Commentary: Reading the Subprime Tea Leaves

Beyond the margin: Industry sources have told Housing Wire this week that Merrill Lynch is doing much more than conducting margin calls on warehouse credit facilities – the Wall Street bank is also aggressively reviewing its subprime mortgage holdings to identify possible repurchase claims. Part of the problem stems from rising early payment defaults, the result of a prolonged housing slump and underwriting standards that many in the industry say have been slow to adapt to market conditions. But rumors have been flying this week that that the issue at Merrill goes far deeper than just EPD repurchases. The Wall Street giant is now allegedly seeking to identify viable repurchase claims wherever they might be, even in seasoned subprime pools and whether or not a loan is currently in default. Inaccurate property valuations are one rep and warranties issue that has been discussed with us, as has the issue of borrower fraud. Ask anyone working in subprime loan administration how common inflated appraisals are, and you’ll immediately see that Merrill’s as-of-yet unconfirmed move involves more than just a few loans.

New Century tie-in: Last week, commentary in this space speculated that a warehouse line with Merrill Lynch might have been behind the financial troubles at the subprime originator. We based that speculation on a master loan purchase agreement we obtained earlier last week from an industry source who wished to remain anonymous. A spokesperson from Merrill contacted HW earlier in the week to clarify Merrill’s role in the matter, noting that no such warehouse line ever existed. (New Century does have numerous credit facilities in place with other Wall Street banks, however). But don’t take this to mean that Merrill isn’t financially connected to the beleaguered mortgage banker – in early 2005, SEC records show that a Merrill Lynch trust issued securities backed by more than $1.0 billion of New Century-originated subprime mortgages, the majority of which were adjustable rate loans. (For those looking to connect the dots, many loans from this pool would just now be nearing a rate reset.) The road ahead is paved with Alt-A: If a soft housing market combined with a bump in subprime EPDs was what ultimately led Merrill Lynch to act “somewhat irrationally,â€? as Accredited senior VP Stuart Martin famously suggested earlier this week, the question of how Alt-A credit will hold up under similar conditions is a vital one. Alt-A has always been a grey area, jokingly called “subprime’s A-paperâ€? by many in the industry. And that should be a very scary thought right now, given the current state of subprime credit. Subprime originators are already tightening their underwriting standards faster than you can say “put option” – but Alt-A loan programs, and the money needed to finance them, remain as readily available as they’ve ever been. Are Alt-A borrowers really that different from subprime borrowers? The answer to that question, frankly, will likely determine the road ahead.

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