To the Bottom Subprime Loans

At the opposite extreme from prime loans are subprime ones, which are given to borrowers with very poor credit histories and low FICO scores, typically below 620 to 660, depending on whose definition you want to use (the average FICO score for securitized subprime loans was 617 as of January 2009). Such borrowers are generally poor, aren 't well educated, have spotty employment histories, and have frequently been late or defaulted on debts—in short, precisely the people a lender should be very cautious about.

For these reasons, subprime mortgages were only a small part of the market prior to 2002, never far exceeding $100 billion worth per year. But then, amid the madness of the bubble, the volume of subprime loans rose sixfold from 2000 to 2005, peaking at roughly $600 billion worth per year from 2004 through mid-2007, as shown in Figure 4.6 '

Approximately $2 trillion worth of subprime mortgages were written from 2000 through 2007, but there is quite a bit less outstanding as of early 2009 because those holding mortgages written prior to 2005 were mostly able to refinance and many subprime mortgages written at the peak have already defaulted. Consequently, there is approximately $700 billion to $800 billion of subprime mortgages currently outstanding (although a Goldman Sachs report puts the figure at $1.4 billion, mostly likely because it counts $515 million of subprime loans at Ginnie Mae, the Federal Housing Administration, and the Department of Veterans Affairs).1

Subprime Mortgage Volume

Figure 4.6 Subprime Mortgage Origination Volume

Source: Inside Mortgage Finance, Inside Mortgage Finance Publications, Inc. Copyright 2009. Reprinted with permission.

Figure 4.6 Subprime Mortgage Origination Volume

Source: Inside Mortgage Finance, Inside Mortgage Finance Publications, Inc. Copyright 2009. Reprinted with permission.

Given the collapse in lending standards, it's not surprising that these loans are suffering catastrophic losses, as shown in Figure 4.7. (Note that all delinquency rate data, both overall and by vintage, in the rest of this chapter, except for Figure 4.27, is for securitized loans—i.e., the loans sent to Wall Street; the data is not available to track delinquencies on loans held by banks and other mortgage lenders.)

Figure 4.8 shows the performance of subprime loans by vintage. It is truly mind-boggling to see that more than 40 percent of the ones written in 2006 and 2007 have defaulted in less than two years!

There is no mystery why the housing bubble began to burst in early 2007. In part, it had to do with home prices, which had peaked in mid-2006 and then started to decline, meaning that refinancing was becoming a more difficult option for all types of loans. But the biggest factor was the resetting of subprime loans, most of which had low initial interest rates that reset after two years. Thus, a surge of subprime loans written in early 2005 began to reset beginning in early 2007, an even larger number of subprime loans written in late 2005 reset in late 2007, and so forth, as shown in Figure 4.9. The resets taper off only in mid-2009, two years after subprime lending dried up in mid-2007.

Sub Prime Mortgage Default Rate

Figure 4.7 Subprime Mortgage Delinquency Rate

Source: Amherst Securities, LoanPerformance.

Figure 4.7 Subprime Mortgage Delinquency Rate

Source: Amherst Securities, LoanPerformance.

Delinquency Seasoning Mortgage

0 5 10 15 20 25 30 35 40 45 50 55 60 Months of Seasoning

Figure 4.8 Subprime Mortgage Delinquency Rate by Vintage

Source: Amherst Securities, LoanPerformance.

0 5 10 15 20 25 30 35 40 45 50 55 60 Months of Seasoning

Figure 4.8 Subprime Mortgage Delinquency Rate by Vintage

Source: Amherst Securities, LoanPerformance.

ans $10

de # de de ^ ^ ^ ^ # # # # ^ c/ ^ C&/ ^ C&/ ^ C? ^f ^ C&/

Figure 4.9 Subprime Loan Resets by Month

Source: Amherst Securities, Credit Suisse, LoanPerformance.

Upon reset, the monthly payment for most borrowers jumps because the interest rate rises and/or the loan becomes amortizing, causing payment shock and triggering a wave of defaults. Figure 4.10 shows the monthly default rate for securitized subprime loans with two-year resets of different vintages. A few months after the reset date (months 27 to 29; a default here is three missed payments), defaults skyrocket and then stay at a permanently higher level. What 's especially shocking is that 12/2006 and 06/2007 subprime loans are defaulting at more than 8 percent per month—before they've even reset!

Anticipating the end of the wave of subprime loan resets, in late 2008 some pundits were starting to get bullish on the outlook for the mortgage crisis. Unfortunately, they missed two things. First, there 's a big lag effect since it's not resets but rather homes being sold off that has an impact on the housing market. Resets often lead to default, which usually leads to foreclosure, but this takes a long time. It varies greatly by state, but on average it takes 15 months from the date of the first missed payment to the home being sold, and going forward this will likely take even longer

Age (in months)

Figure 4.10 Monthly Default Rates for Securitized Subprime Loans with Two-Year Resets by Vintage

Source: Amherst Securities, LoanPerformance.

06/2004 12/2004 06/2005 ■ 12/2005 06/2006 12/2006 06/2007

06/2004 12/2004 06/2005 ■ 12/2005 06/2006 12/2006 06/2007

Age (in months)

Figure 4.10 Monthly Default Rates for Securitized Subprime Loans with Two-Year Resets by Vintage

Source: Amherst Securities, LoanPerformance.

given the glut of homes on the market and foreclosure moratoriums by many lenders and servicers. Thus, the housing market in early 2009 was feeling the impact of subprime loans that were made in late 2005, reset in late 2007, and defaulted in early 2008. Therefore, the impact of subprime resets tapering off won 't be felt until mid-2010.

The second problem with the bullish thesis is that toxic loans weren't limited to the subprime area. Defaults and losses on subprime loans drove the first stage of the mortgage crisis, but another wave of risky loans that had longer reset dates looms.

As for total losses among subprime loans, Goldman Sachs estimates 32 percent, which sounds about right to us.2

Credit Repair

Credit Repair

If You Are Interested In Raising Your Credits, You Won't Want To Miss This Page! Worried About Your Bad Credit? Fret Not! Discover Insider Secrets To Quickly Get Out Of Debt, Erase Your Bad Credit Record And Legally Raise Your Credit Score! Finally! An Info-Packed Guide To Help You Understand The Nuts-And-Bolts Of Credit Repairs And To Assist You In Increasing Your Credits In No Time! Learn Some Little-Known, But Highly Effective Tips And Tricks That Will Shoot Your Credit Score Up!

Get My Free Ebook


Responses

  • gilda
    How much subprime is outstanding?
    6 years ago
  • justiina helminen
    What is 3 subprime loans sixfold?
    6 years ago
  • crispus
    What loans were given in 2005?
    6 years ago

Post a comment