UK headquartered global Bank HSBC on Wednesday evening issued a US trading update in which it said that the impact of slowing house price growth is being reflected in accelerated delinquency trends across the US sub-prime mortgage market, particularly in the more recent loans, as the absence of equity appreciation is reducing refinancing options.
Slower prepayment speeds are also highlighting the likely impact on delinquency of higher contractual payment obligations as adjustable rate mortgages reset over the next few years from their original lower rates.
"We have reviewed critically the impact of these factors in determining the appropriate level of provisioning at 31 December 2006 against the Mortgage Services loan book. We have taken account of the most recent trends in delinquency and loss severity and projected the probable effects of re-setting interest rates on adjustable rate mortgages, in particular in respect of second lien mortgages. It is clear that the level of loan impairment provisions to be accounted for as at the end of 2006 in respect of Mortgage Services operations will be higher than is reflected in current market estimates," HSBC said in a statement.
"We now expect that the impact of increased provisioning in this area will be the major factor in bringing the aggregate of loan impairment charges and other credit risk provisions to be reflected in the accounts of the Group for the year ended 31 December 2006 above consensus estimates by some 20 per cent. This is subject to final review and subject to external audit,"
The consensus estimate is based on the average for loan impairment charges and other credit risk provisions of US$8.8 billion from the most recent reports of 11 analysts.
The world's third-largest bank by market value has in effect set aside $1.76 billion, higher than analysts' consensus estimates.
Risky Subprime Market
So-called subprime customers are ones with risky credit records and at the height of the US housing boom in 2005 and 2006, HSBC bought billions of dollars of subprime loans from other lenders, lured by their higher interest rates.
The Wall Street Journal says that HSBC is one of the biggest subprime lenders in the US and is one of several lenders to stumble in its dealings with low-end borrowers. Subprime mortgage lending surged over the past several years, and these days, subprime mortgages comprise about 12% of the roughly $8.4 trillion U.S. mortgage market, up from 7.5% of the market in late 2001, according to First American LoanPerformance, a San Francisco research firm.
According to the Journal, when interest rates ticked up and the market cooled, HSBC reached a disconcerting conclusion: Its systems for screening subprime borrowers and for assessing the default risk they posed were flawed.
Many of those loans have soured, sometimes quickly. The percentage of HSBC mortgages more than 60 days past due is climbing. Fraud by borrowers has been higher than expected. "We made some decisions that could have been better," says Tom Detelich, the HSBC executive in the U.S. spearheading an effort to clean up the mortgage portfolio.
HSBC, formerly known as the Hong Kong and Shanghai Bank, like Standard Chartered, date back to the 19th century in the former British colony of Hong Kong. HSBC now operates in 76 countries and territories.
On March 28, 2003, US subprime lender Household International, Inc. was acquired by HSBC Holdings, plc. In December 2004, Household International, Inc. merged with its subsidiary Household Finance Corporation and changed its name to HSBC Finance Corporation. HSBC Finance funds its operations through several sources, including the issuance of debt and asset backed securities.
The Journal says that Household, had been criticized for allegedly predatory lending practices and, shortly before the HSBC deal, had reached a $484 million settlement with state regulators. HSBC saw Household as a way to diversify beyond Europe and Asia, and viewed subprime mortgage lending as a far less competitive business than lending to more credit-worthy customers.
After the deal was announced, Household's then-chief executive, William Aldinger, bragged that Household employed 150 Ph.D.s skilled at modeling credit risk. Household had developed a system for assessing consumer-lending risk -- called the Worldwide Household International Revolving Lending System, or Whirl -- which it used to underwrite credit-card debt and to collect from consumers in the U.S., United Kingdom, Middle East and Mexico.