The Mounting Uncertainty over Subprime

Torrents of bad news from the sector leave Wall Street wondering how far the financial fallout will spread

by Will Andrews

The subprime mortgage industry's rapid decline is exerting an amplified effect on the markets as uncertainty grows over who will ultimately foot the bill. On a day when regulators revved up postmortems on the mess and even General Motors was touched by the bad news, the question seemed to coalesce: How deep will the subprime problems extend?

The leeriness spilled into the broader financial markets Mar. 13, with the Dow Jones (DJ) index shedding 242 points and other major Wall Street indices declining about 2%. The selling was spurred by a Mortgage Bankers Assn. report that foreclosures hit a record high at the end of 2006 and government data showing paltry February retail sales (see BusinessWeek.com, 3/14/07, "Consumers Feel a Chill").

Some in the mortgage industry believe investors are provoking a liquidity crisis, overreacting to the correction among subprime lenders, companies that loan to borrowers who are considered risky because of their spotty credit histories or low incomes. "You don't know who is swimming naked until the tide goes out," Countrywide Financial's (CFC) chairman and chief executive, Angelo Mozilo, said in a televised interview with CNBC. Mozilo also said the likely "ugly" shakeout of the pure subprime lenders would help companies like Countrywide—the largest U.S. mortgage lender—and banking giants such as Wells Fargo (WFC).

Less Confident

Subprime lenders have been hit by a sharp increase in early payment defaults on residential loans, and skittish investors who purchased the loans have kicked back an unexpectedly high level of loans to the originators. The sheer level of defaults and lack of adequate loan-loss reserves pummeled the earnings of these institutions, according to a Mar. 9 report from Standard & Poor's Ratings Services, while substantial erosion of investor confidence made it difficult for subprime lenders to unload new and repurchased loans at a reasonable price. And the so-called warehouse lenders—bigger financial outfits that provide financing for subprime lenders—have withdrawn funding amid the troubles.

Also on Tuesday, the state of Massachusetts subpoenaed Bear Stearns (BSC) and UBS Securities (UBS) for information on how they rated the stocks of subprime lenders. Shares of Bear Stearns tumbled 6.7% to $142.97 and UBS dropped 3.6% to $56.02 on the New York Stock Exchange.

One of the largest subprime lenders, San Diego-based Accredited Home Lenders Holding (LEND) plunged more than 65% Mar. 13 after the company said it was hunting new capital to maintain its liquidity. Accredited said it has been forced to pay $190 million to cover margin calls, mostly in the past 30 days, and is likely to cut jobs to save money. At least two brokerages also downgraded the stock, and Accredited finished the session at $3.97, a new 52-week low, on trading volume of 42 million shares—more than 18 times its normal daily volume. Accredited shares traded above $60 in May, 2006.

The NYSE is suspending trading in New Century's shares because of the company's disclosures in Securities & Exchange Commission filings on Mar. 12 and 13 that its lenders were discontinuing their financing arrangements with the company. The shares are expected to be quoted in the Pink Sheets.