“If you lend money to someone who doesn’t qualify to borrow money in the first place, why the surprise when they don’t pay?”

–  Ed Yardeni, economist

Ed’s recent quote about mortgage lenders hits the nail on the head. The financial media recently has been full of stories about the collapse of the subprime mortgage market. What is a subprime mortgage? What is really going on? How is the fallout affecting mortgage lenders? What role is the government taking? In the balance of this newsletter, we hope to answer these questions for you.

Subprime mortgages

Although there are different ways to categorize subprime mortgages, a subprime mortgage is a loan offered at a rate above market rate to individuals who do not qualify for market rate loans. Subprime borrowers typically have a lower credit rating than other borrowers ? their credit scores are generally below 620. In other words, a subprime mortgage is a loan made to an individual who has a poor credit rating and who would not otherwise qualify for a mortgage at prevailing market rates.

The Facts

• In 2006, 20% to 47% (depending on the definition of subprime) of all mortgages issued were subprime. In 2000, the total was less than 2%.
• 40% of the subprime mortgages last year were “no doc” mortgages. This means that the loans were given without proof of wages or other financial documentation.
• 80% of subprime loans are adjustable rate loans whose rates adjust every twelve months and have been held for at least two years. People who closed on a subprime mortgage in 2005 will see their monthly mortgage payments jump 30% -50% this year.
• 70% of subprime mortgages carry huge prepayment penalties if they are refinanced within the first three to five years.
• In 2006, foreclosure filings on subprime mortgages rose 42% – almost 1.2 million in total – from 2005 levels.
• 46% of all home purchases in 2006 were made using 5% or less as a down payment.
• Banks are highly regulated entities and bank regulators raised lending standards in September of last year. As a result, the subprime mortgage market, which grew by more than 50% during the first six months of 2006, turned negative in the last six months of 2006.
• Most unregulated mortgage companies making subprime mortgage loans will not be able meet the new tougher bank standards.

Effect on Mortgage Lenders

The impact of the fallout of the subprime market has been devastating to mortgage lenders both in terms of their businesses and in their stock prices. HSBC Holdings expensed $10.5 billion of bad debts for 2006. Other mortgage company stocks have dropped significantly in the past few weeks – Accredited Lenders (LEND) -63%, Fremont General (FMT) -30% and Countrywide Financial (CFC) -22%. Some subprime lenders have closed shop. This is not surprising. Lending money to non-credit worthy individuals with no proof of income or assets does not make good business sense. It is a logical consequence that these companies will suffer when they make bad business decisions.

What should the Government do

In our opinion, absolutely nothing!!! The market is already forcing these companies to change. For example, Countrywide Financial recently changed their policy that loans must have at least a 5% down payment. Some mortgage companies will go bankrupt – and quite frankly, they should – and others will lose lots of money. This is the free market. The government does have a role in how banks lend money since they are federally insured. Regulators have raised the lending standards at banks and it is changing the way they lend. That should be enough. The collapse of the subprime market is forcing companies other than banks to change on their own. It is too late for the government now to get involved. If it does, such action could have undesirable effects on the market, such as the Sarbanes-Oxley bill which was signed into law in 2002.

Sarbanes-Oxley was enacted in 2002 in response to the Enron and MCI collapses. This law has proven to be a regulatory burden for companies and has had several negative effects on the long-term health of the stock market – i.e., reduced number of public offerings, companies listing on overseas markets instead of US markets and an increase in the cost of doing business for smaller publicly-traded companies to name a few. In our opinion, government action at this point could have a similar stifling affect on the market. If the government wanted to get involved, it should have done so two years ago.

THOR is Moving

It is with both sadness and great anticipation that we inform you of THOR’s intended relocation to Anderson Township late this spring. THOR has been an active member of the Mariemont community since our inception in 1992. However, we have outgrown our space at our current location and have been actively searching in and around the Mariemont area for quite some time now for somewhere to relocate. We were unable to find any space that would accommodate our space needs in Mariemont. We appreciate the assistance we have received from everyone in Mariemont, especially the assistance of the Mayor, Dan Policastro. We will certainly miss the Mariemont community.

Our new location is 7346 Beechmont Ave. in Anderson Township. It is located near the corner of Beechmont Ave. and Five Mile Rd. Although our intended move-in date is still somewhat unclear, we anticipate it will be sometime around June 1. We look forward to occupying this building for many years to come and hope you will stop by and visit us at our new location.