SUBPRIME Mortgage Lending

Copyright (c) 2007 Ottawa Citizen

At first glance, there is neither rhyme nor reason why Canada's
financial markets should have taken such a beating over the subprime
mortgage meltdown wreaking havoc in the United States. But there is no
controlling fear when the pocketbook is threatened. It's the old story
repeating itself; Uncle Sam burps and we get indigestion.

The distress in the U.S. housing market, caused by lenient lenders
with more money than sense, is hitting Americans where it hurts them
the most. If now they slash their spending habits, the retail sector
will get knocked for a loop and Canada's manufacturing sector and
export industry will feel the brunt of it, says Paul Ferley, assistant
chief economist at BMO Capital Markets.

That wasn't in the cards last week when HSBC Holdings, Europe's
biggest bank, with about 125 million clients worldwide, reported that
it had lost $10.6 billion U.S. on bad debts related to subprime
mortgages, much greater than Wall Street's worst expectation.
Tumbling financial markets in Southeast Asia overshadowed that
development. But forget China and the Far East; this problem is a lot
closer to home, and Canadians will be made aware of this as U.S.
subprime lenders come here in far greater numbers than they already
have.

And they are coming.
"Subprime in Canada is the next real big wave of business," says
Michael Hapke, managing partner of Mortgage-Brokers.com in Ottawa,
which has offices nationwide. "We're years behind with the subprime
market, but the U.S. mortgage lenders who handle this business are
starting to pour in. Some of them have been around a long time and
have done very well because they've opened the door for many
homebuyers."

The inherent danger with subprime mortgages is that they carry the
risk of loan defaults and mortgage underwriting among buyers with
less-than-stellar credit who are encouraged to take loans far beyond
their financial means.

The lenders do this by offering adjustable-rate loans that carry
introductory rates that keep payments relatively low for two years.
The idea is that if borrowers can't afford to make the increased
payments at the end of the initial two-year period, they will
refinance with new loans, supported by the increased value of their
home.

That's all well and good in a housing market with rising prices. What
few foresaw was the bursting of the U.S. housing bubble. That has left
tens of thousands of borrowers with rocketing mortgage payments, up to> 40 per cent greater, who are now either unable or unwilling to make
payments on a property worth far less than what they paid for it.
While damage to financial markets is incalculable, the U.S. Centre for
Responsible Lending estimates that approximately $1 trillion U.S. in
subprime mortgages are in default and one-in-five of the subprime
loans written in the past two years is headed for default, costing 1.1
million families their homes and unleashing a flood of foreclosed
properties on the market.
Hapke says that exposing Canadian homebuyers to subprime mortgages
carries the same risks.

"But big companies don't care too much about the overall economy.
They're more interested in hitting the market while it's hot. In terms
of where the mortgage market is going, subprime is where it's headed.
The majority of our business going forward will be there.
"There's no question it's dangerous, but those dangers could be 10
years down the road and you know what industry's like. The companies
insuring these mortgages are very aggressive. They're interested in
growth now. They're not interested in 10 years down the road."
What's happened in the U.S. subprime business confirms this. Dozens of
subprime lenders have closed, scaled back or been sold over the past
15 months.

Shares of New Century Financial Corp., of Irvine, California, the
second-biggest U.S. home lender in the business, have crashed to $1.66
U.S. from $51.97 U.S. The New York Stock Exchange has suspended
trading in the shares, the company says it doesn't have enough cash to
pay its own lenders, it has been subpoenaed by a grand jury in a
federal criminal probe and is expected to file for bankruptcy
protection.

Shares of Accredited Home Lenders Holding Co., parent company of
Accredited Home Lenders Canada Inc., crashed 65 per cent on Tuesday.
Countrywide Financial is down nearly 30 per cent. Fremont General
Corp. has agreed to a cease-and-desist order with bank regulators that
requires it to stop advancing risky mortgages. Fremont says it plans
to exit the subprime home-loan business.

Among the listed companies on the Toronto Stock Exchange that handle
subprime mortgages are Home Capital Group Inc. (HCG), Equitable Group
Inc. (ETC) and Xceed Mortgage Corp. (XMC).
Xceed bills itself as a "non-traditional residential mortgaging
company" with a main client base of "non-traditional customers who are
unable to satisfy the strict underwriting criteria of traditional> mortgage lenders."
Xceed is trading around $6.45, about 37 per cent off its 52-week high.

In England, where subprime mortgages are popular, the financial market
wasn't immediately disturbed by events in the U.S.
Miray Muminoglu, a syndicate banker at Barclays Capital in London,
told Bloomberg, "The stock market is in solid shape. There's no fear
of contagion from the U.S. and further proof that the U.K. is a
different market."
The diagnosis was premature. Yesterday, the British FTSE fell 1.7 per
cent after a wave of selling swept Japan's Nikkei index, down 2.9 per
cent. Indexes in Hong Kong, Malaysia, India and Australia fell more
than two per cent.