Lower Restated Earnings Reveal Trouble in Subprimes
Timmons, Heather, American Banker
Investors have turned cold on the home equity sector.
A massive writedown last week by Green Tree Financial Corp. was taken by many as evidence that the same problems that devastated the subprime auto sector this year could bring down the entire subprime group.
Stock prices dropped throughout the sector, and though prices have recovered slightly, few investors are looking at subprime mortgage companies as long-term holdings.
"I invested in all these companies when they had their initial public offerings," said one portfolio manager at a Piper Jaffrey conference this week in New York. "Now they're just trades."
Increasing competition in the past 18 months is now taking its toll, and not in the way that skeptics had first thought it would.
Some had feared a loosening of credit standards. But a worse problem for Green Tree and other lenders has been prepayments, which force them to radically restate accounting assumptions.
Prepayment rates in some subprime mortgage companies' loan pools are as high as 40%, with borrowers often refinancing less than two years after taking out their loans.
Delinquency rates are also skyrocketing for some lenders, and the ensuing foreclosure losses will be more than triple what had been expected, say industry experts.
"Most companies are only assuming a 50 basis-point loss rate," said Christine A. Reich, managing director of Ocwen Financial Corp., a West Palm Beach, Fla. distressed-asset specialist. "But we're projecting actual loss rates of 180 to 210 basis points."
Gain-on-sale accounting, which enabled subprime lenders to dangle strong earnings growth before investors, is now coming back to haunt the sector. The accounting tool allows lenders to book profits on the returns from loans-and therefore earnings-before the loans are paid off. …