August 9, 2001
Heard on the Street
Subprime Loans Could
Be Bad News for Banks
By PAUL BECKETT and JOHN HECHINGER
Staff Reporters of THE WALL STREET JOURNAL
American Express so far this year has taken more than $1 billion in junk-bond-related write-downs. In late July, federal regulators closed a little-known thrift on the outskirts of Chicago that had run into trouble with subprime consumer loans.
The two events may have more in common than you might think. In many ways, subprime loans, or lending to individuals with poor credit, are the consumer equivalent of junk bonds -- and hold the same potential for nasty surprises as the economy heads south.
The proliferation of subprime loans opens up a new area of exposure for banks. In the last downturn, these loans were largely made by independent finance companies, outside the purview of bank regulators. But now 10 of the 25 largest subprime lenders are parts of banks, according to Inside Mortgage Finance, including a who's who of the nation's largest: Citigroup, Bank of America, Washington Mutual and Wells Fargo, among others.
"We haven't had [subprime loans] long enough in the banking system to know how [they] will perform," says David D. Gibbons, deputy comptroller for credit risk at the Office of the Comptroller of the Currency, the Washington regulator that supervises federally chartered banks.
That subprime has been deteriorating is clear. In May, the latest month for which data are available, the percentage of subprime mortgages nationwide that were seriously delinquent rose to 6.37% from 5.55% at the end of last year, according to Mortgage Information Corp., a San Francisco research and data firm that tracks the majority of all subprime mortgages. That compares with a 4.64% delinquency rate at the end of 1999. A mortgage is defined as seriously delinquent when the borrower is three or more payments late.
The rising delinquency rate could be an early sign that broader consumer-credit problems are just around the corner, much as rising junk-bond defaults two years ago proved a harbinger of deep problems in corporate lending. Some analysts and regulators already see signs of wider trouble as layoffs mount up and the nation's consumers, already dripping in debt, start to feel the pinch of a slowing economy.
Indeed, "prime" mortgages issued in 2000 have a higher serious delinquency rate for this point in their life cycles than the mortgage loans made in any other year since at least 1993, according to Mortgage Information. The serious delinquency rate for last year's prime mortgages -- the ones for customers with good credit histories -- stood at 0.16% at the end of last year, up from 0.07% for loans made in 1999.
"Getting nervous is our specialty, but we are getting even more nervous than usual about the direction of consumer credit," Gary Gordon, analyst at UBS Warburg, wrote in a July 30 report. "Consumer credit levels are at all-time highs. Employment is declining. Credit standards are weakening in the face of a weaker economy."
He added, "That combination usually ends badly, in our view."
Subprime loans are particularly volatile because their borrowers by definition are higher risk and often are the first to default. Banks' regulators are concerned about a variety of subprime loans, including home mortgages, car loans and credit cards.
Mark Schmidt, associate director of bank-supervision policy at the Federal Deposit Insurance Corp., says the 150 banks with the highest concentration of subprime loans have invested more than 25% of their own capital in the sector. In all, those banks carry a total of $60 billion to $80 billion in subprime loans on their books, he says.
This year, regulators asked lenders with high subprime exposure to increase loan reserves and capital requirements. These banks account for only 1.5% of the total number of banks and thrifts but one-fifth of all problem institutions.
The good news is that those banks with high subprime concentrations typically have less than $1 billion in assets; that diminishes the risk they pose to the broader banking system. But banks of all sizes in recent years have bucked their stereotype as conservative investors and gorged on subprime, which can be as much as three times as profitable as their equivalent "prime" products.
Indeed, the big banks have been snapping up subprime lenders and bolstering their own internal subprime lending units. Just in the last year, the nation's largest bank, New York-based Citigroup, purchased Associates First Capital, a big Dallas subprime lender, making Citigroup the nation's largest subprime lender. Meanwhile, No. 2 bank J.P. Morgan Chase, also of New York, purchased the subprime-mortgage operations of Advanta, based in Spring House, Pa. The nation's third-largest bank in assets, Bank of America, Charlotte, N.C., had $26.3 billion in subprime loans in the second quarter, which amounts to 6.5% of its total consumer- and commercial-loan portfolio, a spokeswoman says.
When properly managed, subprime needn't cause serious problems, and the high rates of return have helped banks post strong profit growth for much of the past decade. But now there are some signs of potential problems that go far beyond Superior Bank, the thrift on the outskirts of Chicago that regulators closed July 27.
At San Francisco-based Providian Financial, one of the biggest subprime credit-card lenders, for instance, charge-offs on an annualized basis in the second quarter rose to 10.3% of the loan portfolio, up from 7.4% a year ago. "We believe we're well compensated for the risk we take, and that is reflected in our returns," a Providian spokesman said.
At Citigroup's subprime operation CitiFinancial, which now includes Associates, loans more than 90 days past due in the second quarter jumped 70% to $1.76 billion from $1.03 billion the year before. Robert Willumstad, chief executive of Citigroup's global consumer business, attributes much of that jump to tighter credit and collection standards that Citigroup imposed on the Associates loan portfolio, which it took on in November. "I feel strongly that the industry will do very well through these cycles," he said.
* * *
SIGN OF THE TIMES: Regulation FD, the financial disclosure rule that guides corporate communications to investors, has caused many companies to shy away from closed-door meetings with analysts. Not so at Compaq, the Houston computer maker struggling to redefine itself after losing its personal-computer crown last year to rival Dell Computer.
Compaq is anxious to get investors viewing the company as a full-service computer maker competing in growth markets beyond its beleaguered PC business. So it has scheduled a closed-door meeting with Wall Street analysts and institutional investors to lay out its plan to boost its computer-services business to a third of revenue by 2004 from about 20% today. To fit within Reg FD, Compaq will broadcast the meeting over the Internet. But for shareholders without Wall Street credentials, information on the meeting has been scant. The company only Wednesday disclosed the start time for its Webcast.
A Compaq spokesman said the company had restricted information on the presentations to a note on its investors' Web-page listing with the day and its New York City location, but no start time, because it was slow getting its logistics together. "It's a meeting specifically designed for the analysts, and not something we're making public," a spokesman said. "It's got a very narrow audience."
-- Gary McWilliams
Write to Paul Beckett at paul.beckett@wsj.com1 and John Hechinger at john.hechinger@wsj.com2 |
