The latest report from Irvine’s New Century Financial Corp. revealed a developing strain on the fat profits of subprime mortgage lenders: peculiar behavior by interest rates.
In the fourth quarter, New Century’s profits came in at $79 million, up from $74 million a year ago. The slower growth is notable, since New Century’s profits have been skyrocketing for years amid a lending boom.
New Century’s profit before taxes,which some analysts consider a more accurate measure of a company’s performance,dropped 15% to $110 million, versus a year earlier.
Lately, the company is making less money buying and selling loans. Subprime lenders such as New Century make loans to people with tarnished credit histories or who have a hard time getting a traditional mortgage for other reasons.
New Century pays brokers for loans and then turns around and sells them. The company also is growing its retail business, where it generates loans directly from borrowers.
The company packages its loans in pools, usually in $1 billion chunks, and sells slices to investors in the form of mortgage-backed securities. The securities pay interest.
The company’s profits come from charging more in interest to borrowers than what it pays in interest to bondholders. It also makes money from fees.
Subprime lending has boomed along with the housing market. But so has competition.
Amid competition, New Century has been unable to raise the average rate it charges to consumers, now at around 7% for fixed-rate mortgages. Meanwhile, the rate it has to pay out is rising.
The interest New Century pays to investors is tied to the London Inter Bank Offer Rate. Many lenders pay LIBOR plus a premium. It’s an industry standard in the same way credit card companies charge the prime rate plus a premium.
And LIBOR is rising. Last week, one-month LIBOR was at 2.6%, up from 1.1% a year ago.
“Interest rates continue to rise, which we expect will result in lower net operating margins in 2005 compared with 2004,” said Patti Dodge, New Century’s chief financial officer, in a statement.
Another factor is competition, which “remains challenging,” according to Dodge.
Calabasas-based Countrywide Financial Corp., which does traditional and subprime lending, is feeling many of the same pressures as New Century.
But it seems to be willing to accept less profit to keep market share, putting added heat on New Century and others.
“I certainly would have to acknowledge that competitive conditions remain intense, and we as an industry have not raised rates in step with the market,” said Brad Morrice, New Century’s chief operating officer, during the company’s conference call.
New Century officials said they want to charge more to borrowers this year. Industry analysts are unsure if that’s realistic.
There also is the much darker possibility that big investors one day might shun subprime loans altogether.
It’s happened before when short-term rates rose as long-term rates remained steady,what’s known as a flattening yield curve.
There still is a gap between the two, but it’s narrowing.
It’s surprising that long-term rates haven’t moved, according to Richard Eckert, an analyst at Newport Beach-based Roth Capital Partners LLC.
He said with the dollar falling you would expect foreign investors, namely China and Japan, to demand higher yields on 10-year Treasury bonds. Instead, the yield on a 10-year has fallen in recent weeks, nearing 4%.
Perhaps China and Japan want to avoid precipitating a spike in U.S. interest rates, which could cool the economy and spur Washington to erect trade barriers, Eckert said.
A mounting federal deficit should be placing upward pressure on long-term rates, he said.
Meanwhile, the Federal Reserve Bank earlier this month raised a key short-term rate to 2.5%, its sixth hike since summer.
New Century affirmed its 2005 profit forecast but left open the possibility that earnings might fall short of Wall Street forecasts.
Last year New Century converted to a real estate investment trust.
Homebuilding Down in ’04
2004 was a down year for the building of houses, condominiums and apartments, according to Orange County data recently released from the Construction Industry Research Board.
There were 9,101 building permits issued last year, down slightly from 9,311 permits in 2003.
The difference is small. But in 2002 there were 12,020 permits issued to developers and builders.
The total can swing from year to year, depending on when large projects are finished. And there weren’t a lot of big housing developments to build at last year, as was the case in 2002.
Add to that high prices,OC’s housing market cooled last year as buyers reeled from sticker shock.
2004’s total was the lowest since 2001, the year of a recession and the terrorist attacks. 1999 and 2000 also saw more than 12,000 permits issued.
Last year, permits for traditional homes dipped 23% to 4,299 from a year earlier,lower than 2001’s total of 5,925.
Condos and apartments, which are lumped together, were up 28% to 4,802 permits.
