The B&C Meltdown: It's All About Capital

Another month and another column about the subprime meltdown. As Mortgage Servicing News went to press this month, a tidal wave of bad news was sweeping the B&C or "nonprime" industry.

Here's the unhappy recap: Mortgage Lenders Network of Connecticut, a top 15 ranked niche funder - and a $17 billion servicer - went belly up; New Century, considered to be one of the better managed shops in the industry, saw its stock price plunge by 50% in two days after saying it would restate earnings for the first nine months because of accounting gaffes tied to loan buybacks; and the icing on the cake: Mega-bank HSBC upped its loan loss reserves on its subprime business to $10.6 billion. That's not a misprint. The number is $10.6 billion.

If you think the subprime meltdown of 2006-07 is starting to look a lot like the meltdown of 1998 you're right. It was ugly then and it's ugly now. Back in '98 the Russian debt crisis sparked the B&C train wreck but there were other factors as well, in particular a little thing called "gain-on-sale" accounting which allowed firms to book profits on securitizations before the cash ever came in the door. Overoptimistic assumptions on GOS forced lenders to unwind huge profits that never should've been booked in the first place.

But let's not forget Wall Street. Pre-1998, Wall Street firms were financing and taking subprime and high LTV lenders public like it was going out of style. (Sound familiar?) When the debt crisis hit, Wall Street got nervous, pulled financing, and started cracking down on GOS (rightfully so), but also swung the pendulum a little too far the other way. Some good players got hurt, too, but hey, that's life. Right? (Sound familiar?)

Zip ahead to late 2006. Subprime wholesaler Ownit Mortgage Solutions of California goes bust. Six weeks later, MLN and Sebring Capital of Texas close their doors. What do all these firms have in common? They were privately held B&C lenders that depended on warehouse lines of credit from - you got it - Wall Street.

Wall Street (Merrill Lynch, others) said to Ownit and MLN: buyback the delinquent loans you sold us or we won't lend you more money. MLN and Ownit said: can't we talk about this? We don't have a lot of money. (I'm paraphrasing.) Wall Street said: we can talk all you want but we want our money. The rest you read about in National Mortgage News, MSN and American Banker, not to mention some of the bigger dailies.

As I've noted before, Wall Street has its rights and these MBA-carrying, Ivy League-educated tough guys (and gals) hovering over trading boxes do not fool around. The word "forbearance" isn't in their vocabulary.

So, here we are. Subprime non-depositories are failing left and right. Have you noticed that not one depository engaged in subprime lending has failed during this crisis? Do you know why? Because they have liquidity. They have deposits.

In short, it's all about having capital, folks. When Wall Street (and other investors) ask a shop to buy back bad loans they need cash to pay the piper. If they don't have cash, they're gone. For years Countrywide CEO Angelo Mozilo has been saying how "capital intensive" mortgage banking can be. The industry's sage wasn't kidding. I wonder now, how many ignored him?

How many B&C lenders will be left standing by year-end is anyone's guess. According to the Quarterly Data Report, there are 50 subprime funders originating $100 million or more a quarter. I would venture that figure will be reduced to 25 by year-end.

At press time, the rumor mill was running rampant about who would fail next, and which firm was being whipsawed by loan buybacks. Will the GE-owned WMC Mortgage exit the business? (The company says no, others say yes.) Will Ameriquest and Option One ever sell? Will the profit picture ever improve? Will Wall Street calm down on its buyback requests? Keeping reading the trade journals. It's going to get even more interesting. (c) 2007 Mortgage Servicing News and SourceMedia, Inc. All Rights Reserved. http://www.mortgageservicingnews.com http://www.sourcemedia.com