Commentary: Subprime Hits a Wall

Merrill Lynch gets cold feet: Unless you’ve been living under a rock, by far the biggest news of the week came in the form of an acknowledgement from the nation’s third-largest originator, New Century Financial Corporation, that it had not only failed to properly account for the impact of loan repurchases on its financial statements throughout 2006, but had also grossly misestimated the volume of repurchases it would be faced with. It’s pretty clear at this point that at least one investment firm is tightening the screws on subprime credit. That firm? Merrill Lynch, recently stung by bankruptcies at both Ownit and MLN USA, who were both funded through agreements with the Wall Street giant. Competing industry publication National Mortgage News first broke the story on Merrill’s recent margin calls, and although Merrill did not provide New Century with a large warehouse line, it’s clear that loan buybacks are becoming a growing problem for any subprime lender regardless of which Wall Street operation is providing the funding.

The doomsday scenario, at least within the mortgage industry, has never been about homeowners losing their homes. It’s always been about Wall Street getting cold feet. And with Merrill Lynch now pushing back on subprime credit, the question is whether other Wall Street banks — Credit Suisse and Barclays Capital in particular — will follow suit. If that happens, look out below. Biting the hand that feeds: As subprime loan performance deteriorates, even firms that fund and securitize their own loans are running into problems. Case in point: HSBC, who reported this past week that loan impairments in its U.S. mortgage unit will exceed $10 billion. The only real difference between the woes ailing both HSBC and New Century is that HSBC owns the source of its pain; HSBC purchased subprime-specialist Household International in 2003. The award for unintentional comedy goes to: Wells Fargo COO John Stumpf, who displayed a disturbingly brilliant misunderstanding of his own company’s mortgage business earlier this week when he said that the nation’s largest subprime lender won’t run into the same problems affecting HSBC. Stumpf cited the fact that most of the subprime mortgages it issues are sold to Wall Street banks, which then assume the risks. “They take those risks and they sell that off to investors so we never get into the chain of ownership,” he said. “It’s that simple.” The company sold off more than 72 percent of its loans during the first half of 2006, he said. Here’s hoping that Wells hasn’t been selling its loans to Merrill Lynch. Next week: More developments surrounding New Century, interest rate and application volume summaries, and more. Don’t subscribe? Be sure to sign up today to get our email updates delievered direct to your inbox.

[ed. note: Earlier commentary here speculating that Merrill Lynch was behind the current woes at New Century has been voluntarily retracted at the company’s request, and after subsequent clarification. While HW did recieve a MLPA with New Century’s name on it, which served as a solid basis for our earlier speculation, the Wall Street bank has made it clear in an email to HW that they did not provide New Century with a large warehouse line.]

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