HSBC and subprime mortgages
HSBC has reported a significant deterioration in its subprime mortgage portfolio and its stock price is falling. Finanical companies who have any exposure to this segment of the mortgage market are also under pressure and, given the importance of the securitized mortgage market to the overall financial market health of investors, it has led to a down day in the market despite decent retail sales data. A few comments:
---Less than ten years ago it would have been amazing to even think of HSBC being in a pickle like this. A Scottish bank that was started in the 1800's in China and eventually developed into a global bank with its headquarters in London, it was for its entire history viewed as conservative, with the strictest of standards for credit and the appearance of integrity. It was bizarre to many when in 2003, in order to expand their U.S. retail presense, they bought Household Finance, a downmarket lender on many fronts that was even in midst of settling regulatory issues related to predatory lending practices. Not only did HSBC acquire Household, but once in the business they actively sought to augment their earnings by buying portfolios of subprime loans originated by others in areas where Household did not have branches. No doubt 140 years of flinty Scottish bankers were rolling over in their graves.
---HSBC does, however, have that tradition of a credit culture and cultures do not go away in a few years. They believed that they had the systems and the mathematical talent to analyze this business on a risk/reward basis that made economic sense. It is also likely that with this culture, in which at least 90% of the top management was raised(it's one of few companies today that still has great pride in the number of lifers in the company, and it touts the average number of years experience in the executive ranks), that HSBC is addressing the problem as quickly and as forthrightly as it can. So if this presumption is correct, the question is how much more serious will this problem become and where will the problems surface. Some smaller subprime focused firms have already gone under and inevitably more will, so the bigger mortgage players are where the next important negative news could arise.
---The industry subprime default rate in November was just over 10%. In 2006, 15% of all mortgages originated were subprime, triple the level of seven years ago. On the back of the run-up in housing prices until recently, there is reason for concern about how this plays out. The bigger concern, however, is whether what we're seeing in subprime today bleeds into the lower segment of the prime market tomorrow. The prime market with its higher loan to value ratios and creative products like interest only loans could be just as ugly as subprime at its lower end.
Enough cheery speculation.
---Less than ten years ago it would have been amazing to even think of HSBC being in a pickle like this. A Scottish bank that was started in the 1800's in China and eventually developed into a global bank with its headquarters in London, it was for its entire history viewed as conservative, with the strictest of standards for credit and the appearance of integrity. It was bizarre to many when in 2003, in order to expand their U.S. retail presense, they bought Household Finance, a downmarket lender on many fronts that was even in midst of settling regulatory issues related to predatory lending practices. Not only did HSBC acquire Household, but once in the business they actively sought to augment their earnings by buying portfolios of subprime loans originated by others in areas where Household did not have branches. No doubt 140 years of flinty Scottish bankers were rolling over in their graves.
---HSBC does, however, have that tradition of a credit culture and cultures do not go away in a few years. They believed that they had the systems and the mathematical talent to analyze this business on a risk/reward basis that made economic sense. It is also likely that with this culture, in which at least 90% of the top management was raised(it's one of few companies today that still has great pride in the number of lifers in the company, and it touts the average number of years experience in the executive ranks), that HSBC is addressing the problem as quickly and as forthrightly as it can. So if this presumption is correct, the question is how much more serious will this problem become and where will the problems surface. Some smaller subprime focused firms have already gone under and inevitably more will, so the bigger mortgage players are where the next important negative news could arise.
---The industry subprime default rate in November was just over 10%. In 2006, 15% of all mortgages originated were subprime, triple the level of seven years ago. On the back of the run-up in housing prices until recently, there is reason for concern about how this plays out. The bigger concern, however, is whether what we're seeing in subprime today bleeds into the lower segment of the prime market tomorrow. The prime market with its higher loan to value ratios and creative products like interest only loans could be just as ugly as subprime at its lower end.
Enough cheery speculation.
posted by John Borden at 2:53 PM
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