Business Problem-Solving Case: Hsbc's Mortgage Lending Decisions: What Went Wrong?

Case Study

Business Problem-Solving Case: HSBC's Mortgage Lending Decisions: What went wrong?

On of the biggest stories of late summer and fall of 2007 was about the U.S. subprime mortgage loan crisis and its effect on worldwide financial markets. A Major Player in this crisis was HSBC Holdings PLC, the third largest bank in the world based on market value. With headquarters in London, HSBC operates in 76 countries and territories. In 2006, it had become one of the largest lenders of subprime mortgages in the United States. ubprime mortgages are targeted toward low-end borrowers who represent a risk of default, but at times, a good business opportunity to the lender. Subprime customers often have blemish credit histories, low incomes, or other traits that suggests a greater likelihood of defaulting on a loan. Generally speaking, lenders try to avoid making such loans. However, during a housing boom, competition for customers motivates lenders to relax their lending standards. During such a time, subprime mortgages, including those that do not require a down payment and have very low introductory rates, become far more prevalent, as they did between 2001 and 2006 in the United States.

By 2007, 12 percent of the total $8.4 trillion U.S. Mortgages market consisted of subprime mortgages, up from just 7.5 percent near the end of 2001. In early February 2007, HSBC revealed that this risky lending technique had become a major problem. As the U.S. real estate market slowed in 2006, the growth rate of home values also slowed. With the coinciding rise in interest rates, many borrowers with adjustable-rate mortgages were unable to make their mortgage payments and defaulted on their loans. HSBC anticipated seeing the number of delinquent and defaulted accounts grow, but not to the level it actually discovered. Mortgage lenders in the United States participate in a complicated business that involved more than a simple lender-borrower relationship. A bank or mortgage broker that originates a mortgage may not keep it. Mortgage wholesalers often buy loans and then turn right around and resell them to large financial institutions. The default risk passes along to whomever winds up with the account last. HSBC participated in several zones of the mortgage market. One unit of HSBC Mortgage Services originated mortgages, often of the subprime variety. HSBC flipped some of these loans to other companies, but kept others as investments. The ones HSBC kept provided revenue from the interest they generated, assuming the borrowers kept current with their payments. If the borrowers fell behind or defaulted, HSBC suffered the losses.

In its quest for higher revenue, HSBC began buying up subprime loans from other sources. In 2005 and 2006, with the housing boom in its final stages, HSBC bought billions of dollars of subprime loans from