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Friday, February 1, 2008
All twisted

A ‘sub prime’ housing loan is simply a mortgage offered at a rate lower than the ruling prime lending rate, but with a twist: it is often the last financing resort for borrowers in the US, and is granted with little or no credit or income checks. They are often granted for a term of 28 years, at a reduced interest rate (sometimes referred to as a ‘teaser’ rate) for the first two years, but which is adjusted upwards later in terms of the loan contract.

Says Gareth Bern, credit analyst at Prudential Portfolio Managers (SA),
“Considering that many of the sub prime lenders have been going into arrears within the first few months of lending, the chances of these lenders defaulting when the teaser interest rate gets adjusted upwards is extremely high.”
But he also reminds investors that the US sub prime market represents only about 10% of the US mortgage loan market.  Quoting FitchRatings statistics, he says that sub prime loans issued in 2005 have been facing an interest rate increase of 3% from around 7% to over 10% causing greater numbers of these loans to go into arrears. The problem is, he says, that loans granted in 2006 at around 8% will face a rate increase next year when the teaser rate expires taking them potentially above 11%. The deduction is that the sub prime default saga has only just begun.
“Since these are high risk borrowers anyway, the chances of them defaulting on these rate increases are extremely high,” says Bern.
He points out that the biggest problem is not simply that the lenders are defaulting, but that the underlying property prices secured against the loans are unlikely to cover the loan value. This means that investors with exposure to these loans will also suffer losses.
Gerhard Cruywagen, Chief Investment Officer at Prudential says it is important for South African investors to understand that local banks do not offer sub prime loans (the US type, as opposed to ‘below prime’) and that very few local financial institutions have any exposure to low grade US Residential Mortgage Backed Securities.

Copyright © Insurance Times and Investments® Vol:21.1 1st February, 2008
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