Why It’s Now Time To Worry Again About Subprime Mortgages

Finance companies are tip toeing back into the business of subprime mortgages again. Improvements in their financials aren't enough to mitigate the risks of this heavily scrutinized industry.

Apr 2, 2014 at 7:00AM

Flickr / RCB.

The infamous subprime mortgage business is rearing its ugly head again, as companies like American International Group (NYSE:AIG)Fortress Investment Group (NYSE:FIG) and Nationstar Mortgage Holdings (NYSE:NSM) -- which operated in the space prior to the housing collapse of 2008 -- are once again seeing a prime opportunity to line their financial coffers.

Many of the investors who profited from the subprime mortgage space, as well as new investors, may be tempted to reenter or boost their positions in some of the companies that operate in the space. However, there are some things investors should be aware of, as the subprime mortgage is still one of the most worrisome investments out there right now.

Their Subprime Lending Roles
American International Group, best known as AIG, insured many of the toxic bonds that were backed by the risky mortgages. On the brink of going under due to its dealings in the subprime mortgage industry, AIG received $182.3 billion in bailout money from the federal government in 2008 to cover its failed mortgage, investments, according to Bloomberg.

In 2006, Fortress bought Nationstar, which operated as a subprime mortgage service company. Two years later, the housing market went bust and Nationstar struggled to turn a dime. Fortress took Nationstar public in 2012, and the stock's value has increased dramatically.

Not Over Yet
As Nationstar's loan portfolio has grown, it has drawn the ire of the superintendent of New York's Department of Financial Services. The concern stems from complaints from New York consumers complaining about the company's mortgage practices, including improper fees.

When that news hit the wires, Nationstar's stock barely moved. In fact, it closed up almost 8% with the company's CEO pledging to comply with New York's request. So far, any rumblings about the resurgence of the dealings that tanked the housing market have not affected investor appetite for these companies, with all three showing solid growth in share price over the past year.

Is it different this time around?
Unlike their previous tangling in the subprime market industry, the current housing market climate may work in the favor of financial institutions like these.

Also, companies willing to get back into the business of subprime mortgages are more likely to take advantage of products to protect them in the event a borrower defaults. A consumer website called FrozenPea.com highlights a fairly new way subprime lenders are trying to make sure they are protected if a borrower defaults. The practice allows borrowers to obtain mortgages, even if they have no verifiable income, by taking out a whole life insurance policy with the lender.

Moving from the past to the future
The low interest rate environment and skyrocketing home prices were the main drivers behind the insurgence of subprime loans prior to the 2008 housing collapse. Mortgage financing players were willing to loosen and bend loan rules, as well as create products to get around the rules to help people qualify for loans they could not afford. Investment firms threw caution to the wind, and backed bonds with the toxic loans and sold them to investors, some of whom may have been just as willing to turn a blind eye to the fraudulent nature of some of these schemes.

I still see there being a place for lenders willing to loan those with subpar credit, as there will always be that need. If there are stricter regulations in place that are truly enforced, I see these companies being less likely to make the mistakes that doomed them before. But nevertheless: they should be watched extremely closely.

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Tedra DeSue has no position in any stocks mentioned. The Motley Fool recommends American International Group. The Motley Fool owns shares of American International Group and has the following options: long January 2016 $30 calls on American International Group. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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