An Emerging Risk in Emerging Markets

Implications: Subprime loans have become popular on the fringe areas of Phoenix.  Tightening subprime standards poses a threat to the market recovery.

Analysis:

Today’s Wall Street Journal article is likely not the first subprime lender article you have seen in recent weeks. Subprime lenders are those lenders providing loans that bridge some or all of the gap between traditional, 80% loan-to-value first mortgages and the full value of homes. As housing affordability diminished throughout the first half of the current decade, subprime loans became a popular tool for entry-level buyers otherwise not able to afford a home. Buyers that didn’t have a 20% down payment simply secured a second loan covering some or all of the difference in price between their first mortgage and the home price.

It turns out that these loans are riskier than lenders previously thought. Default rates are higher than anticipated, perhaps as a result of “loose” underwriting procedures. The Wall Street Journal article cites First American Loan Performance in saying that 12.9% of subprime loans packaged into mortgage securities had payments at least 60 days overdue in November 2006.

Subprime lending standards, as a result, are rapidly tightening. For home builders in emerging market areas, where most of the demand comes from cash-strapped, entry-level buyers, tightening could hinder any recovery in current conditions. In the Phoenix metro area, submarkets on the outskirts will likely be most affected. Currently, home builders eagerly offer 100% financing programs in these areas, knowing the limited financial wherewithal of potential buyers. How many potential buyers will now qualify for advertisements touting “$500 Down”?

We should know the affect of loan tightening on the market in the near future…. Until then, builders should add the risk of tightening credit to their lists of concerns, especially in emerging markets.