increasing credit score requirements and documentation firming up.They *suggest* that lenders should evaluate the borrower’s ability to repay the debt before offering a loan !!!!

Many of those borrowers have now been effectively shut out of the market as lenders tighten their standards, causing major problem for borrowers wanting to access credit products such as portgages. This will increase delinquencies and foreclosures, causing more credit problems down the road, not to mention that massive impact on the secondary market and overall economy.

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