Mitigating Risk of the Subprime Mortgage Market
By: Ken Torgler, Regional Manager-East Region
The recent stock market fluctuations have been magnified by the subprime lending market. Market fears within the United States have spread globally due to foreign investment in the mortgage-backed U.S. bond market. Subprime lenders are going out of business at warp speed, while surviving lenders are trying to weather the crisis with massive layoffs in hopes of avoiding bankruptcy.
Subprime lending is a targeted business line phenomenon of the 1990's. Subprime loans are also called B-paper, near-prime, or second chance lending. The terms refer to the credit characteristics of the borrower and are an indicator of higher risk.
Hybrid and adjustable rate loans have been pricing upwards causing a squeeze on homeowners. The rate increases have come at a time that corresponds with increases in energy, education, and other general household expenses. Combine all this with a cooling in the housing market and a low savings rate, and some consumers are losing ground.
Did your bank anticipate and plan for these economic conditions? Is your management team appropriately protecting shareholder interests? The warning signs are not new, as regulatory agencies and the media have discussed these economic stressors at length for years. The issues did not simply come to light in 2007.
How could this economic downturn affect your bank? Banks could see a decrease in profitability due to charge offs, higher loan reserves, and/or a decrease in fee income. Adversely classified assets could increase. Other real estate balances and related costs could climb. Secondary lenders are drying up and banks could be forced to book long-term, lower-rate loans that otherwise would have sold; and capital could be at risk if problems persist.
An area of high risk in today's market is the 1-4 family construction portfolio. Due to the increased risk, management is advised to evaluate all homebuilders and consider doing the following:
