Shares of local mortgage lending giants Countrywide Financial Corp. and IndyMac Bancorp Inc. were hit hard last week as evidence mounted that the mortgage loan crisis was spreading beyond the subprime sector to more mainstream borrowers.


Countrywide and IndyMac are two of the nation's largest originators of so-called Alternative-A loans that are made to borrowers who fall short of top-notch prime credit scores but rate well above subprime borrowers. Often these borrowers can't fully document their income or have to stretch to buy homes that might otherwise be out of their price range.


Last year, about one in six borrowers fell into this middle category, accounting for a record-high $612 billion in loans, with one-fifth of those made in California.


What's more, Los Angeles County is the center of the Alt-A lending universe. According to the trade publication Inside Mortgage Finance, Pasadena-based IndyMac ranked No. 1 in the nation last year with $49.6 billion in Alt-A loans and Calabasas-based Countrywide was a close second at $47 billion.


Last week the Alt-A market came under siege as funding to buy repackaged loans dried up, a major Alt-A lender teetered on the edge of bankruptcy and mainstream lenders like Wells Fargo & Co. are cutting back on Alt-A loans.


As a result, shares of both companies have plummeted about 23 percent in the last two weeks.


"You will see quite a bit of pain at these larger institutions as this crisis progresses," said Zach Gast, analyst with Rockville, Md.-based Center for Financial Research and Analysis.


In many ways, this latest mortgage crisis has unfolded like a slow-motion train wreck.


When the subprime loan market imploded six months ago, taking with it giant subprime lender New Century Financial Corp. and a host of other smaller boutique subprime lenders, Wall Street and industry analysts were concerned that the Alt-A market would fall next in quick succession. After all, many of the same techniques used in the subprime market to make loans more affordable teaser rates that reset after two or three years, interest only loans, low-documentation requirements were also prevalent in the Alt-A market.


Any hopes that the Alt-A lenders would skate by were dashed by a series of events. Trouble started July 10, when rating agency Standard & Poor's downgraded the portfolios of several Alt-A lenders. Standard & Poor's researchers had been eyeing a disturbing trend of rising delinquencies among Alt-A borrowers.


According to First American Loan Performance, which tracks delinquencies and foreclosures, the percentage of Alt-A loans considered delinquent (60 days or more past due) hit an all-time high of 3.67 percent in May, triple the level of May 2006.


While still way below the subprime delinquency level of 16 percent, "this is as high as it's ever been and is cause for great concern," said Bob Visini, spokesman for First American Loan.


Similarly, foreclosures on Alt-A loans also zoomed up to 1.3 percent in May, four times the 0.3 percent rate in May 2006.


Liquidity crisis

The rating downgrade on Alt-A loan portfolios created a liquidity crisis for boutique Alt-A lenders. Just as in the subprime sector, Alt-A lenders had been able to make these riskier non-prime loans only because Wall Street was willing to snap them up in huge packages and absorb the risk.


Hit hardest so far by the shutoff of the secondary loan market has been Melville, N.Y.-based American Home Mortgage Investment Corp., which last week teetered on bankruptcy and had laid off hundreds of workers. Unlike Countrywide or IndyMac, which both have major depository institutions, American Home Mortgage is almost entirely funded by loan repurchases and lines of credit.


"They have no other source of funding other than people wanting to buy up the mortgages," Gast said. "When that goes, you have a real liquidity crisis on your hands."


American Home Mortgage has about 20 offices in the Southern California area; company executives did not return calls last week seeking comment on the status of those offices.


But on July 24, any thought that big diversified lenders like Countrywide and IndyMac would escape unscathed vanished when Countrywide released its earnings and stated that delinquencies were rising among borrowers it considered prime.


Countrywide reported a 33 percent drop in net income as the percentage of its borrowers with good credit who were delinquent on their loans more than doubled in the past year to 4.6 percent. (The company refused to divulge how much of these delinquencies were from Alt-A loans and how much from strictly prime loans.)


Countrywide chairman Angelo Mozilo said in a conference call with investors that the scope of home price depreciation in many parts of the country had exceeded projections. "We are experiencing home price depreciation almost like never before, with the exception of the Great Depression," Mozilo said.


His comments not only signaled that the residential housing slowdown would likely be longer and deeper than many thought but also prompted a massive sell-off on Wall Street, with the Dow Jones industrial average plunging more than 500 points, or nearly 4 percent, in a week.


The earnings report prompted analysts to lower their expectations.


"Management has given improved disclosure on credit trends, none of which are encouraging, and highlight the spread of subprime credit problems into prime home equity and Alt-A first mortgage portfolios," said Frederick Cannon, lead analyst on a report on Countrywide from Keefe, Bruyette & Woods.


'Major changes'

In this environment, the markets were not kind to IndyMac when it released its second quarter earnings last week. IndyMac's net income plunged 57 percent to $44.6 million while revenues were off 21 percent to $298 million.


In a conference call with investors, IndyMac chairman Michael Perry maintained that IndyMac's balance sheet was still very strong with $31 billion in assets.


"We have tremendous liquidity of more than $3.5 billion and we've had no lines of credit pulled; in fact, we've added lines of credit," Perry said.


But analysts focused instead on the value of loans that were delinquent, which more than tripled over year-ago levels to $516 million.


In his conference call, Perry bristled at those who focused exclusively on the lender's Alt-A delinquencies. "Those of us at IndyMac are sick of hearing that Alt-A is near subprime... IndyMac continues to perform well with its Alt-A business," he said.


Nonetheless, last week, Perry sent out a memo to his employees indicating there would be "very major changes" to the company's lending standards, citing a change in the secondary market for mortgages, which Perry described as "very panicked and illiquid." (For more, see Comment, Page 46.)


Analysts also were concerned that the rest of the mortgage sector's troubles would scare investors away from IndyMac.


"We are lowering our price target to $22 per share from $32 to reflect the dislocation in the secondary market for mortgage loans coupled with IndyMac Bank's higher credit costs," said Paul Miller, research analyst with Friedman Billings Ramsey & Co. Inc. "We believe most mortgage banking companies will trade weaker over the coming months until the mortgage market stabilizes and liquidity returns."


Just when that will be is far from certain. As recently as June, there was a fragile consensus on Wall Street that the mortgage lending industry's problems could sort themselves out by the end of this year. But after the spread of loan troubles into the Alt-A sector, that time horizon has lengthened.


"This will have to work its way through. How long it takes for the proverbial pig to go through the python is the question. It could take one year or it could take up to two years. A lot depends on interest rates, on housing prices and just when these loans reset," said First American Loan Performance spokesman Visini.


The good news, Visini said, is that it's not likely that the troubles now plaguing the Alt-A market will penetrate deeply into the prime mortgage loan market.


"Delinquencies in the prime sector are still very much under control," he said. "Everything that we can see from the numbers tells us that this crisis will likely be limited to subprime and Alt-A loans."

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