Say Goodbye to the Subprime 2/28 — At Least for Now

HW readers already know, thanks to a great tip off from Morgan at Blown Mortgage, that Option One Mortgage recently ditched its 2/28 subprime loan program.

The Wall Street Journal reported this afternoon that the rest of the industry is doing the same, confirming that both Countrywide and Merrill Lynch’s First Franklin lending unit have also stopped offering the product this week.

Sources that spoke with me also said Accredited Home and even NovaStar have stopped offering a subprime 2/28 loan program, although I haven’t confirmed if this is indeed the case.

The reason is simple - investors don’t want to buy paper that’s going to lose them money. And lots of it, from the looks of current market conditions.

There was a mantra on the Street not too long ago that absolutely anything could be securitized when it came to mortgages (scratch-and-dent, anyone?); all that was needed was an accurate assessment of risk. I can recall a large fund manager once telling me, “If we know the borrower will default in six months, we can still take the loan, securitize it, and price in the risk to make money before then.”

It’s pretty clear at this point, however, that Wall Street investors have figured out the very hard way that there is some risk that simply isn’t worth owning - and the 2/28 is a perfect example. (For those who don’t know, a 2/28 is a 2 year adjustable rate mortgage, which subprime lenders used liberally during the housing boom to both squeeze borrowers into a house for a small payment and also to ensure they had their sales pipelines refilling every few years).

The mortgage credit contraction rolls on - and with more subprime borrowers in trouble than ever, let’s just say I’m glad I don’t work in loss mitigation right now.