Bargains and Blowups in the Subprimes, Part 2
By Graham Summers
March 01, 2007
Which subprimes are going bankrupt and which will rebound?
As I wrote earlier this week, it's all a matter of leverage and liquidity.
Subprimes make loans to consumers with bad credit. They then sell these loans to big banks – Citigroup, Bank of America, etc. – which hold the mortgages or sell them as mortgage-backed securities to institutional investors or hedge funds.
In a way, you can think of a subprime mortgage loan as a bad credit hot potato that is tossed from the subprime lender to a big bank to institutional investors.
No one likes to hold a hot potato, particularly if that hot potato is a $300,000 loan to a consumer who most likely will never pay all of it off. Institutional investors can trade in and out of mortgage-backed securities. Banks, on the other hand, charge the subprimes a fee in return for their services.
The subprimes like this setup because the big banks give them cash equal to the loan, minus the fee. They then use this cash to make more loans to consumers with bad credit. Subprimes rely on the sheer volume of loans they make for profits, since they only receive a small amount in individual consumer payments. The more loans they make, the more monthly payments they receive from consumers.
The problem is that this whole system hinges on the consumer. And as we've stated countless times before, these are consumers with bad credit. If they were great at paying up, they wouldn't be borrowing subprime loans to begin with.
So when the consumer starts missing payments, the subprimes can't make loans at the same pace because their cash has to cover the payments they owe the big banks. And if a lot of consumers miss monthly payments, and the subprimes' futures look shaky, the big banks might pull the plug on the whole operation and demand their money back.
Because of this, contracts between the big banks and the subprimes require the latter to maintain certain amounts of cash in order to cover the loans should the consumers default. It's called a liquidity clause. And if a subprime falls below its liquidity requirements, the bank will pull the plug, demand its cash back, and drop the faulty mortgage hot potato back in the subprime's lap.
And that's what's happening today.
We're up to 27 subprime bankruptcies since December 2006. And the number increases every week. So who's still liquid enough to stay in business?
Below are the liquidity requirements for several of the remaining subprimes. You'd think that given the seriousness of the liquidity requirements that these numbers would be readily available in SEC filings. But you'd be wrong.
If you see the term "n/a" in the liquidity requirement category, it's because the company doesn't put this number in its SEC filings. To me, it's absolutely incredible that this information would not be made easily accessible to shareholders.
Company |
Symbol |
Liquidity Req. |
Cash |
| |
|
|
|
New Century |
NEW |
$134 million |
$350 million |
NovaStar Financial |
NFI |
N/A |
$182 million |
Fieldstone |
FICC |
$15-$20 million |
$26 million |
Countrywide |
CFC |
$1 billion |
$1.5 billion |
Fremont General |
FMT |
$33 million |
$53 million |
Somehow I don't think NovaStar will be around for too much longer.
Good trading,
Graham 
