Only the Strongest Sub-Prime Lenders Will Survive: Update

by: Prakash Kolli

On February 22nd, I opined that only the strongest sub-prime lenders would survive. Specifically, I wrote,

With credit quality deteriorating (approximately 1 in 10 sub-prime mortgages defaulted by the end of 2006), investors forcing the repurchase of packaged loans and reducing purchases of new ones, a slow down in originations, lawsuits, and interest rates trending up, only the strongest lenders will survive.

Since that time the number of failed sub-prime lenders has increased from 23 to 37. Many of the ones that remain have had their access to financing curtailed and their stock prices depressed. In the case of New Century Financial (NEW), the stock was delisted from the NYSE and, according to the NY Times, the company is the focus of investigations by the Securities and Exchange Commission [SEC] and a federal grand jury.

An article in blames Greenspan for maintaining interest rates too low for too long; irrational lenders for applying minimal lending standards or none at all; Wall Street for packaging, warehousing, and trading mortgage securities; and the rating agencies for not downgrading sub-prime securities. Clearly all have some degree of responsibility, but ultimately, it was poor underwriting standards of many sub-prime lenders, which allowed the loans to be made.

I am sure additional sub-prime lenders will fail, but whether traditional lenders will be impacted is hard to say. Some like ResCap, a unit of General Motors Acceptance Corporation [GMAC] have reported higher loan defaults and weak results. Investment banks such as Goldman Sachs (NYSE:GS) and Lehman Brothers (LEH) are claiming the impact will be minimal due to hedging of risks. Retail banks and thrifts are also claiming varying levels of impact. The traditional lenders, however, have significantly larger asset bases and probably can weather the storm. In fact some have and others will take advantage of the situation and purchase mortgage loans from sub-prime lenders at significant discounts.

Disclosure: The author does not have a position in any stocks discussed at the time of writing.