Jul 23 2007
Problems in the sub-prime market first arose after the Federal Reserve ended a campaign in August 2006 to hold back inflation with 17 consecutive monthly rate increases.
The effect for sub-prime borrowers was that repayments on loans lent at the bottom of the rate cycle grew beyond their means and levels of those in arrears and repossessions rose.
The upshot for a number of lenders specialising in what was considered to be the lucrative sub-prime market was that last year saw many take a large cut in profits. HSBC, which had bought US sub prime lender Household International in 2003 for $15.5 billion, was forced to put $10.56 billion aside in loan-loss provisions.
A year on GE has announced that it is to sell its US subprime lender WMC.
Laurent Bossard, president and chief executive of WMC, wrote in a memo to staff: "The mortgage industry has greatly changed since the purchase of WMC.
"The current sub-prime market environment has made a significant negative impact on the business."
RealtyTrac, the American mortgage research firm, now predicts a 44 per cent increase in foreclosures in the US this year, hitting 1.8 million homes. It is estimated that 58 per cent of foreclosures will affect sub-prime borrowers, despite the fact they represent a minority of the market.
A year after the initial shock, the sub-prime prime problems have now returned to the market further up the chain.
In June, the investment bank Bear Stearns announced disappointing results due to a downturn in mortgage-back bonds. The securities firm is now providing $1.6 billion to rescue one of its hedge funds that invested in subprime debt and a further one is to be wound up.
Barings World Market Monthly Review for June reveals that lenders in the two Bear Stearns funds rejected a proposed rescue plan and seized collateralised debt obligations (CDOs) assets held as collateral. In addition, Bear revealed that earnings in the second quarter fell ten per cent
Bear Stearns has now called off a planned public offering for a fund holding debt securities backed by subprime mortgages, "amid a crisis at two other related funds managed", reports the Barings World Market Monthly Review.
The review also finds that that uncertainty of sub-prime securities have seen government bond yields rising as investors seek "safe havens".
Analysis from Credit Suisse this month reveals that losses for investors on bonds backed by sub-prime mortgages could total $52 billion.
Losses from on sub-prime CDOs are predicted to be around $26 billion for hedge funds, while banks are expected to lose between $5 billion and $15 billion from their CDO investments.
Credit Suisse explains that the maximum potential losses from CDOs is the equivalent to about ten per cent of the $513 billion of equity capital for the world's biggest ten investment banks, or less than a quarter of the $227 billion that flowed in to hedge funds and mutual funds in the first three months of this year.
This month ratings agency Standard & Poor's (S&P) has announced that it may cut its rating of over 600 residential mortgage-backed securities backed by sub-prime loans, which would affect $12 billion of debt.
The bonds under review by S&P were issued in late 2005 and most of 2006 and represent around 2.1 percent of the mortgage-backed bonds rated by S&P between the fourth quarter of 2005 and the fourth quarter of 2006.
The immediate response was for both the euro and sterling - already at highs against the dollar - to strengthen further. Markets also saw falls, in particular for banking and property stocks.
In the US the sub-prime issue saw June stocks finish the month down.
Threadneedle Globetrot-US states: "Helpful macro economic data fuelled a strong start, only for a rally in bond yields and renewed concerns over sub-prime mortgage lending to trigger a bout of selling."
SWIP Global Economic Prospects Monthly expects the housing downturn in the US to come to an end.
Sebastian MacKay, economist on the global bonds and economic team, writes: "We continue to expect the Federal Reserve to cut interest rates twice to 4.75 per cent over the next year in response to sub-trend growth and diminishing inflation concerns.
"Lower interest rates and the end of the housing market correction should allow US growth to recover to trend by the second half of next year."
He added: "Economic disappointment in the US has been balanced by favourable growth surprises in Europe and emerging markets.
"There is scope for disappointment on the ability of the rest of the world to weather the US downturn, and global liquidity is being withdrawn gradually. However, the impact of these factors does not appear to be sufficient to produce a significant correction in risk assets in the near term."
In Standard Life Investments Property Alex Watt, managing director of property investment, explained that global property remains an attractive asset class when combined with others such as bonds and equities. However, he sees a "divided property world".
"Direct property investment volumes in the UK and US have fallen victim to rising interest rates. Continental Europe is still enjoying growth in investment volumes but investors are increasingly focusing on Asian property," Mr Watt writes.
Looking forward he sees the high levels of liquidity in the global market moderating and less favourable returns from the UK property market in the next few years.
"Other international markets offer a more attractive yield margin over bonds, as well as the prospect of rental growth. These markets are likely to see significant inward yield pressure over the next 12 to 18 months," he added.
In SWIP European Real Estate Fund , Nigel Bolton, fund manager of SWIP European Real Estate Fund is upbeat about European outlooks.
He states: "Looking ahead, we remain positive on the outlook for European real estate, although we are unlikely to see a repeat of the stellar gains made in 2006. We will continue to be highly selective in our investment choices, with an emphasis on the identification of well managed companies with robust track records."
The US sub-prime crisis seems to be continuing to take effect around the world, but for the most part investors seem to be taking it in their stride and moving on.
