Subprime Worries Spread - TheStreet

Subprime Worries Spread

Big lenders swoon after warnings at HSBC and New Century.
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Problems in

HSBC's

(HBC)

subprime mortgage portfolio are giving investors a case of the jitters.

The huge U.K. bank warned late Wednesday that it would spend 20% more than expected this quarter to cover loans gone bad. The announcement, coupled with a host of unhappy developments at the big subprime lender

New Century Financial

(NEW) - Get Report

, sent shares of lenders down across the board Thursday.

Shares of a couple of big mortgage players,

Countrywide Financial

(CFC)

and

Washington Mutual

(WM) - Get Report

, dropped more than 2%. The damage was greater among smaller lenders that focus on lending to customers with poor credit histories:

Novastar

(NFI)

dropped 13%, and

Accredited

(LEND) - Get Report

fell 7%.

Early Thursday afternoon, HSBC was down 3%, and New Century was down 29%.

"This is a problem that we have taken very seriously," said Michael Geoghegan, HSBC's group chief executive, on a call Thursday to discuss the issue. ""We are focusing on it. We're definitely going to get through to the other end."

But analysts worry that the problem might not be so easily fixed.

New Century "spooked everyone," says Matt Shields, a bank stock trader at FIG Partners, a broker-dealer in Atlanta. "This is one of the most recent clear examples of what the ramifications are in subprime lending."

While Accredited, NovaStar and New Century have similar subprime practices, stocks such as Countrywide and WaMu, while down, have not been hit as hard because they have less exposure to the subprime business. "They're a lot more diversified," Shields says.

At HSBC, "Management suggests that it has attempted to ring fence the problem to include maturing products in second half 2007 as these roll over into the higher interest rate environment," write Keefe Bruyette & Woods analysts James Hutson and Mark Thomas in a joint note. "However as we have seen with today's release, the environment is prone to rapid change. Hence we continue to grow provisions faster than loans out to 2009, falling increasingly into line with loan growth as we move further out into the forecast."

New Century, the Irvine, Calif., subprime lender, also "expects to record a fair value adjustment to its residual interests to reflect revised prepayment, loss and discount rate assumptions with respect to the loans underlying these residual interests, based on indicative market data."

New Century is also restating earnings for 2006 to fix accounting for loan-repurchase losses.

Kenneth Bruce, an analyst at Merrill Lynch, downgraded the stock to sell from neutral.

New Century's "accounting issues and deteriorating fundamentals at its lending operation could put it on a steep downward slope," Bruce writes in a note. "We are more concerned that liquidity issues and adverse market reactions could undermine its business model and financial stability even further."

Scott Valentin, an analyst at Friedman Billings Ramsey, cut his 2007 earnings estimate on New Century to 83 cents a share from $4.22 and downgraded the stock to underperform from market perform.

He expects a "continued challenging environment" for New Century with declining origination volume, elevated loan repurchases and deteriorating credit following the company's earnings warning.

Valentin adds the downgrade stems from New Century's "pressure on liquidity, projected significant reduction to book value and significantly reduced ability to return capital to shareholders," he writes in a note Thursday.