Death Spiral / No Bull Interview

I had an interesting interview today with Dave Donhoff at No Bull Mortgage regarding the implosion of New Century Financial and subprime lenders in general. Before checking in with Donhoff here is some recent news on the Death Spiral at New Century.

Several analysts agreed Monday that New Century Financial Corp., one of the nation's largest subprime mortgage lenders, likely faces liquidation or bankruptcy following revelations that it's under criminal investigation and in violation of debt covenants with several lenders.

"New Century is more likely to enter the death spiral we had feared, as filing delays, financial difficulties, likely restricted liquidity and regulatory/criminal investigations could conspire to limit its options outside of bankruptcy," Merrill Lynch analysts wrote early Monday.

New Century's shares were down more than 69% at $4.53 in afternoon trades Monday, after dropping in Friday's session as well. Analysts at Jefferies & Co. also said the company has moved into worst-case scenario territory with its Friday filing. They cut their rating on the shares to underperform from hold.

"New Century's situation is not unlike the 'Prisoners Dilemma.' If the majority of lenders stand pat, they can mitigate losses. However, if they believe that other lenders will pull their lines, those first to act will be best served," Jefferies analysts told clients.

Let's see. Now that New Century Finance has plunged a 69% on March 5th alone and is now down a "mere" 86.21% since February 8th, Jefferies finally managed to dredge up the nerve to cut their rating to "underperform" from "hold".

Here is a tip to Jefferies: When doing downgrades like this, try and do it when no news agency is looking. The way you did it makes you look silly. The point being someone may just start wondering about all of your other recommendations.

Then again, isn't everyone supposed to know that "hold" really means "sell"? But if so, then what exactly what do "underperform" and "sell" mean? While everyone is pondering that, inquiring minds are wondering: If a criminal investigation and an 86% plunge does not generate a sell recommendation, exactly what will? Note: 86% is from the February high to the downgrade by Jefferies. NEW plunged an additional 25% today bringing the total decline to roughly 88% .

No Bull Interview

What prompted my call to Dave Donhoff was his post on The Market Traders.

Mortgage Implode is only showing registered LENDERS.
BROKERAGES going tits-up are probably 10-15 to every individual lender.
BLOOD in the streets EVERYWHERE.

A phone conversation revealed that 10-15 is an extremely conservative estimate. There are no national statistics available and depending on how one classifies "brokerages" (e.g. the number of firms vs. the number of branches vs. the average individual running his business on his PC, the number could be as high as 100-1 or even 500-1.

The reason there is "blood everywhere" is that mortgages are being returned (sold back) not just to lenders from securitizations gone bad, but lenders are in turn forcing the re-purchase of those mortgages back to brokers in record numbers as well. A typical contract between a brokerage firm and a lender might stipulate that new loans must stay current for at least 90 days or they must be repurchased by the originating brokerage. On Alt-A or subprime loans the length of time might be as long as 6 months.

Now that delinquencies are rising everywhere, brokerage firms simply have not been prepared for the forced repurchases of loans. Donhoff noted that each lender's wholesale relationship contract is different as "stay current" timeframe requirements are negotiated between lenders and brokerages. The larger warehouse banks (e.g. Merrill Lynch, or Lehman) that provide the funding for retail banks like OwnIt, MLN, AmeriQuest, etc, have even stiffer requirements within their contracts.

Once a certain threshold of 90 day late pays is hit, contract stipulations might require reserve requirements that the retail banks can not meet. "The situation is not unlike a margin call" said Donhoff. "Unless reserve requirements are immediately met, new loan funding is shut off and the retail mortgage bank is forced out of business."

I asked Dave Donhoff how he was doing personally. Donhoff replied that he has a "ten year record of no mortgage buy-backs and no foreclosures". Perhaps that can be expected from someone who steers people away from risky loans and will not accept stated income loans if he thinks the applicant was exaggerating. Nonetheless Donhoff said "I was lucky. A few close calls over the years were all worked out."

I find it interesting that many small brokerage firms had to put up personal guarantees in the form of bonding and/or pledged personal assets. That means owners of those companies are personally liable above and beyond corporate liability. Looking ahead, there is potential for another wave of litigation over these blow-ups as the larger players start targeting some of those who not too long ago were riding high in their Ferraris. It's a death spiral on multiple fronts.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/