Subprime Lending Takes Center Stage on Wall Street

It would probably be safe to bet that six months ago 90 percent of Americans had never heard of a subprime loan. It would be equally safe to wager that six weeks ago that number hadn't changed much.

Don't bet your bus fare on that premise today.

Financial reporters, public officials, advocacy groups, even the mainstream news programs have been filled with news about the subprime mortgage market for several weeks but especially since the stock market began its precipitous decline last week; subprime news is all over the place. It is called a contributing factor to the rugged week on Wall Street; one subprime lender has been sold out of bankruptcy and another has put itself on the auction block; Congress is calling for new regulations, hearings are about to begin, and there are doubts that some of the principals in the subprime game will survive the current fallout.

Last Friday Fremont General Corporation announced that it was ending its subprime residential real-estate lending business because of a proposed cease and desist order issued by the Federal Deposit Insurance Corporation that contained requests for changes that would restrict the companies level of subprime residential activity. Fremont is seeking a buyer for its subprime division which makes up approximately half of the company's business but plans to continue its successful commercial lending and retail deposit-gathering businesses. On Monday The Fremont General Corporation, the financial services holding company, put some of its residential loan staff on paid leave "pending further information" but said that managers and operations people "are continuing to work today and are making certain that our business data is secure and our customers are taken care of."

Fremont General stock dropped 34.2 percent on Friday and continued that trend through Monday. The stock's 52 week high was $23.53. It hit a low of $5.55 on Monday and was trading in the $6 to $7 range Tuesday morning.

Also on Friday San Francisco-based New Century Financial Corp., reported to be the second-largest subprime lender in the country, said that The U.S. Attorney's Office for the Central District of California is conducting a federal criminal inquiry into the trading of its securities as well as accounting errors and that it was in default with several of its lenders. The Securities and Exchange Commission and the New York Stock Exchange are also looking into company operations.

As reported by Greg Morcroft and John Spence writing for MarketWatch, this Monday several industry analysts agreed that New Century likely faces liquidation or bankruptcy. Analysts for Merrill Lynch concluded that "New Century is more likely to enter the death spiral we had feared, as filing delays, financial difficulties, likely restricted liquidity and regulatory/criminal investigations could conspire to limit its options outside of bankruptcy."

New Century said that six of its 11 lenders which provide warehouse lines for the company had granted it waivers for being out of compliance with its debt covenants but obtaining waivers from the remaining five was uncertain.

Following substantial losses on Friday New Century stock dropped 69 percent on Monday to close at $4.56 and was up slightly on Tuesday trading in the $5 to $6 range. The stock's 52 week high was $51.97.

And New Century's troubles might spill over from the market niche. Last March the company changed its own rules limiting single investor ownership of its stock from 9.8 percent to 19.6 percent to allow Greenlight, a hedge investment fund, to increase its stake in the company. If Greenlight followed through on that ability it too will be suffering serious losses.

Analysts also downgraded Accredited Home Lenders, NovaStar Financial, and HSBC Holdings. The latter had announced in February it would be writing off about 20 percent more bad debt from its U.S. operations than it had earlier projected.

Not all subprime players are considered untouchable, however. On Monday another hedge fund, the Citadel Investment Group agreed to buy the ResMae Mortgage Corporation, which is in bankruptcy protection, for about $180 million, paying $20 million for the business and 98.5 cents on the dollar for the company's $160 million loan portfolio. According to Bloomberg News, ResMae was the third subprime lender to seek bankruptcy protection since the end of December and is one of more than 20 that have "shut down, scaled back or been sold since last year as default rates rise."

In the regulatory area, House Financial Services Committee Chairman Barney Frank, D-Massachusetts, speaking before an international banking conference on Monday said that there should be a national law regarding subprime lending. Frank said the law should ensure that banks, "don't lend people more money than they can pay back."

The Federal Reserve on Friday invited comments on a proposed Statement on Subprime Mortgage lending which it said would address certain risks and emerging issues relating to subprime lending practices, especially those under the general umbrella of adjustable-rate mortgages. Last October the Fed along with other agencies such as The Federal Deposit Insurance Corporation, and Office of Thrift Supervision issued, after months of comments and review, "Guidance" for federally regulated banks and credit unions regarding adjustable rate mortgages. This new statement is proposed as a complement to that document, concentrating mostly on exotic loans. Almost immediately, however, the Mortgage Bankers Association attacked the statement saying "We are concerned that the proposed statement, if adopted as proposed, may restrict credit to many consumers in high-cost areas and deny credit to many deserving low-income, minority and first-time homebuyers."

If further proof is needed that subprime lending is Topic A, even Warren Buffett, chairman of Berkshire Hathaway (a single share of its stock sells for $106,400 - and to think I could have bought it for $32,000) threw his thoughts into the mix. In his annual letter to his shareholders last week he said that the slowdown in residential real-estate markets can be partially laid at the doorstep of lenders and their weakened lending practices over the last few years. He cited optional mortgage and teaser rates which have allowed borrowers to make initial payments on their loans that fall far short of allowing the loans to amortize normally. "But payments are not made to principal and borrowers who can't afford normal monthly payments early on are hit later with above-normal monthly obligations."

"This is the Scarlett O'Hara scenario: 'I'll think about that tomorrow.' For many home owners, 'tomorrow' has now arrived."