Investment Opportunities in Subprime?
High default, foreclosure and bankruptcy rates are scaring off subprime market investors. But according to an Advantus Capital Management report, when investors overreact opportunities emerge, mainly in the form of businesses being sold "at severely reduced prices."
Beyond the bad news for the industry in general and individual players in particular, the study maintains those who will weather the storm will benefit from the subprime market ordeal. As to what type of investor is missing out and who can benefit the most from potential opportunities, it may depend on expertise and long-term goal-oriented management.
In their second-quarter 2007 company report, investment analysts Sean Timonen and Joseph Scanlan suggest, "The market dislocation, however volatile, has also provided the potential for opportunity. Even those players looking to maintain, or reduce capacity (without exiting altogether) will benefit as the competitive landscape becomes more rational."
It is indicative that data as of April 6 show two of the country's largest subprime lenders, New Century Financial and Fremont Investment & Loan, had filed for bankruptcy. Also on file for bankruptcy, Ownit Mortgage Solutions ranking 20th with 1.5% market share, ResMae Mortgage Corp. ranking 21st with 1.2% market share and Mortgage Lenders Network USA ranking 22nd with 0.9%.
The industry profile certainly is not rosy, yet analysts state, "A more careful assessment shows that while some companies in the subprime market face serious difficulties, mitigating factors will protect others."
If so far mortgage experts and common sense of "do not put all your eggs in one basket" always stressed the importance of diversification, it appears the marketplace once again proved the old belief right.
According to the study there are two main mitigating factors.
"Financial institutions that boast diversification across product type, geographic region and sources of capital, in addition to those players that benefit from strong parental support are likely to not only weather the subprime storm but end up stronger in the aftermath."
While companies that relied solely on subprime loans, the study notes, are threatened by drying up of their funding resources, traditional lenders involved in the subprime market have been punished by association because they "have seen their spreads widen in 2007 even though subprime mortgages make up less than 5% of overall loans."
The report notes survivors and beneficiaries are companies like HSBC Finance, formerly Household Finance, currently the North American arm of HSBC Plc, an international banking organization with resources to counterbalance losses recorded by the subsidiary, almost double its fourth-quarter 2006 provision for bad loans, "which translated into a loss." In 2006, the parent company saw its profits increase, however, due to strength in its operations in Europe and China.
These types of institutions can afford and chose to provide funding to backstop potential downward ratings options.
As of now the report notes, the mortgage universe breakdown based on data from the Bank of America Securities LLC estimates is as follows: $1.51 trillion, or 14% subprime; $6.37 trillion, or 59% prime; $2.92 trillion, or 27% alt-A.
Analysts argue that "negative revenue drag from any slowdown in subprime-related revenues was not evident," thanks to the rapid securitization model applied by major Wall Street banks originating mortgage products. Hence, their goal is "to capture origination and securitization spreads and quickly sell the assets," investment banks like Bear Stearns and Lehman Brothers "do not keep subprime loans on as balance sheet assets."
These types of investors also benefit from an in-house revenue-balancing act that allows them to increase profit, the repost notes, "despite weaker residential mortgage securitization revenues." In the case of Lehman Brothers, for example, analysts find, "Lehman, like its peers, is benefiting from strong secular growth in capital markets around the world, which helps mitigate volatility from such flare-ups as the subprime dislocation."
In addition, the report highlights how other large lenders, like JPMorgan and Citigroup on the other hand, have the advantage of operating very large amounts of liquidity, which allows for "a sizable advantage over monoline subprime lenders," consequently either company "relies exclusively on any one funding vehicle, giving each the ability to withstand stress in any one market." (c) 2007 Mortgage Servicing News and SourceMedia, Inc. All Rights Reserved. http://www.mortgageservicingnews.com http://www.sourcemedia.com