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Relax, We're Not Subprime!



March 08, 2007 – Comments (2)

Original Article is HERE


The market's manic response to mortgage stocks these days is good for a giggle -- so long as you don't own the stocks.


The reaction to the fallout from the implosions at Novastar Financial (NYSE: NFI), New Century Financial (NYSE: NEW), and Fremont General (NYSE: FMT) has run the gamut from panicked to bizarre.


After its shares were pummeled along with the subprimes, Impac Mortgage Holdings (NYSE: IMH) took the unusual -- and to my mind, unusually suspicious -- step of issuing a press release that said, in effect: "Remain calm! All is well! We're not a subprime lender!"


Perish the thought! Impac's loans are "Alt-A," a designation which includes stated income loans, commonly called "liar" loans.


Personally, I don't buy Impac's feel-good story. Part of my skepticism stems from whispered scuttlebutt. I've gotten email from some loan officers (not Impac's, mind you) warning of impending doom in the stated-income loan market. Even big banks, so the claim goes, are booking huge percentages of liar loans.


One correspondent asked me a very good rhetorical question: "Why do people with good credit scores need stated income loans?" The answer, he believed, was that fudging income numbers was the only way to qualify to buy as much house as they wanted. What happens when people who can't afford the house they're in see an ARM reset?


Default, I'm guessing.


Impac's SEC filings don't seem to reveal how much of its biz is in "stated income," but this article reports that in 2005, Impac ran a seminar called "How to Make a Fortune in the Alt-A Market." Remarks attributed to an Impac Lending Group's senior vice president report that 75% of that business is stated income, and that half of the borrowers "can't or won't tell us where their down payment came from."


Sounds like pretty shaking underwriting to me.


But if you think that's an ugly bit of data, just look at Impac's filings. The Q3 2006 report detailing mortgages held as securitized mortgage collateral shows 60-day delinquencies that more than doubled year over year. More than half the mortgages were in bubble-icious California, and only 79% of the properties were owner-occupied. Oh yeah, 85% of the loans were ARMs, while 73% of the loans were interest-only.


Looks to me like there's plenty of potential for major problems, subprime or non-subprime.


At the time of publication, Seth Jayson had no positions in any company mentioned here. See his latest blog commentary here. View his stock holdings and Fool profile here. Fool rules are here.

2 Comments – Post Your Own

#1) On March 09, 2007 at 10:19 AM, TMFBent (99.16) wrote:

Got these comments from a Neil Notkin, who couldn't get the blog to work, but said


I have been a Subprime Lender for sometime now and offer this for
your thoughts.

The Industry was based on lending money to people with high risk
profiles (late pays etc.) and charging them a higher rate of interest
to compensate for the risk.

Wall Street figured out a way to securitize the paper and sell it off
in pieces to very large investors. As a result the demand for paper
grew. This was in the early 1990s. Many of us were very saavy lenders
who understood the risk and compensated for it in terms of interest
rate and loan to value ( loan as a percent of appraised value). We
spent a good amount of time touching each loan and looking at each
appraisal so that when we lent money we did so with the intent of
getting it back. If we couldn't, there was plenty of equity to offset
the risk.

With the increase in Investor demand for the paper the market started
to grow. By the late 1990s (98-99) there was aggressive standards
that led to a similar period of retrenchment such as we will see now.
The difference is that in the late 90s, we had the Long Term Capital
Crisis that cratered liquidity and Subprime Lenders were able to buy
loans from loan brokers buy paying huge premiums (commissions). As
liquidity dried up the market fell apart similar in some respects to
today, but yet again very different.

It took several years (into 2002) for the market to recover and rebuild.

As Greenspan started to lower rates, the demand for Subprime grew
again. Heck, if you can refinance a 10% rate to 8% and give the
borrower more money, well maybe that is a good idea. With the wind in
the Subprime Lender's sails volume grew and so did competition. With
competition comes the challenge of growing your business. Loan
programs changed. The Loan to Values given to the riskiest component
of the borrowers were increased and loans were made to people at
amounts that might be considered overly optimistic. However, real
estate values were apprciating dramatically during this time and if a
borrower became delinquent, the odds were they would be refinanced
and end up on someone else's balance sheet. So it appeared that the
loans were solid and delinquencies were good, but the truth is the
problems were being defered.

As the real estate market started to take a breather, the Subprime
market was at its' peak lending to people at the highest loan to
value and basis their evaluations on Income that may not necessarily
have to be supported (stated income loans). These loans started to
default. First a few and then many. The bids for the loans decreased
and many small lenders were forced out of the market (Late 2006).

As volumes started to decrease, Wall Street had time to look at the
loans they had purchased and their contracts permit them to put back
loans that didn't make their first few payments, back to the original
lender (aka..New Century et al).

This is where the foundation starts to crack. Most of these lenders
do not or (did not) have the wherewithall to buyback these loans and
Wall Street said, okay but pay us 20-25% of the value and we will not
force you to take them. This put a cash squeeze and a credit squeeze
back on the lenders. This is where we are at today.

The Industry will retrench and go back to lending at reasonable Loan
to Values and all will adjust. This will take some time, but it is
for the best and is typical of a market that gets too overheated with
little barrier to entry.

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#2) On March 09, 2007 at 11:44 AM, TMFBent (99.16) wrote:

Yahoo must be broken today.


There's a very interesting board thread here on IMH, and aside from a few people talking about how I don't know what I'm talking about, it's got some solid pro and con to consider.


Whooda thunk it?

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