Subprime Will Be Back: Analyst

Craig Focardi, research area director – banking practice for TowerGroup, likened the current state of the subprime mortgage market to the failed Apollo 13 lunar mission.

“They found a way to survive and come back, despite difficult times,” Focardi explained during a Webinar presentation Thursday. Similarly, the subprime mortgage market will find a way to come back, though “in some areas it will get worse before it gets better.”

The problem also extended overseas to the United Kingdom, Focardi said, though the UK is less likely to experience the depth of the problem in the U.S.

In the U.S., the problem was largely due to the credit and housing bubble of 2002 through 2004, when underwriting standards were relaxed for several types of loans, particularly those featuring below market teaser rates, Focardi said. The approval of many of those loans was based on the teaser rate, not on the higher reset rates that would kick in a couple of years later. That time has come and many borrowers are struggling to handle the new cost of their loan.

As those troubles started appearing, the subprime market dried up and some mortgage lenders went out of business. Business has slowed for other mortgage business as well, Focardi said, pointing to a Challenger, Gray & Christmas report that 37 percent of September layoffs were related to the housing industry.

Yet payment delinquencies are still largely limited to the subprime arena with 14.8 percent of loans delinquent, and the FHA markets with a 12.6 percent delinquency rate, not in prime mortgages, where less than 3 percent of mortgages are delinquent. There’s also a regional basis for the problems, with former high growth housing states Florida, California and Arizona suffering the most. Illinois, Indiana and Ohio comprise a second tier of states with problem loans, according to Focardi.

Even with these problems, “subprime will come back,” Focardi said. Historically, subprime has been 8 to 12 percent of the market, but rose to 20 percent during its peak a few years ago. Though the market has all but dried up for the time being, Focardi expects it to recover to its historical average. FHA lending will also grow.

However, he still expects overall mortgage lending to have another down year in 2008, with the caveat that Federal Reserve interest rate cuts could change that scenario.