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The typically short memories of the markets have already put the US sub-prime meltdown behind them.
It’s as if investors think that, because the roof hasn’t caved in on the entire sector yet – despite some high profile casualties – it never will.
And a rise in pending home sales in the US in February had the optimists out in force yesterday, driving the Dow Jones up 128 points to close at 12,510, a five-week high.
So is all right with the world again?
The National Association of Realtors said that pending US home sales rose 0.7% in February, helping to drive the Dow Jones index to a triple-digit gain.
But investors would do well to remember that pending sales are still down 8.5% on last year. And more importantly, even the NAR admitted that sales might be experiencing ‘some fallout from a decline in subprime lending.’
As one analyst quoted on Markwatch argued, investors are clutching at straws. ‘Pending home sales data, when did that become a market moving piece of information?’ said Eliot Spar of Ryan Beck & Co. ‘When the market is range bound, it doesn’t take much to move traders off the fence as they extrpolate one data point into a trend.’ In other words, one swallow doesn’t make spring – and there’s plenty of other news to suggest the sub-prime debacle is far from over.
For example, New Century Financial finally went to the wall earlier this week. It filed for Chapter 11 bankruptcy protection and has sacked more than half its workforce – 3,200 people.
Before the collapse, the group was the biggest independent sub-prime lender in the US, doling out $60bn in loans in 2006. Only HSBC (also having problems with its US sub-prime unit) wrote more business last year. The stock, trading above $30 a share at the start of this year, now trades at around $1.
New Century was particularly vulnerable to a downturn, say analysts. Cash and other liquid assets accounted for less than 5% of the loans it held for sale. 10% is more typical in the sector. But that’s still not much of a margin during a crisis.
We already knew about New Century’s troubles, but the wider fallout hasn’t stopped yet – far from it. Regional banking group M&T Bank also issued a profit warning on Monday. Its first-quarter earnings will take an $11m hit due to problems in the Alt-A loan market.
Alt-A loans are considered to be somewhere between sub-prime and prime – these are loans made without detailed documentation of income, similar to ‘self-cert’ in the UK. Of course, what happens in a surging market, where lenders are desperate to write more business, and borrowers are desperate to get on the property ladder, is that borrowers lie, and lenders don’t check. They only start to care when the markets starts to turn down – as it has now.
M&T’s woes are happening for two reasons. As with the other sub-prime lenders, M&T sells its mortgages onto third parties like investment banks to be parcelled up into mortgage bonds. But more of its loans are going bad (ie borrowers aren‘t paying out), more quickly than it expected – and the banks are entitled to a refund when that happens. So M&T is having to buy back more loans than it had budgeted for.
The other problem is that when investors see housing loans going bad, they become less eager to buy bonds backed by mortgages. So that means that M&T is also having problems getting a decent price for all those Alt-A loans it‘s been writing.
The bank is one of the first to report such problems. But as Joseph French of Sandler O’Neill & Partners told Marketwatch, “We would not be surprised to see similar-type pre-announcements from other banks heading into earnings season.”
Among the banks that look particularly vulnerable is Regions Financial. Regions has already felt the squeeze from the housing slump – it agreed to sell its sub-prime unit, EquiFirst, to Barclays in January for $225m. That has since been slashed to $76m
The reason for the sharp price cut isn’t the performance of last year’s loans – it’s more to do with current loans. As Antony Currie on Breakingviews.com points out: “Subprime lenders sell most of their loans to investment banks, which repackage them into mortgage bonds. Many of the riskiest slices of these are bought by collateralised debt obligations (CDOs). Investors are still trying to determine how much pain the subprime mess will cause them, so they’re not keen on buying new CDOs – even if the underlying loan quality is better.”
So, as M&T has found, “mortgage lenders are having a harder time selling their loans at a profit.”
That might be good for Barclays at the moment – “it can snap up the 12-largest subprime lender at a bargain price. But in the longer term, if… appetite doesn’t rebound, none of these businesses will do well.”
Turning to the stock markets…
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In London, the FTSE 100 was 50.6 points higher at 6,366.1, Scottish & Newcastle featuring highly as a rumoured bid for the group by Diageo pushed its share price up 16p to 605p. For a full market report, see: London market close.
In London, the FTSE 100 was 50.6 points higher at 6,366.1, Scottish & Newcastle featuring highly as a rumoured bid for the group by Diageo pushed its share price up 16p to 605p. For a full market report, see: London market close.
On the Continent, the Paris CAC-40 ended the day 66.35 points higher at 5711.91, whilst the German DAX-30 closed 108.39 points higher at 7,045.56.
Across the Atlantic, the Dow Jones was 116.20 points higher at 12, 498.50, while the tech-heavy Nasdaq was up 30.58 points at 2,452.84. And the broader S&P 500 was up 13.20 points to 1437.75.
In Asia, the Nikkei gained 300.04 points or 1.74 pct at 17544.09.
Crude oil was $64.43 a barrel, down 21 cents, while Brent Crude was trading at $67.66 a barrel in Singapore this morning.
Spot gold was trading at $664. Silver, meanwhile, was at $13.44/oz.
And in London this morning, recruitment firm Michael page showed the jobs market is performing strongly, after posting a 33.2% rise in Q1 profit to £105.4 million.
And our two recommended articles for today…
Is this the investment trend of the decade?
– To find the next big investment trend, you should ‘follow the silicon’. And right now it’s heading for medical diagnostics. To find out why Michael Orme thinks the ‘end of medicine’ could be the beginning of a great investment opportunity, click here: Is this the investment trend of the decade?
How to solve a problem like the dollar
– The US is running a current account deficit larger than that of any other of the world’s major developed economies. But its return to a sustainable level could see some major upheavals for the economy – and a weaker currency. For more on the economic addjustments America is set to undergo in the near future, read: How to solve a problem like the dollar