Economist's Commentary: April 18, 2008

Major Bank Losses

By George Ratiu, Research Economist

This month witnessed another wave of record subprime write-downs. So far, UBS has written-off $37.4 billion, Merrill Lynch $22 billion, and Citigroup $21.1 billion. A host of other major banks, including Morgan Stanley, Bank of America, Barclays and Credit Suisse have lost a combined $58 billion in the credit crunch.

Subprime loans continue to be at the center of the write-down storm, particularly since the majority of the seriously delinquent ones were originated in 2005 and 2006, at the height of the housing boom. Based on 2007 data recently released by the Federal Reserve Bank of New York, the majority of subprime loans on the market (90.9 percent) were for owner occupied homes. The remaining 9.1 percent of subprime loans represented non-owner occupied homes.

The large volume of losses witnessed by the banks is not surprising given the fact that the average age of subprime loans on the market in 2007 was 28 months. Looking at owner-occupied subprime loan vintage, only 20.4 percent originated in or before 2004. The remaining loans, 70.5 percent, originated in or after 2005. Most of the owner occupied subprime loans originated in 2006 (34.3 percent).

Taking a quick look at the state-by-state subprime loan vintage, it is apparent that states where rapid price appreciation and a high volume of transactions led to the housing boom were also heavily exposed to subprime loans. Arizona, where investor speculation pushed up house prices, has subprime loans with an average age of 21 months (originated in the first half of 2006). The situation is similar in states like Nevada, California and Florida, which average loan age of 23 and 24 months. In contrast, states that avoided speculative frenzy and accompanying rise in prices, subprime loans are of an older vintage. Mississippi is at the top of this list, with an average loan age of 38 months, followed by Arkansas, Louisiana, South Carolina and West Virginia, each with subprime mortgages that are 36 months old.

Another contributing factor to the performance of these subprime loans was the prevalence of no or low documentation (no/low-doc) loans issued. Nationally, 29.8 percent of subprime loans in 2007 were originated with either no or low documentation, likely exacerbating the current losses. A large portion of these no/low-doc mortgages were issued in states with high price appreciation and speculative investing. Topping the list, California had 44.6 percent of no/low-doc subprime loans. By comparison, at the opposite end, Iowa recorded 15.5 percent of no/low-doc subprime loans, half the national average.

Given that many of the subprime loans of younger vintage and with no/low-doc origination were re-packaged in mortgage-backed securities, the increasing wave of delinquencies and foreclosures accompanying these loans led to the large write-offs in the banks' portfolios.

The upside of the subprime loan situation is that exposure to these loans has been decreasing nationwide. Taking advantage of continuing low interest rates, many homeowners are also refinancing, as evidenced by mortgage applications over the past two weeks. Based on the latest Mortgage Bankers Association data, 53.5 percent of mortgage applications represented refinancing activity. Moreover, the economic stimulus package, which temporarily raised the conforming loan limits, should provide for more liquidity in the market.

However, it is not easy reading the current market. Non-performing subprime loans will continue to affect banks' assets during 2008. A boost in consumer and investor confidence would go a long way towards stabilizing the market, particularly during the second half of the year.

This is one in a series of commentaries by the Research staff of the National Association of REALTORS®. Read more commentaries >

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