As sub-prime lender implodes, housing shudders
Big Irvine-based lender to risky borrowers nears bankruptcy in wake of mounting defaults. By David Streitfeld and E. Scott Reckard Times Staff Writers
March 13, 2007
An Irvine company that was the nation's largest independent provider of high-risk home loans skidded closer to bankruptcy Monday, stoking fears that the mortgage industry's woes could further damage a sluggish housing market.
Easy-money loans from New Century Financial Corp. and other lenders specializing in borrowers with poor credit helped fuel the housing boom, swelling the ranks of homeowners with people who could not have qualified for mortgages in years past.
But many of these borrowers turned out to be bad bets after all and are beginning to default, forcing some lenders out of business and leading others to stiffen their lending standards.
That could hurt the housing market by shrinking the pool of eligible buyers. In addition, many homeowners with high-risk loans whose rates will adjust upward in the next year or two won't be able to refinance into loans with better terms. That could put some into foreclosure.
"If foreclosures continue to mount and they are already climbing rapidly we could see a scenario similar to California in the early 1990s, where banks' sales of foreclosed properties pushed home prices down even further," said Zach Gast, an analyst at the Center for Financial Research and Analysis, an investment research firm.
In some parts of the state including the Central Valley, the Inland Empire and San Diego foreclosures have gone from rare to plentiful in a little more than a year. Real estate appraisers say home values are beginning to be affected.
George Hatch, a San Diego appraiser, said he surveyed a group of his colleagues last week. Almost all of them reported that they were running across distressed sales or foreclosures.
"There is a flip side to exuberance, which is that every party has its hangover," said Hatch, a 22-year veteran of the business. "When your house loses $100,000 in value, that will make you sick all right."
The so-called sub-prime lending industry that specializes in loans to risky borrowers has been tormented for months by soured loans, creating huge losses and forcing about three dozen large lenders to be sold to other companies, to file for bankruptcy protection or to close operations altogether.
On Monday, New Century announced that the Wall Street firms that supplied its funding had either cut off fresh capital or were poised to do so, leading some industry observers to say bankruptcy was likely. The company's stock plunged $1.55, or 48%, on Monday to $1.66 before the New York Stock Exchange halted trading.
Less than a year ago, New Century shares were worth nearly $52 each.
As New Century's stock sank, those of other sub-prime lenders suffered too. Santa Monica-based Fremont General Corp. fell $1.30, or 16%, to $6.73. The firm said last week that it would exit the business under pressure from regulators.
Homebuilder shares also stumbled on fears that they will have fewer customers. Hovnanian Enterprises Inc. fell 6% and Pulte Homes Inc. dropped nearly 5%.
Also Monday, the nation's largest mortgage lender Calabasas-based Countrywide Financial Corp. said foreclosures were pending on 0.7% of its mortgages, up from 0.47% at the end of February 2006. The company, which makes both prime and sub-prime loans, plans to lay off about 100 people from a sub-prime office in New York, a Countrywide executive said during a conference call Monday.
The collapse in sub-prime is "a warning sign" for California, said Anthony Sanders, professor of finance at Ohio State University and a former Deutsche Bank executive. "I wouldn't be at all surprised if we got a [housing market] crash, especially if interest rates rise."
Scott Simon, a mortgage-bond fund manager for giant Pacific Investment Management Co. in Newport Beach, cautioned against reading too much into the woes of the sub-prime lending industry.
"There will continue to be bad headlines, mortgages will certainly be tougher to get for [people with low credit scores] and first-time borrowers, but the overall mortgage market should be just fine," Simon said.
Ray and Ruby Hayes of Yorba Linda aren't so sure things will work out.
Ray Hayes, 62, said the couple refinanced their home with a sub-prime lender in the spring to get cash to help them make ends meet.
"We had bad credit but were told that in six months we could refinance and get a better loan with a lower interest," he said. But when they tried to refinance, Hayes said, the lender told them they were not eligible for better terms.
The Hayeses are now months behind in their payments. "Things just spiraled out of control," he said.
Sub-prime loans were a relatively small market until recently. In 2001 and 2002, they accounted for fewer than 10% of all home loans written in the United States and California, according to Inside B&C Finance, a trade publication.
By 2005, that percentage had more than doubled, to 20.2% in California and 21.5% nationally.
Founded in 1995, just as California was recovering from a recession, New Century was one of the few sub-prime mortgage lenders to weather the last contraction in the industry. That was in late 1998 and 1999, when investors spooked by Russia's default on its debt refused to buy bonds backed by risky mortgages.
Until recently, at least, the company employed 6,700 people.
"We haven't told people to go home," New Century spokeswoman Laura Oberhelman said Monday. "Everybody's here working."
As a reporter attempted to interview employees outside the company's 11-story office tower in Irvine on Monday, Oberhelman interceded, saying they had been warned not to talk to the media. Otherwise, she said, people might comment on "rumors or speculation."
Analysts say that as the housing market began to cool in 2005, sub-prime lenders tried to maintain their loan volume by loosening standards and cutting rates. That kept the companies in business, experts say, but also resulted in questionable loans to borrowers who couldn't prove their incomes and made no down payments expecting to refinance or sell their homes at a profit when their payments shot higher.
As housing prices leveled off or declined, borrowers could no longer refinance or cash out their homes for a profit, triggering a rising tide of defaults, the first step to foreclosure.
The Wall Street firms that buy thousands of loans from originators such as New Century can force the originators to buy back loans that become duds quickly. The lenders then must resell them at a discount in the "scratch and dent" mortgage market. One sub-prime insider compared it to a child who takes a new lollipop out of its wrapper, chews on it for a while, then re-wraps it and hands it back to a parent.
Christopher Cagan, director of research and analytics at First American Real Estate Solutions, anticipated the rise in sub-prime defaults more than a year ago but forecast that the turmoil would be contained.
Monday, he stood by his prediction.
"Some lenders are contracting, others are failing. Wall Street is tightening up. And unfortunately some people those who bought at the peak and put nothing down will lose their houses," he said. "This is part of the business cycle. It will not break the economy."
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---------- david.streitfeld at latimes.com
Times staff writer Leslie Earnest contributed to this report.