Last Saturday's Towel hit the declining $1.3 trillion subprime mortgage market hard -- with two articles and the lead editorial. Since the stock market won't be open until Tuesday -- the Towel's timing will either give investors a long time to stew about subprime's woes or to forget them as they ski in Aspen or warm themselves in the Turks and Caicos. But does the Towel's wide coverage also signal the end of the trend?

The best of the three articles was The Subprime Market's Rough Road [subscription required for all Towel links] since it included statistics which paint a compelling picture of a widening subprime collapse, including the following:

• Subprime loans have grown to 12.75% of the $10.2 trillion mortgage market in 2006, up from 8.5% in 2001
• 47% of subprime loans are "creative" -- up from 2% in 2000 -- featuring "piggyback" loans which require no down payment and "no-doc" loans that let borrowers state their incomes without supporting documentation. While this creativity works fine when housing prices rise -- if a borrower defaults, the lender can profit by selling the property -- it does not work when housing prices are going down.
• 80% of subprime mortgages are exploding ARMs (adjustable-rate mortgages) with low fixed-interest payments in their first few years which later adjust to higher interest payments. When the ARM adjusts upward, some borrowers can't afford to pay. The resulting foreclosures lead the mortgage company to sell the house to get back some of the loan principal. The sudden increase in the supply of houses on the market puts further downward pressure on prices.
• Nearly 1.2 million foreclosure filings were reported in 2006, up 42% from 2005, representing one in 92 U.S. households. This trend will worsen if interest rates rise.
• Borrowers have never been more leveraged. Loan-to-value ratios, the loan amount expressed as a percent of the property value, have grown to 86.5% last year from 78% in 2000. With all the new supply on the market, these loan-to-value ratios are likely to rise as the values decline. This will mean steeper loan writeoffs for mortgage lenders which will deplete their capital.
• At least 20 subprime lenders have filed for bankruptcy or have been sold. As mortgage-backed securities buyers exercise their rights to force mortgage originators to buy back the bad loans, the loan originators will likely be unable to come up with the buyback cash -- leading more of them to file for bankruptcy.

Continue reading Towel Talk: Flooding the subprime zone

Towel Talk: Flooding the subprime zone originally appeared on BloggingStocks on Tue, 20 Feb 2007 09:09:00 EST. Please see our terms for use of feeds.