New Century’s Stock Suspended on NYSE

New Century Financial Corporation provides mortgages to subprime borrowers, those with credit problems. In return, the company and others like it get higher interest payments to make up for the increased risk. Fair enough, except New Century has lost track of borrowers’ defaults, its loan portfolio wound up overstated, and a federal prosecutor and securities regulators want documents from the company as part of an investigation. Trading in its stock has been suspended on the New York Stock Exchange, and the next stop could be Chapter 11.

The real profits in this business come from securitizing the loans made. In other words, New Century and others originate the loans, then bundle them together and sell them off to others, usually hedge funds, insurance companies and others with deep pockets and an appetite for risk. Having pocketed the money, the originators are in a position to make new loans. This works fine unless one of two things occur: the borrowers stop borrowing or the buyers of the securitized loans stop buying.

The subprime mortgage market is usually the one most affected by rising interest rates. When prime borrowers’ costs go up 25 basis points, subprime borrowers often get hit with more. So the cost of borrowing has gone up for these people in recent months, and that has resulted in fewer originations. That in turn results in smaller securitizations, meaning smaller profits for originators. Smaller profits, however, don’t get a stock suspended from trading.

The bad books at New Century have effectively finished off any interest in buying the securitized loans. Delinquencies and defaults are dealt with in securitizations with actuarial precision. Built into each deal is an assumption about how many loans are going to go sour. The fact that New Century doesn’t have a handle on the delinquencies and defaults undermines that completely.

The subprime mortgage industry is a tough one. According to MSNBC, more than 20 companies have left the market in the last year. Accredited Home Lenders Holding Co., a rival of New Century, has seen its stock price drop by more than half, in part a contagion effect from New Century, and in part, due to weak underwriting standards (which is rife in the industry). However, a little perspective is needed. Subprime loans accounted for only 20% of the $600 billion US mortgage market last year. It’s bad, but it isn’t the kind of thing to start a recession, at least, not all by itself.

© Copyright 2007 by The Kensington Review, Jeff Myhre, PhD, Editor. No part of this publication may be reproduced without written consent. Produced using Fedora Linux.

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