SIPPS shock as Brown shelves tax loophole for residential property.

Housing Bubble Bursts in the Market for U.S. Mortgage Bonds

Dec. 6 (Bloomberg) -- In the U.S. bond market, the housing bubble has burst.

Bonds backed by home loans to the riskiest borrowers, the fastest growing part of the $7.6 trillion mortgage market, have lost about 2.5 percent since September on concern an 18-month rise in interest rates may force more than 150,000 consumers to default.

``We've been hearing about risks of a house price bubble, easy credit and loans to borrowers that really don't qualify, and now in the last couple of months we're starting to see things turn for the worse,'' said Joseph Auth, a bond fund manager who helps oversee $135 billion at Standish Mellon Asset Management in Boston. ``We don't know if it's going to be a hard or soft landing.''

Mortgage securities with low ratings and loans from Ameriquest Mortgage Co. and New Century Financial Corp., two Irvine, California-based companies that specialize in lending to the 50 million people with histories of late payments and bankruptcies, yield the most in two years. The rise in yields reduced the value of loans made by lenders, resulting in lower profit margins and higher rates for consumers with bad credit.

The slump in the bonds is one of the first signs the housing boom is ending after the Federal Reserve's 12 interest- rate increases. Real estate has accounted for about half the economy's growth since 2001, according to Merrill Lynch & Co.

Growing Market

About 13.4 percent of all mortgages at the end of June were to borrowers considered most likely to default, such as those with high credit card balances, up from 2.4 percent in 1998, according to the Mortgage Bankers Association. The Washington- based trade group's 2,700 members represent 70 percent of the home-loan business.

The amount of bonds backed by these high-risk loans has more than doubled since 2001, to a record $476 billion, according to the Bond Market Association, a New York-based trade group of more than 200 securities firms.

The market ``will deteriorate as housing slows down,'' said Christopher Flanagan, who runs asset-backed debt research at New York-based JPMorgan Chase & Co., the fourth-largest mortgage lender in the U.S. The amount of loans made next year may fall by as much as 25 percent, he said.

Borrowers with credit scores below 620 as measured by Fair Isaac Corp. have a higher risk of defaulting, and loans to these people are considered subprime. About 20 percent of the U.S. adult population has a score below 620, according to Fair Isaac, the Minneapolis-based company whose FICO ratings are the benchmark for loans and credit cards. The test scores borrowers from 300 to 850 and the lower the mark, the riskier the credit.

Delinquency Rates

The last time delinquency rates on lower-rated mortgages jumped was in

The weighted average default rate on the riskier loans rose to 10.1 percent in November 2001 from about 7 percent in early 2000, according to Michael Youngblood, a managing director of asset-backed debt at Friedman, Billings, Ramsey Group Inc., an Arlington, Virginia-based securities firm that specializes in mortgage-related assets.

The late payment rate is 5.51 percent now. Every 1 percentage point increase in that rate means another 34,700 home-loan defaults, according to Youngblood's calculations.

``Employment drives credit conditions in subprime loans and as long as we see a robust labor market we should not expect deterioration in subprime performance,'' said Youngblood, who expects the default rate to reach 5.75 percent by August.

The Labor Department said last week that the unemployment rate in November held at 5 percent for a second month, below the 5.64 percent average over the past 20 years.

`Big Fear'

Irene Von Toussaint, a 33-year-old married mother of one from Bayville, New York, said she's depending on improvements to her credit to avoid paying a rate of as much as 12 percent when the fixed period of her New Century interest-only loan expires in two years. Von Toussaint's credit score is 584.

November 1985 was the last time any prime borrower paid 12 percent on a

``Paying bills on time is the big fear because I've been disorganized,'' said Von Toussaint, who now has her payments deducted automatically from her checking account.

Loss Estimate

Losses on mortgage bonds backed by subprime loans that will be made next year may rise to 7 percent, contrasting with 2 percent for bonds issued the past two years, should home prices hold steady, said Kenneth Posner, a New York-based finance analyst at Morgan Stanley.

The average yield on bonds rated BBB-, the lowest investment-grade ranking, and backed by payments on adjustable rate mortgages made to the riskiest borrowers is 7.23 percent, the highest since December

The 1.53 percentage point increase compares with a rise of 0.4 percentage point to 5.93 percent for higher quality 30-year mortgage securities guaranteed by Fannie Mae.

