Mortgages: Congress Acts, But It's Tardy

A bill on Capitol Hill could help some home buyers avoid foreclosure, but lenders are still facing loan writedowns due to the subprime mess

The House of Representatives passed a bill on Sept. 18 that would allow the Federal Housing Administration (FHA), a government agency that insures mortgages for low- and middle-income borrowers, to back refinanced loans for borrowers who are delinquent on payments because their mortgages are resetting from low "teaser" rates. This is the first act of mortgage-related legislation since the subprime situation started earlier this year.

The stakes are high. An estimated 2 million to 2.5 million of adjustable-rate mortgages are scheduled to reset this year and next. In October alone, these resets are expected to affect nearly $50 billion in mortgages.

The legislation, spearheaded by Representative Barney Frank (D-Mass.), chairman of the House Financial Services Committee, raises the limit on the size of mortgages that the FHA can insure to $500,000 in the nation's high-cost areas, from its current cap of $362,000. The bill will next move to the Senate. The White House is opposed to raising the FHA's cap.

Refinancing: Any Incentive?

Although these moves and the Sept. 18 interest rate cut by the Federal Reserve should help mitigate some of the foreclosures Standard & Poor's had been expecting, we believe that a sizable number of home buyers who accepted low teaser rates will likely still have difficulty paying back their loans. Moreover the question remains as to whether some borrowers will have an incentive to refinance their loans.

Despite the best efforts by Congress, buyers who purchased homes in 2006, at the peak of the real estate market, may continue to find that the current value of their home is less than the balance remaining on their mortgage.

The mortgage finance companies that we cover basically have moved away from subprime lending. However mortgage lenders are apt to continue to be hurt by loans they made over the past two years that they're still holding. Although efforts by Congress to help borrowers refinance loans should mitigate foreclosure rates, loan writedowns will be significant in the quarters to come, in S&P's view.

Countrywide's Woes Continue

We have a sell opinion on Countrywide Financial (CFC; $21), as the company holds a significant amount of residual securities that we believe will need to be marked down. We also maintain that in 2008 Countrywide's loan volume will be down 30% from this year's levels based on lower expected home sales and the company's move to initiate mostly agency-qualifying loans.

S&P also has a strong sell recommendation on IndyMac Bancorp (IMB; $24) as we look for the company's portfolio of loans held for sale to be up significantly in the third quarter. IndyMac will need to take further writedowns of these loans in the quarters to come, in our view. We project IndyMac's loan production to be down 25% in 2008 from this year's level.

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