Remember how all those cuddly mortgage companies, like GM's (NYSE:GM) now half-owned GMAC, were interested in helping out all those questionable-credit, but oh-so-deserving homeowners-to-be? (Click here for GM cuddles.) Non-prime? No problem! Just sign here! We trust you!
Yeah, well, it turns out GMAC's not so interested anymore, because those folks aren't so profitable. And by "not so profitable," I mean, "very unprofitable." We'll get to this discussion of the fallout in a minute. First, let's take a look at the catalyst.
GM may have sold half of GMAC, but it wasn't able to fully dodge the bullet of the crummy subprime lending game. The results here nailed GM as a whole, but I'll leave that tale for another Fool.
Here's the grim, but predictable, news: For the first quarter of 2007, GMAC's residential capital business lost some $910 million dollars, more than offsetting the smaller gains in GMAC's finance and insurance divisions.
The release tells a familiar tale for anyone who's followed HSBC Holdings (NYSE:HBC), New Century, Countrywide Financial (NYSE:CFC), M&T Bank (NYSE:MTB), and other lenders under pressure -- a story of bad loans going bad(der). These loans are being sold at losses, because of the illiquid market for such secondary loans, and increased reserves against the possibility that bad and bad(der) gets worse.
In short, Wall Street lost its appetite for risky loans as soon as home prices stopped bubbling up, leaving GM and other lenders stuck holding the hot potato. Once burned, they're not going to pick up any more.
While some companies out there, like M&T, are hanging onto mortgage instruments rather than selling them at cut rates in the markets, a look at GMAC's 30% drop in cash and equivalents over the quarter makes you wonder whether its at-a-loss sales weren't necessary to maintain adequate liquidity. In other words, it looks to me like GMAC's having to burn the furniture to heat the house.
GMAC's taking the only responsible measures -- clamping down on those with crummy credit, and making better loans. In official corporate-speak, they're "mitigating risk." (By which I mean, "Sorry, Mr. And Mrs. Jones. You're being mitigated.") For the quarter, non-prime loan production dropped a stunning 64%, yet prime production moved up only 3%. That's how total net revenues for GMAC fell 27% year over year.
It'll be tough for some of these lenders, but the big and well-capitalized will survive. They just won't be experiencing the growth investors came to expect during El Bubble Grande, and as they all tighten down on the low-end credit that fueled that particular Bubblezilla, demand for homes will likely continue to dwindle. That will continue pinching the Beazer Homes (NYSE:BZH) and Pulte Homes (NYSE:PHM) of the world, in addition to dropping prices, scaring off other buyers and "investors," and feeding a corrective cycle long overdue.
It'll be vicious for those who didn't do their homework and can't pay their bills, especially those who jumped into adjusting option-ARMs. But that's how business works. Risk doesn't make you money forever. Sometimes, you've got to mitigate it. So much for the mortgage industry's cuddly side.
At the time of publication, Seth Jayson had no positions in any company mentioned here. See his latest blog commentary here. View his stock holdings and Fool profile here. Fool rules are here
