Sub-Prime Industry Tanking

NEW YORK (AFX) - The mortgage industry plunged deeper into distress this week as two lenders said sagging home prices and higher interest rates are pushing many borrowers into delinquency

HSBC Holdings PLC, Europe's biggest bank and a major player in the U.S. mortgage industry, said the market for "subprime" mortgages, or home loans to people with blemished or limited credit histories, is in trouble

Analysts' estimate for how much HSBC needs to sock away for problem loans is shy by a fifth, HSBC said. The London-based bank estimates it needs to set aside almost $10.6 billion to cover loans it won't be able to collect

Shares of mortgage providers fell across the board on Thursday, but none were hit as hard as New Century Financial Corp., a subprime mortgage lender based in Irvine, Calif. The company said late Wednesday accounting errors caused it to lose track of how drastically some of its mortgage loans are losing value

Three Wall Street analysts downgraded New Century, and the company's stock plummeted $9.21, or 30 percent, to $20.95 in afternoon trading on the New York Stock Exchange. The stock crashed through its previous 52-week low of $29.07, set last month

During the housing boom, many mortgage banks devised crafty loans allowing people to borrow money with no down payment and pay low interest rates for the first few years on adjustable mortgages. Now, as interest rates reset higher, more borrowers are missing payments and many lenders are going out of business or putting themselves up for sale

Subprime loans were once very attractive to some banks due to their higher interest rates

But HSBC said the weak housing market exacerbates credit problems in the subprime mortgage space. Until a little more than a year ago, stretched borrowers who needed to raise cash could take out a second mortgage on their houses and use that money to pay off loans. With housing prices stagnant -- and in some markets falling -- consumers' best source of financing has shriveled

The problem for these types of lenders may not go away quickly

"We expect poor subprime credit trends to continue at least through 2007 and into 2008," Merrill Lynch analyst Kenneth Bruce wrote in a research report

U.S. shares of HSBC Holdings fell $2.17, or 2.4 percent, to $90.05 in midday trading on the New York Stock Exchange

Another reason bad credit plagues mortgage lenders is it shrinks appetite for home loans in the bond market

Most mortgage lenders don't keep their loans; they package them into bonds and sell them to investors. Lenders' profits are determined by how much the bonds sell for

A loan marred by a missed payment loses value because of higher risk the loan won't be repaid. The price of a bond falls if it's backed by mortgage debt that has become riskier

When lenders sell loans, the deals normally include clauses allowing investors to force a lender to buy back a loan if the borrower misses an early payment. Roth Capital Partners analyst Richard Eckert said missed payments on subprime loans have become "epidemic," and investors are sending loans back to lenders with unusual frequency

New Century made two accounting mistakes: It didn't assume more investors would sell back loans, even as loan repurchases surged throughout 2006 amid defaults. And, New Century didn't assume the repurchased loans would be worth less. Piper Jaffray analyst Robert Napoli estimated a repurchased loan has typically lost 15 percent to 20 percent of its value

New Century said it will restate results for the first three quarters of 2006 and expects to post a loss for the fourth quarter. The company needs to set aside money anticipating more loan repurchases, and reflecting the lower value of those repurchased loans. The lender also said new loans this year will fall 20 percent as the company becomes more selective about which borrowers it lends to

Shares of mortgage lenders fell across the board Thursday. Countrywide Financial Corp. and IndyMac Bancorp., the two biggest independent U.S. mortgage lenders, each fell more than 2 percent. Novastar Financial Inc. fell 13 percent to a new 52-week low

Another sector hurt by the troubled subprime mortgage market is mortgage insurance. Companies like PMI Group Inc., Radian Group Inc. and MGIC Investment Corp. underwrite insurance policies that trigger when borrowers miss a payment on their mortgages. If mortgage credit worsens, these companies pay out more in insurance claims

Shares of PMI, Radian and MGIC each fell around 3 percent on Thursday