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U.S. Subprime Lending Goes GlobalBy Graham SummersMonday, February 12, 2007 Our reputation for excessive spending and bad credit has extended beyond our borders.
Last Wednesday night, the British banking giant HSBC (HBC) issued its first profit warning in history. That says a lot for a company founded in 1865. And the reason?
Bad U.S. mortgage lending.
HSBC entered the U.S. mortgage-lending business in 2002 with its $14.7 billion purchase of U.S. consumer lender, Household. In 2005 and 2006, HSBC began building up a massive portfolio of risk-heavy mortgages – mortgages aimed at lower-income homebuyers with a history of missing payments. Seeing how the subprime lending segments had boosted growth at domestic lenders like Countrywide Financial (CFC) and New Century Financial (NEW), HSBC wanted a piece of the rotten credit pie.
During the next five years, the Federal Reserve raised interest rates 17 times. As you'd imagine, consumers with bad credit don't stop spending money they don't have once they own a house. And those mortgage payments just kept rising.
The growing cracks in the U.S. subprime lending market have been evident for some time. However, New Century and HSBC's profit warnings late last Wednesday were a real red flag. New Century dropped a whopping 36% on Thursday and another 5.5% on Friday.
However, because domestic and international lenders have so much on the line, I believe the U.S. housing market will not collapse. The Fed and international lending sectors will do everything they can to stop this from happening.
When the Swiss dropped the gold standard in 1999, Europe became paper currency only. Paper currency markets are too easily manipulated for domestic and international lenders to allow the mortgage-lending market to collapse. There is simply too much at stake, particularly when you consider that international giants like HSBC have a vested interest in these markets.
Bad loans will be rolled into other loans and debt instruments. Subprime companies will consolidate. And bad credit will be sustained in one way or another until it's eventually written off.
Meanwhile, major subprime lenders are now ridiculously cheap. New Century is trading at the unbelievable level of two times earnings and 0.5 times book value. At this level, its current dividend yield is 25%.
The dividend will most likely be cut. But even if the company cuts it by 75%, New Century would still yield 6%. And if the stock rebounds, that 6% could help produce double-digit gains as shares rise.
In the short term, this sector will continue to take hits. But I find it very difficult to believe that in the long term, we'll see subprime lenders disappear. There are always going to be people who try to buy homes without a lot of money.
At current levels, subprime mortgage lenders are some of the most hated stocks in the world. To me, they're looking more and more attractive.
If you're a true contrarian and are willing to be called a lunatic for some time, you should look at New Century. If this company's business doesn't fully recover, it will either merge with another lender or get bought out by a larger player. And whoever buys at these levels could collect a very handsome profit.
Good trading,
Graham
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