Lenders that rushed to provide mortgages amid rising home prices are now stuck with loans worth less than they expected because bond investors are demanding more protection. They are raising mortgage rates help to make up the difference.

`Changing Environment'

``In a rapidly changing environment, you can find yourself ahead or behind the yield curve,'' Robert Cole, chief executive officer of New Century, the No. 2 lender to people with the lowest credit scores, said in a Nov. 15 interview in New York. ``With rates going up, it's more likely behind.''

Profit margins for New Century may narrow to 15 to 25 basis points this quarter from 61 basis points in the third quarter, and 175 basis points in 2004, Chief Financial Officer Patti Dodge said in an interview. A basis point is 0.01 percentage point.

New Century is increasing rates twice as fast for subprime borrowers than for others, Cole said. The company lifted its weighted average rate to about 7.9 percent in November from 7.18 percent in August, pushing up the cost of a $200,000 loan by $98 a month. A prime borrower would only have to pay about $56 more.

Gains from sales of loans at New Century fell 13 percent to $176.2 million in the third quarter from a year earlier even as sales rose 43 percent.

At Kansas City, Missouri-based NovaStar Financial Inc., another lender to borrowers with poor credit histories, profit from sales tumbled 23 percent.

Yield Spreads

``Originators don't charge enough for the risk'' and will lose money as investors demand higher yields, said Alex Wei, who co-manages $3 billion in bonds at Philadelphia-based Delaware Management.

Ameriquest, the largest company specializing in loans to subprime borrowers, had to pay investors a yield of 2.75 percentage points more than benchmark one-month lending rates to sell $14 million of BBB rated mortgage bonds last month.

The extra yield was 1 percentage point higher than on a similar issue sold by the company in June, according to data compiled by Bloomberg. The $1.2 billion AAA rated portion was priced at 24 basis points, 1 basis point higher than in June.

Sales of bonds backed by risky loans will fall next year to about $375 billion, JPMorgan's Flanagan said.

The Fed is signaling that it's unlikely to stop lifting borrowing costs until housing cools. The Commerce Department said last week that new home sales in October increased 13 percent, the most since April 1993, to a record 1.424 million annual rate.

``Froth'' in housing markets may be spilling over into mortgage markets, Fed Chairman Alan Greenspan warned an American Bankers Association convention in September. A rise in interest- only loans that initially don't pay down principle and the introduction of ``exotic'' variable-rate mortgages ``are developments that bear close scrutiny,'' he said.

To contact the reporter on this story: Al Yoon in New York at snipped-for-privacy@bloomberg.net. Last Updated: December 6, 2005 00:02 EST

Oh.... dear, looks like his cheques are bouncing.

Thanks for a fascinating pointer. Yep, it's all going swimmingly. Next up I expect some hiccups in the credit default swaps markets. Anything major there means it's time to take cover.

FoFP

Obviously 35% of the electorate did not want any of that which was on offer

Didn't want any of them.

It looked like a choice between adolf and uncle joe whoever you voted for. Adolf for nulabnazi, oldtorynazi and libdemslightlynazi or respectstalinist and greenverystalinist

As it's already been pointed out, it's not at all obvious.

tim

If 10% of the properties in your area were to suddenly come onto your books and those of the other agents in your area, that would probably be a pretty significant increase in the number of properties you had to sell.

Either that or they didn't think it made any real difference who got in.

Or alternatively, if you don't like the candidates on offer, you could always stand as a candidate yourself.

In which case they were the perceptive ones. Anyone spot the difference between Blair and Thatcher?

The crucial similarity is that they both got massive majorities with a minority of the votes.

Thom

This is the strategy of "It you can't beat 'em, join 'em".

FoFP

In fact if one does the calculation of "does the value accrued to me of doing the research to make the correct choice exceed the cost of doing that research?" then I suspect the answer for most people is "no".

FoFP

In message , "tim (moved to sweden)" writes

To paraphrase Yes Prime Minister, 'they don't care who's in power as long as she has bit t*ts'

Despite that they do continue to go up - we are on the 4th montly rise with predictions from the Mortgage Lenders Council of 3-4% house price inflation over next three years.

I agree with you that property SIPPs were not a good idea.

And here is the sadness in this move:

There were undoubtedly large numbers of people who had been enticed by newspaper reports into considering putting a second home or a BTL property into a SIPP which was a wholly inappropriate idea. (Frankly, I bet that if you asked these people if they thought that they could withdraw the proceeds of the house sale later, the majority would say yes.)

