Investing in Sub Prime Lenders: Headed to Bankruptcy
By Ian Cooper
The housing bottom call was a bad call. We’re still not nearing a housing bottom, or an improving lending market.
Ask companies Fremont General, New Century Financial, or the 30 other doomed sub prime lenders. Ask Lennar, KB Home, and DR Horton, who still don’t see this mythical housing bottom.
Or, just ask Mortgage Lenders Network USA, which just filed for Chapter 11 protection, becoming yet another casualty of the lending market in a slowing housing market. Ask sub prime lender, ResMAE Mortgage Corporation, which just filed for bankruptcy protection.
Even JP Morgan’s CEO, James Dimon, is bearish on the sector, saying, “’Mortgages are the one area of sub prime lending where ‘we really see something taking place that looks like a recession….’” That’s just an inkling of the tumultuous future for sub prime lending.
MortgageDaily.com believes “The sub prime sector still has another year of tough times ahead.” That’s supported by Countrywide Financial, which says, “We’ve got another eight, nine, 10, 12 months of headwinds. You’re seeing 40 or 50 (sub prime companies) a day throughout the country going down in one form or another. I expect that to continue throughout the year.”
A recent Center for Responsible Housing report projects that “2.2 million borrowers will lose their homes and up to $164 billion of wealth in the process.” Even MarketWatch.com has reported, “Signs of credit deterioration from the slowing U.S. housing market have already shown up in recent results of other banks as more borrowers fall behind.
Investing in Sub prime Lenders: Cause for major concern
Indeed, rising loan defaults and foreclosures are on the rise and are likely to continue crushing sub prime lenders for this reason: “Sub prime lenders are particularly susceptible to the current housing-market downturn because they often deal with borrowers who stretch financially to buy homes.
More than half of these borrowers, for instance, take out adjustable mortgages, whose interest rates are often lower than those of fixed-rate mortgages. But adjustable rates change, based on market conditions. In addition, many sub prime lenders are not obligated to follow the tougher regulations that apply to commercial banks,” according to United Press International.
And should interest rates rise further, many more homeowners could begin to fall behind on the aggressive sub prime loans, which could then lead to foreclosure, which would then force more homes onto the market. Eventually, that could then lead to depressed home prices, and eventual impact consumer spending, which then raises the fear of recession again.
“The sub prime market will remain under pressure for at least the next half year,” according to Edwin Groshans, vice president of mortgage finance for Fox-Pitt Kelton, as referred to by Forbes.com. “We expected to see $30 billion of losses in the sub prime mortgage space this year. And it’s coming in faster than expected.”
Investing in Sub prime Lenders: Delinquencies have already led 31 companies down the toilet
Joining that list was Fremont General (FMT), which plunged after the company announced plans to exit the sub prime lending business following the receipt of an FDIC proposed cease and desist order. Death Cross Trader readers already took 51% gains on half of the FMT puts. They still hold a position with 91% gains.
And should things get any worse for the likes of New Century Financial, it’ll be 32.
New Century Financial (NEW), which traded above $30 just weeks ago, now trades under $6 as this is being written. The drop came after the company announced it was the target of a federal criminal inquiry into the accounting and trading in the stock, on fears that auditors could warn of substantial doubt over the company’s ability to stay in business, and after the company warned that it will likely breach a lending covenant with financial backers.
Quite honestly, I don’t think New Century will survive much longer. The company, one of the United States’ biggest sub prime lenders, now faces possible liquidation or bankruptcy. And I’m not alone in that thinking. In fact, Zack Gast, a financial sector analyst at the Center for Financial Research and Analysis, as quoted by MarketWatch.com says, “If New Century’s lenders do not grant the requested waivers, the company is likely to be forced to sell or shut down.”
Death Cross Trader readers have already taken 89% and 214% on NEW puts. Readers are back in for more gains as we speak. The best part – there’s still plenty of time to short sub prime lenders. Things are going to get a lot worse.
Not even HSBC is out of harm’s way. In fact, its finance director, as referred to by Forbes.com, says, “he’s predicting a weaker U.S. credit environment this year coupled with an uptick in the rate of bankruptcies.”
Investing in Sub prime Lenders: The worst has yet to come
Tighter lending standards, demanded by Congress, would make it increasingly difficult for lenders to provide controversial sub prime loan structures, which helped millions of Americans afford homes. Those are the same millions that are now at risk of delinquencies and foreclosures.
According to The Buffalo News, “The federal guidelines, if approved after a 60-day comment period, would apply to federally regulated banks and thrifts, such as Fremont. They also could serve as a model for state rules that would apply to nonbank lenders such as New Century.
Under the proposals released Friday, lenders would be expected to:
• Fully consider a borrower’s ability to repay loans after they rise to a fully indexed rate that may cost hundreds of dollars more a month than the introductory rate.
• Provide consumers with clear-cut disclosures on the prospects of “payment shock,” as well as features such as pre-payment penalties that can make it extremely expensive for a borrower to pay off a loan early.
• Fully document a borrower’s income in most cases and not depend on the borrower’s verbal representations alone.”
Indeed, the sub prime lending market is in deep trouble. Stay out of the way, or buy sub prime puts.
Take care,
Ian L. Cooper, Editor, Death Cross Trader