That’s the title of an article in today’s Financial Times, describing how concerns about the implosion of the subprime mortgage market has led to concerns about the broader mortgage market. As the piece sets forth, this isn’t simple speculative precaution; it turns out delinquencies are running higher than expected in mortgages that are rated just above subprime. We pointed to the possibility of contagion earlier, when most commentators were maintaining that the subprime meltdown was an isolated phenomenon. From the FT:
Treasury prices rose on Monday as fixed income investors sought a safe haven amid fears that repayment problems involving “subprime” US mortgage borrowers could have knock-on effects in the broader $8,000bn mortgage market and beyond.
The latest concerns centre on the Alt-A market, in which consumers with slightly better credit than the weakest subprime borrowers can obtain loans with loose terms – such as no proof of income. Late payments and defaults on such loans are running at four times the historical rate.
“The delinquency numbers for the 2006 Alt-A originations are materially worse than a lot of people would have expected,” said Charles Sorrentino, mortgage analyst at Merrill Lynch.
The flight of investors into more secure investments helped send yields on 10-year Treasuries down four basis points to 4.633 per cent. The price of insuring against default on subprime mortgage bonds also remained near record levels. The annual cost of credit protection on the ABX index of mortgage bonds rated BBB- rose to 14 per cent, up from 13 per cent at the start of the day and just slightly off last week’s record of 15 per cent. Three weeks ago, the price of such protection was 2.5 per cent.
There are particular concerns about the estimated $600bn of adjustable rate mortgages – of which two-thirds are subprime – that are scheduled to reset at a higher interest rate this year. Analysts worry that higher rates will lead to more foreclosures and lower consumer spending.
“The sub-prime story seems to have developed legs as Treasury traders seized on the idea that ABX [index)] woes may seep into other markets and create a credit dilemma,” said William O’Donnell, interest rate strategist at UBS. He said subprime problems were “topic number one in the US rates market place”.
Michael Kastner, portfolio manager at SterlingStamos, said: “Investors are not fully pricing in the risk of contagion, but as structured deals start to go sour and get downgraded, the pain will spread.”
Shares in subprime lenders were also hit hard on Monday. Novastar Financial slid 6.1 per cent to $7.96, and New Century Financial fell 1.8 per cent to $15.24. Shares in Countrywide, were off 1.5 per cent at $38.72.
“Subprime is hitting some financial institutions hard, though typically this market is dominated by independent mortgage companies and the knock-on systemic impact to the broader lending market should remain restrained,” said Alan Ruskin, chief international strategist at RBS Greenwich Capital.