There are however a small number of people for which it was to be a good opportunity to diversify an established pension fund.

Tis a pity that these people should suffer because of inappropriate marketing of the scheme.

tim

The Council of Mortgage Lenders would say that wouldn't they ? ;-)

Do you believe them ? lol

One commentator on TV yesterday said they would have been the 'biggest tax loophole of the century' or words to that effect.

SIPPS was a lousy scheme giving huge tax breaks of 40% for the wealthy to buy property while many young first time buyers are priced out of the market.

Ultimately though these investors were led up the garden path and conned by Gordon Brown, SIPP providers, media froth, and, in some cases, estate agents.

Their money is now stuck in the SIPP (apart from 25% they can withdraw at age 50) and they will have to look at other investments like shares. The absence of regulation means that compensation claims for misselling may be unlikely to succeed except, perhaps, where someone has been persuaded to transfer investments from another pension to a SIPP.

The old adage CAVEAT EMPTOR should always be borne in mind when making investments. There was plenty of information available on SIPP rules. Ignorance is no excuse.

"tim (moved to sweden)" wrote

I agree with you insofar as self-employed and business people do not have final salary or even contributory Company Pension schemes as an option, thus investment in property may be one of the few ways to provide themselves with a secure 'pension'.

Here's a sob story from todays Times.

This guy expected tax relief of upto £102,000 on a £200,000 property purchase !!!!

All together now .........aaawwww

The Times December 07, 2005

Stuck with a £200,000 flat and no tax relief Christine Seib

JULIAN WARD is one of thousands of investors who planned to pour as much as £8.5billion into the British housing market on the back of a generous tax break on residential property.

Instead, after the Chancellor's dramatic turnaround yesterday on what investments would receive tax concessions in self-invested personal pensions (Sipps), Mr Ward is stuck with a £200,000 second property and has missed out on tax relief of up to £102,000.

The 40-year-old mortgage broker recently completed the purchase of a two-bedroom flat in Colchester with the intention of putting it into a Sipp.

He hoped eventually to add to his property portfolio, which includes a family house in Kent, with a holiday home that he also planned to put in the Sipp.

Yesterday Mr Ward described the Treasury's U-turn on Sipps as "very disappointing" and said that it had soured his views on pensions even further.

"I still think putting your money into property is the most sensible thing to do but now I'll be 40 per cent worse off," he said. "The idea of having a property but getting pension tax benefits was fantastic.

"Now I'm just not going to open a pension, although I will keep the personal pension I have from a previous job."

Mr Ward said that he was persuaded to buy a property to put in a Sipp by "hype" from the media and financial services industry. "I was influenced by the positive spin that was put on it by everyone," he said. "You can't just blame the Government, The Treasury has back-tracked on its own rules that, from April 6 next year, would have allowed savers to buy residential properties and other exotic investments with their Sipp, to take advantage of tax breaks of up to

Because Mr Ward bought his property before the Sipp rules came into effect, he planned to transfer the property into the Sipp after next April.

To avoid breaching the £215,000 annual limit on personal contributions to Sipps, Mr Ward would have transferred his house in two chunks over the next two years.

Tom McPhail, head of pensions research at Hargreaves Lansdown, the financial adviser, said that Mr Ward could have gained tax relief worth up to £102,000 on his purchase because the Government would have grossed-up the initial £200,000 at the basic tax rate, equal to £56,000. He would then have received additional higher-rate relief on the £256,000, worth about £46,000.

Mr McPhail said, however, that at the time Mr Ward made his property purchase, the Government had not set out detailed rules on how it would treat properties used in lieu of cash contributions to pension funds, so the total amount of tax relief might have been less than expected..................

PLAYING THE NUMBERS

Value of annual sales insurers had expected from Sipps: £200 million Amount that had been expected to pour into UK housing market from Sipp investors: £8.5 billion Amount Sipp investors had been expected to spend on overseas property: £1.5 billion Initial investment savers had expected to need to purchase a £150,000 property: £60,000 Top tax relief that would have been available on Sipp investments: 40 per cent Value of the fund that can be borrowed to pay for investments: 50 per cent Annual limit on contributions to a Sipp in 2005: £215,000 Annual limit on contributions to a Sipp in 2010: £255,000 Percentage of pension pot that advisers recommend should be invested in property: 20 per cent