Irvine, Calif.-based subprime mortgage lender New Century Financial Corp., one of the largest issuers of subprime mortgage ABS in the market, last week announced that it's having difficulty selling loans to secondary market investors. Pointing to market conditions, company representatives during a conference call said whole loan bids were substantially lower than expectations - while some sources say bids for the company's loan pools are well below those of its competitors, forcing it to sell at least one recent pool of loans at a loss.
Its loan pools are being priced 30 to 50 basis points lower than comparable levels seen 30 days ago, according to New Century - the squeeze may reduce the company's operating margins to 30 to 50 basis points in the fourth quarter, compared with earlier estimates of 80 to 100 basis points. On Sept. 23, citing the lower bids and anticipated losses from Hurricanes Katrina and Rita, New Century lowered its annual earnings outlook to between $7.25 and $7.75 per share, versus a previous range of $8.25 to $9.00. Prior to August, the company's full-year earnings estimate was above $9.00. New Century shares have fallen nearly 50% this year, and in the hours following its earnings revision New Century's shares fell 10%.
Subprime mortgage lenders, which have historically enjoyed wider margins than their prime counterparts, have winced over thinning operating margins as stubbornly low long-term rates and competitive pressure have kept mortgage rates low, while funding costs have increased. Meanwhile, the loans have continued to be consumed at a rapid pace in the secondary market, largely because of the CDO bid, while risk premiums have stayed relatively light according to some analysts, who anticipate a push for wider spreads as fears of a downturn in the housing market mount.
New Century, which operates as a real estate investment trust, has downsized its 2005 earnings estimates twice in as many months. During last week's conference call, the mortgage lender said it will forgo efforts to drum up volume in favor of refining its pallet of product types and borrower qualifications for those products in order to gain back some of the ground it lost with investors. The company estimates that move could result in a 30% monthly decline in loan volume from peak levels of $1.6 billion in August.
In order to win back whole-loan buyers, New Century plans on reducing its overall portion of I/O loans. In the first half of the year, the company's I/O loan production was at least 33% of total originations and although a New Century spokeswoman did not return a request for comment on its current I/O loan composition, its stated goal is to reduce the portion to 25%.
New Century is not the only lender taking a second look at product types. Both Countrywide Financial and Washington Mutual plan to tighten underwriting standards for their option adjustable-rate mortgage products, which New Century does not offer. To compensate for narrowing the spectrum of buyers that can qualify for an I/O loan, New Century will soon begin offering 40-year mortgages.
Defending rumors of low bids on their own pools compared to competitors, New Century's Executive Vice President and Chief Financial Officer Patti Dodge said last week those impressions could come from the way they "slice and dice" their pools, with some substantially concentrated with I/O or subprime product. She added that the atmosphere at the recent Information Management Network's ABS East conference confirmed the current jitteriness of whole loan buyers. Brad Morrice, the company's vice chair and chief operating officer, said the lower bids were not due to predominantly low FICO product.
"We are certainly not delivering lower FICO-grade product," Morrice said, "But even if you deliver higher coupons, the pick-up on these in the market has not been as much as it has been in recent months."
New Century sells 70% to 80% of its loans in the wholesale market - typically, after warehousing its loans for 60 days, the cost of delinquencies dilute the income generated by interest on the loans, said Edward Gotschall, vice chair of finance, and in any case, warehousing agreements typically don't allow for lengthening the amount of time loans are held.
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