January 18, 2008 549 VIEWS


EDITORS NOTE: For more information and understanding of the US Subprime Mortgage crisis, go to http://en.wikipedia.org/wiki/2007_Subprime_mortgage_financial_crisis .




Of late, we see many articles related to US sub-prime mortgage crisis in business magazines, web sites etc. Jude Opia attempts to discover the background of this crisis and its effect on the Nigerian stock market.



Overview of sub-prime mortgage industry:


Before we understand the crisis, let us first define what is mortgage and sub-prime mortgage.


Mortgage: In simple terms, it is a “conditional” conveyance of property as security for the repayment of a loan.


Sub-prime Mortgage: It means offering loans to borrowers who do not qualify for them at market interest rates due to their deficient or poor credit history. Since this involves risk of non-payment by the client, it is usually offered at a higher interest rate.


Sub-prime lending may be utilized for sub-prime mortgages (few home loans), sub-prime car loans, sub-prime credit cards etc. Subprime mortgages totalled $600 billion in 2006, accounting for about one-fifth of the US home loan market. Some of the sub-prime mortgages include:


* Interest-only mortgages, which allow borrowers to pay only interest for a period of time

 * “pick a payment” loans, for which borrowers choose their monthly payment

 * Initial fixed rate mortgages that can be converted to variable rates


Potential sub-prime borrowers may comprise of financially troubled people i.e. those who lost jobs, those with a history of previous debts, those who have had marital problems or those who had unexpected medical conditions. Sub-prime lenders take a higher degree of risk; by increasing the interest rates they manage to offset the risk to an extent.



The current sub-prime mortgage crisis in US:



The US real estate industry had a boom between 2001 and 2005 as property prices reached historic highs on account of low interest rates, price-to-rent ratios and other factors. When property prices began to fall due to saturation or lack of demand, the owners had to face mortgage loan which was higher compared to property value. The collapse of the US market had a direct impact on housing values, mortgage industry, real estate companies, hedge funds etc. (A hedge fund is an investment fund charging a performance fee and typically open to only a limited range of investors; unlike mutual funds and pension funds, hedge funds are not usually regulated by Securities Exchange Commission.)


In late 2006, several US sub-prime mortgage companies had to close down due to losses. New Century Financial Corporation had to file for banktrupcy. Some companies were accused for actively encouraging fraudulent income inflation on loan applications. This led to collapse of stock prices for many companies in sub-prime mortgage industry, notably for some large lenders like Countrywide Financial and Washington Mutual.



Recent news on sub-prime mortgage industry:


* On June 20, 2007, Merrill Lynch seized $800 million in assets from two Bear Stearns hedge funds that were involved in securities backed by subprime loans. The two funds are now reported to be essentially worthless


* American Home Mortgage Investment Corporation filed Chapter 11 bankruptcy on August 6, 2007, after a layoff of its employees the week before


* On August 8, 2007, Mortgage Guaranty Insurance Corporation announced it would discontinue its purchase of Radian Group after suffering a $ 1 billion loss of its investment in Credit-Based Asset Servicing and Securitization. C-BASS is seeking to restructure its financing. The MGIC-Radian transaction would have been a $4.9 billion deal.


* On August 9, French bank BNP Paribas stopped valueing three of its funds and suspended all withdrawals by investors after United States sub-prime mortgage woes had caused \"a complete evaporation of liquidity”


* Accredited Home Lenders reported on August 10 that the company expected to see up to a $60 million loss for the first quarter 2007


* Goldman Sachs\' $8 billion Global Alpha hedge fund, its largest, reportedly lost 26% in 2007


* Citigroup has reported taking $700 million in losses in its credit business in July and August 2007



Impact of the crisis on stock markets:


Ideally, only the companies belonging to the US real estate sector or sub-prime mortgage industry should have been affected. But, the stock markets all over the world, right from From New York to Tokyo, were sliding and it was reported in media that the reason for the ‘meltdown’ is US sub-prime mortgage crisis.


Is this really true for the Nigerian market? This is what Director General of the Nigerian Stock Exchange, Dr. (Mrs.) Ndi Okereke-Onyiuke, had to say (Source: businessday)


“Our capital market can not crash because the fundamentals in terms of price, capacity for growth, listed companies’ potential and the economic horizons are all in favour of the market.’’


Reviewing the activities of the market in 2007, only this Tuesday in Lagos, the Director-General said that the capital market had not absolved one-quarter of its capacity for securities.


At present, 310 securities, comprising 212 equities and 98 bonds, are listed at the NSE.


Okereke-Onyiuke explained that other issues strengthening and guaranteeing safety of investments were operations of high market discipline, zero tolerance regulation and the emerging character of the NSE.


She said that contrary to other views about the exchange outpacing the economy in the last few years, the tremendous market growth in 2007 was attributable to dividends of consummate economic reforms.


The other larger positive economic indices which had impact on the capital market, according to her, are high lending rates in the money market, improved macro-economic performance, profit-taking and stock-switching by investors.


She said that about six million investors in the emerging capital market cumulatively earned 74.73 per cent as returns from investments, during the period under review.


The returns were influenced by increased awareness of the stock market, improved operating results and large available float by banks and insurance companies, she said.


She adduced other reasons to sustained inflow of pension funds and low interest rates on deposits in the money market.


A breakdown of market-based activities in 2007 shows that NSE was also highly attractive to foreign investors who staked N256 billion or 12.3 per cent of the turnover compared with N35 billion achieved in 2006.


Okereke-Onyiuke, who described NSE as one of the fastest windows of foreign direct investments, also attributed foreign investors’ high appetite in Nigerian-quoted companies’ shares to their confidence in the Nigerian economy. Overall, the market turnover shows a growth of N2.1 trillion or 19.5 per cent of the nation’s gross domestic product (GDP) in 2007 compared to N470.25 billion recorded in 2006.


Equities accounted for the bulk of the transactions’ turnover with N2.08 trillion or 99.86 per cent, up from 99.6 per cent recorded in the previous year. The Industrial loans sub-sector also accounted for N2.87 billion or 0.14 per cent of the market turnover in 2007. The Federal Government development stock and preference stocks sub-sector in the period remained inactive with only N1.6 billion turnover.


A further breakdown also shows that high net worth individuals and corporate investors in 2007 were preferred to over the counter (OTC) market. This is because the Federal Government listed bonds recorded a turnover of N4.13 trillion in 30,182 deals compared with N624.81 billion achieved in 5,448 deals in 2006.


Foundation of Assurance


The Director General is of the belief that a fall in the indices cannot be linked to one factor especially if that is external.


It would be an oversimplification if the fall in the stock market in Nigeria is linked only to sub-prime mortgage crisis in the US. It is quite clear therefore that the US sub-prime mortgage crisis has nothing to do with Nigerian stock markets.





The media, be it print or electronic, always speculate. In stock markets, ups and downs are always a part of the price action. Investors have to visualize it as a normal business and try to find investing/trading opportunities during the days when index falls considerably.


But that may not be the problem for Nigeria now, it has a lot of issues right under its noses to content with. Such issues include the glaring abuse of process by registrars, the disclosure gaps in director’s dealings prior to public offers, enforcement of rules to encourage a level playing field, the new market makers role and transparency issues and most importantly, the integration of the market services into a user friendly process. That should keep us all busy for a while.


Sent in by Jude Opia (research reference Sundaramurthy Vadivelu, India Street)

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