US subprime borrowers sink deeper into trouble

According to a report released by the Mortgage Bankers Association, subprime borrowers are getting into deeper trouble with their lenders, particularly in California, Florida and other formerly hot real estate markets. With U.S. mortgage rates hitting a one year high, here’s an excerpt from a NYT piece on the subject:

“Nearly 19 percent of all subprime loans, or 1.1 million mortgages, were either delinquent by more than 30 days or in foreclosure, up from 17.9 percent at the end of last year.”

What impact will a 19% delinquency rate have on the investors that bought packages of these loans in the credit markets? The other question, posed here in the past (“Next stop: Corporate Subprime?“, March 25-07), is pretty clear: if the marginal consumer borrower is hurting to this extent, how can rising interest rates have no impact on the financial health of subprime corporate borrowers and their capital providers?

The wide use of fixed rates – particularly for term loans – will help. And there’s been little evidence that lenders (subprime or standard) are actually boosting their rates, depite the major move in the bond market over the past few weeks.

The only other piece of the puzzle relates to the secondary loan market, and what happens to all of the liquidity folks rely on each day in light of:

1. Subprime paper is going into default at ever higher rates.
2. Bear Stearns (BSC:NYSE) is trying to sell about US$4 billion of highly rated mortgage backed securities that it owns in its own portfolio to cover losses in one of their hedge funds. As the U.S. market’s 2nd largest underwriter of mortgage bonds, Bear’s own second quarter profit fell 10% yesterday, primarily on mortgage troubles. This was the first quarterly profit drop in two years. Revenue from the fixed income business dropped 21%.
3. And even Goldman Sachs (GS:NYSE), despite topline revenue growth, saw their stock cut yesterday by more than 3% on their mortgage woes. According to CNBC, “the world’s biggest investment bank reported its slowest profit growth in three quarters as its key fixed-income business declined 24 percent.”
4. The Federal Reserve is thinking about new regulations to combat questionable lending standards in the subprime market (something to do with the practice of closing loans without any documentation proving a borrowers income, for example). New regulations won’t spur new deals.

If the biggest investment banks are seeing a drop in the sector, what happens to the trading markets? Spreads widen, for one. And if the Goldman’s Chief Financial Officer David Viniar is right, “there will be more pain.” What does that do to the CLOs, CDOs and syndication groups that are currently funding about 80% of U.S. corporate loans (see “Maybe there is a credit bubble after all“, June 1-07)?

MRM
(disclosure – I own GS)