Are Sub-prime Lending Worries Overdone?
Mar 25th, 2007 by Wealth Builder [This post is written and copyrighted by Wealth Building Lessons (http://www.wealthbuildinglessons.com).]
In a previous post, I mentioned how the sub-prime lending collapse might throw the US into a recession.
The entire sector of mortgage lending stocks have been slammed across the board. Some of them have gone under as their credit lines have dried up and they have been asked to repurchase loan portfolios with high deliquencies.
Some of the companies may have been unfairly punished. TheStreet.com just published an article, Subprimal Fears Signal a Time to Buy where they mention that one such company is American Home Mortgage (ticker symblol: AHM). At current stock prices, it yields a 16%+ yield! (As of writing the article it was 18%+).
The main reasons for such enthusiasm in their recommendation of the stock were:
- Sub-prime lending made up less than 2% of their business last year
- There have been no insider selling of the stock in the face of this calamity.
Hmm….contrast this with the insiders at CountryWide (ticker symbol: CFC) who have been dumping their stock like it was toxic. - Management has boosted the dividend and except only modest dividend cuts in future
These seem like stellar reasons to own a stock, but what if the sub-prime hysteria isn’t overblown?
What if the 44 sub-prime lenders that went under is only the tip of the iceberg and the poison of loose lending standards to un-creditworthy borrowers spread deeper than currently expected. Currently 14% of the $1.28 Trillion sub-prime loans are late on their payments! If alt-A and prime borrowers start defaulting in similar numbers, mortgage stocks might be depressed for while.
As lending standards continue to tighten, less loans might be made and the overall revenue and profits of these companies will drop.
On the flip side, if the FED steps in to bail out the US homeowner by dropping the rates again, these lenders might not do so badly. Especially companies that lend only to prime lenders and purchase loans that are backed by the US government (ie. Fannie Mae and Freddie Mac loans).
But I don’t know how this will play out so I’m so for now I’m not venturing into this mess. I already own real estate so buying lending company stock is just over-leveraging in correlated sector.
A fascinating book on how Nobel prizing winning laureates invested in non-correlated sectors that all correlated at the same time and bankrupted them because they were over-leveraged is When Genius Failed. They were renowned professors and the Federal Reserve had to step in to prevent a melt-down in the US markets.
Note: This is definitely not a recommendation to buy or short this stock or sector. Although I know some you have already placed some bets!
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One Response to “Are Sub-prime Lending Worries Overdone?”
I worked for 2 of these subprime companies (NEWC and FMT). While I was an employee it seemed the attitude was like money grows on trees and it will keep coming in forever. They all hired as many employees as they wanted, including friends, uncles, aunts, boyfriends, iguanas, etc. at the highest prevailing salaries, they were buying up all the latest hardware and software to originate loans, service loans, buy loans, sell loans, you name it. The upper managers were always talking as if they were mother Teresa, as if they were God’s gift to the poor souls who were unable to afford a home without them. Having been through the tops and bottoms of economic cycles before, I knew it was time to get out of the industry over a year ago. I do not believe that it is a bottom yet, housing prices (at least in Southern California) are still extremely unaffordable to more than 80% of the population. How can the sector recover when nobody can even afford the house they are in? Who is going to buy it from them? All that can be done is a shell game of current home owners exchanging homes with other home owners, this is not a likely scenario for growth in this market.