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UBS Investment Bank, the London-based unit of Switzerland's largest bank, UBS AG, analyzed subprime mortgages made in 2006 and found that borrowers were missing payments on loans made that same year at the highest rate since 2000.
In fact, UBS found subprime loans made in 2006 are on track to be the worst-performing loans ever issued.
Let's look at that last statement: "Worst performing loans, EVER. That means that in the rush to cash in on the housing bubble, lenders lowered standards to such a degree as to hurt their own business - possibly to the point of bankruptcy:
H&R Block's Option One in Irvine is up for sale. So is Ameriquest Mortgage in Orange. ECC Capital of Irvine is selling its loan-making operations to New York's Bear Stearns Cos., although the sale has been delayed.
So -- how are these loans actually performing?
Brea-based Fremont Investment & Loan, a unit of Santa Monica's Fremont General Corp.,topped UBS' list of poor performing loans. By late last year, 7.26 percent of Fremont's subprime loans made that same year were 60 days or more delinquent.
Argent, a unit of ACC Capital in Orange, which also owns Ameriquest, scored high on the list with a delinquency rate of 5.86 percent.
Option One landed closer to the middle with a 4.54 percent delinquency rate, and Irvine's New Century Financial Corp. had a 4.33 percent default rate.
Those above figures indicate credit underwriting standards were non-existent for at least the last year, and possibly longer.
Borrowers took advantage of "stated income" loan programs, where they simply tell lenders what they earn, said David Liu, director of UBS' mortgage strategy group.
And many first-time homebuyers made a small down payment or none at all. Often they took out simultaneous second mortgages to avoid paying mortgage insurance.
Borrowers gambled on rising home prices to bail them out of trouble, analysts said. Consumers thought home prices would keep climbing, which would enable them to sell or refinance if they got into a jam, analysts said.
Here's where the real rub comes in. Individual loans are sold up the financial food chain to larger and larger institutions. Basically, your local bank sells your loan to larger institutions. These institutions then pool your loan with other loans of similar size, maturity and interest rate. These pools are then "securitized", meaning they are essentially made into bonds and sold on the open market to pension funds, insurance companies and mutual funds who essentially treat these loans as bonds in their respective portfolio. Theoretically, this helps to diversify risk. For example, suppose California loans have a high rate of default. If a pool of mortgages has a high percentage of California loans then that particular pool is obviously in trouble. However, if the California loans are a small part of a larger pool of mortgages from other areas of the country then a default on the California loan isn't that big a deal. However, there are no uniform standards for underwriting these pools.
And there's another catch. If the loans start performing poorly within a certain time frame, the purchaser can sell the loan back to the originator.
Lenders package loans in big pools and sell them as bonds to investors. If a borrower misses the first payment, an investment bank putting the whole deal together can compel the lender to buy back the loan.
Lenders typically lose a lot of money when they must buy back delinquent loans. They lose transaction costs and may sell the loan again at a loss. Often when a borrower has defaulted, there is little or no equity in the home, so a foreclosure sale will not cover costs.
This is why we've seen three major sub-prime lenders go bankrupt in the last two months. They were all forced to buy-back poor performing loans. The originators didn't have the money to make all the purchases. As a result they were forced into bankruptcy.
The sub-prime story is just beginning to play out. As with most all things economic, we'll have to wait and see how this plays out in the larger economy. However, these developments certainly don't help.