Banks, Brokerages Feeling Chill From Subprime Mortgage Woes

Mounting concerns on Wall Street that mortgage lenders might be hurt by increasing defaults and delinquencies sent investors fleeing Monday from some of the biggest names in the industry.

The meltdown among lenders that specialize in home loans to people with weak credit, known in the industry as subprime lenders, again ravaged stock prices. Financial institutions from Britain's HSBC Holdings to subprime leader Countrywide Financial sank amid reports of strained portfolios as loans went bad. Top U.S. banks and brokerages also saw their stocks decline.

Still, some investors have managed to profit on the subprime lenders' woes: hedge funds. CNBC's David Faber said there are a number of hedge funds that have sold short pools of subprime mortgages. As a result, some hedge funds are up 70% to 80% for the month of February alone, Faber reports.

The latest to rattle the markets was New Century Financial, the nation's second-largest subprime lender. The Irvine, Calif.-based company disclosed a criminal probe into the trading of its securities, and into the lender's accounting procedures.

Already beleaguered investors were swift to react. New Century's shares lost 60% on Monday --wiping $532 million from its market value. Wall Street, still wobbly after last week's huge plunge, also punished the rest of an industry blamed for loosening their lending standards amid an eroding housing market.

"We see increasing evidence that this industry is now in a downward spiral whereby each negative development fuels additional deterioration in key fundamentals including origination volume, pricing, credit and most importantly funding," Stifel Nicolaus analyst Christopher Brendler said.

Troubles Mounting

The troubles at New Century had been mounting since February, when it announced that it lost track of how severely the loans in its portfolio were losing value. The company on Friday disclosed it is being investigated the Securities and Exchange Commission and the U.S. Attorney for the Central District of California on its accounting methods and the trading of its securities ahead of a Feb. 7 earnings restatement announcement.

Investors who buy the company's mortgage loans in the secondary market have been selling the loans back when borrowers default, New Century said. The company said that because of accounting errors, it underestimated how many loans would be resold and how much value those loans would lose before ending up back in New Century's portfolio.

Concerns of a meltdown at New Century include the possibility it will not be able to meet covenants with major financial backers, the company said. Subprime lenders enter into agreements with big banks to finance their operations. These backers require subprime lenders meet minimum financial targets, or face breaching loan agreements that would force banks to pull out of the deals.

This dragged down shares of some of the top U.S. banks and investment banks.

Morgan Stanley, which had a 5.5% stake in New Century as of Dec. 31, dropped. State Street, with a 3.8% stake, also moved lower.  Citigroup with 3.5% stake, got hit as well.

Other subprime lenders also tumbled. Countrywide Financial fell and is down about 14% since January. Novastar Financial plunged and is down about 40% this year.

Banc of America Securities analyst Robert LaCoursiere reiterated a "sell" rating on IndyMac, sending its shares sharply lower, and cut his price target to $27 from $33.

Shares of subprime lender Fremont General were also trading lower Monday. The company agreed to a cease-and-desist order with federal bank regulators on Friday and said it hired Credit Suisse to advise on a sale of its subprime unit. It also expects to report a fourth-quarter loss.

Taking Their Toll

Higher U.S. interest rates and a stagnant housing market began to take their toll on borrowers who had been relying on the rising value of real-estate markets to help them refinance their mortgages.

Last year, 13.5% of mortgages originated in the U.S. were subprime, according to the Mortgage Bankers Association. This is up from 2.6% in 2000. The subprime market accounted for about 20%, or $600 billion, of the $3 trillion mortgage market.

The New Century case is of particular concern because of fears that trouble in the subprime business could spread to prime mortgages, causing pain for many more lenders. Leading those concerns was HSBC, Europe's largest bank with significant operations in the U.S., which warned in February its profits would be weaker because of subprime lending.

The world's third-largest bank on Monday reported its highest annual profit of $15.79 billion for 2006. Bad-debt charges jumped 36 percent to $10.57 billion, roughly in line with expectations.

Chief Executive Michael Geoghegan attempted to fend off criticism that the bank had provided loans in the United States to people who were not in a position to pay their debts.

"This is not trailer park lending," Geoghegan said, adding that the typical HSBC Finance customer has average household income of $83,000, is 41 years old, has two children and a home worth $190,000. "This is Main Street America."

Concern about subprime exposure also has spilled into major U.S. investment houses. Standard & Poor's on Monday downgraded Lehman Brothers and Merrill Lynch, partly on subprime mortgage woes. S&P noted that subprime loans are a small piece of the company's overall assets, but was still concerned about recent market trends.