On Monday, US Treasury prices rose amidst fears that repayment problems involving “subprime” US mortgage borrowers could have knock-on effects in the broader $8,000bn mortgage market and beyond.
The latest worries focus on the Alt-A market, in which consumers with slightly better credit than the weakest subprime borrowers can obtain loans with loose terms - such as no proof of income. Late payments and defaults on such loans are running at four times the historical rate.
“The delinquency numbers for the 2006 Alt-A originations are materially worse than a lot of people would have expected,” Charles Sorrentino, mortgage analyst at Merrill Lynch, told the Financial Times.
The move of investors into more secure investments helped send yields on 10-year Treasuries down four basis points to 4.633 per cent. The price of insuring against default on subprime mortgage bonds also remained near record levels. The annual cost of credit protection on the ABX index of mortgage bonds rated BBB- rose to 14 per cent, up from 13 per cent at the start of the day and just slightly off last week’s record of 15 per cent. Three weeks ago, the price of such protection was 2.5 per cent.
The FT says that there are particular concerns about the estimated $600bn of adjustable rate mortgages – of which two-thirds are subprime – that are scheduled to reset at a higher interest rate this year. Analysts worry that higher rates will lead to more foreclosures and lower consumer spending.
The Wall Street Journal says that as more consumers and companies start having difficulty paying their debts, the funds that banks set aside to cover soured loans stand at the lowest level since at least 1990.
The Journal says that the situation is causing consternation among regulators. And as credit quality begins to deteriorate from unusually strong levels, the issue also is causing jitters on Wall Street, where analysts predict the need to boost loan-loss reserves will cut into banking-industry profits this year.
Banks establish reserves for a portion of loan portfolios or big individual loans that they estimate could go unpaid. The reserves ensure that banks have enough capital to cover any losses from loans that go bad.
But each increase in those reserves results in a charge that cuts into banks' profits.
Banks set aside an average of 1.09% of the total value of their loans at the end of last year, according to data from 518 publicly traded banks compiled by SNL Financial for The Wall Street Journal. That is a dip from 1.14% in 2005 and from 1.63% in 1992 and 1.48% in 1990. The SNL figures date to 1990.
"There is a growing concern about loan quality and it isn't reflected at all in the reserves," says Brian Shullaw, an associate director at SNL, a Charlottesville, Va., research firm that focuses on the financial-services industry.
According to SNL, the nation's three biggest banks had above-average reserves at the end of 2006: 1.32% at Citigroup Inc., 1.28% at Bank of America Corp. and 1.51% at J.P. Morgan Chase & Co.
Some large regional banks' reserves are well below average. Among them: SunTrust Bank Inc.'s 0.81%, First Horizon National Corp.'s 0.87% and Washington Mutual Inc.'s 0.60%, SNL says.