Interest Rate Roundup

Monday, December 31, 2007

Builders cutting back sharply in my neck of the woods

I've been saying for some time that the Southeast Florida and Southwest Florida housing markets are among the worst off in the nation. Sales are down sharply, inventories are off the charts, and the speculators that fueled so much of the demand during the bubble days have long since fled. So a couple of recent news items come as no surprise ...

First, M/I Homes said it sold off approximately 3,700 lots for $82 million. Most of that land is in Florida, with more than 500 lots being dumped in the West Palm Beach market (which the company is exiting after doing business here since 1985). M/I Homes' local communities include a mixed townhome/detached home community called Paloma not too far from where I live and the Oaks at Hobe Sound.

Second, private builder Mercedes Homes just sold 130 vacant lots in Port St. Lucie for an average price of about $19,400, according to the Palm Beach Post. How big a discount is that from their previous value? Here's an excerpt from the story, with my emphasis added:

"The lots that we sold, we bought at the top of the market," said Rob Smithwick, Treasure Coast division president for privately held Mercedes Homes.

Instead of continuing to pay interest on lots that might be worth one-third of what it paid, the home builder decided to take what cash it could get and move the properties off its books. Smithwick said Mercedes' losses on a per-lot basis were as high as $70,000 in some cases.

"But $70,000 on paper doesn't buy me a hamburger," he said.

So what's the outlook like for this area? Smithwick had some comments there, too:

"I do believe '08 will be the worst of all the years," he said. "Our objective is to hunker down ... so when we come out in '09 we will be one of the few standing."

November existing home sales flatline

New home sales stunk up the joint in November. So how did the existing home side of the market do? Let's get to the latest stats from the National Association of Realtors:

* Sales edged up by 0.4% to a seasonally adjusted annual rate of 5 million from 4.98 million in October (previously reported as 4.97 million). That was roughly in line with economists' forecasts for no change. Regionally, sales were off 3.3% in the Northeast and 2% in the South. They were unchanged in the Midwest, but up 10.3% in the West. The November sales rate was down 20% from 6.25 million in November 2006.

* For sale inventory came in at 4.273 million single-family homes, condos, and co-ops. That was down 3.6% from 4.433 million in October (previously reported as 4.453 million units), and up 12.2% from 3.81 million in November 2006. On a months supply at current sales pace basis, inventory was 10.3 months, down from 10.7 months in October (previously reported as 10.8) and up from 7.3 months in November 2006.

* Median prices rose 1.6% to $210,200 in November from $206,900 in October (previously reported as $207,800). On a year-over-year basis, prices were down 3.3% from $217,300 in November 2006.

The November new home sales figures provided some fireworks. Not so the existing home data. The numbers were roughly in line with expectations, with a slight monthly increase in sales, a slight monthly decline in inventory, and another yearly decline in median prices.

Still, there's little reason to pop open any champagne corks. November's sales rate was the second-lowest on record behind October's. Supply remains elevated. And home prices have now fallen from year-ago levels in 15 of the past 16 months.

So what about the big picture? Well, we have a bit of a battle royale going on. On the one hand, the Federal Reserve is cutting interest rates and pumping liquidity into the banking system to encourage lenders to make more loans. You also have policymakers getting serious about updating the FHA mortgage program to make it a viable alternative to subprime and Alt-A loans. On the other hand, you have foreclosure activity surging, consumer confidence waning, home prices trending lower, and tighter lending standards in the private mortgage market.

The net effect is that home sales will likely chop around in the shorter term. Meanwhile, prices should generally trend lower -- on the order of the mid-single digits in 2008.

One last wildcard to consider: The performance of the broader economy. So far, housing has been in its own private recession, but the rest of the economy has been chugging along. That may be starting to change now. Jobless claims are trending higher, retail sales are lackluster, and manufacturing activity appears to be cooling. If the job market weakens notably in early 2008, it could knock another leg out from under the housing market stool.

Friday, December 28, 2007

An article worth reading from the Dallas Fed

Looking for a succinct summation of the past several years in the housing and mortgage industry -- and an explanation of how we got into the mess we're in today? Then take a look at the latest Economic Letter out of the Federal Reserve Bank of Dallas. An article titled "The Rise and Fall of Subprime Mortgages" walks you through many of the highlights and lowlights of lending/housing activity, circa 2000-2007.

There's not a lot of new ground covered, but there are plenty of key points and stats for us to chew on. Here are some excerpts (with select passages emphasized in bold by me):

* Some 80 percent of outstanding U.S. mortgages are prime, while 14 percent are subprime and 6 percent fall into the near-prime category. These numbers, however, mask the explosive growth of nonprime mortgages. Subprime and near-prime loans shot up from 9 percent of newly originated securitized mortgages in 2001 to 40 percent in 2006

The nonprime boom introduced practices that made it easier to obtain loans. Some mortgages required little or no proof of income; others needed little or no down payment. Homebuyers could take out a simultaneous second, or piggyback, mortgage at the time of purchase, make interest-only payments for up to 15 years, skip payments by reducing equity or, in some cases, obtain a mortgage that exceeded the home's value.

* As problems began to emerge in late 2006, investors realized they had purchased nonprime RMBS with overly optimistic expectations of loan quality. Much of their misjudgment plausibly stemmed from the difficulty of forecasting default losses based on the short history of nonprime loans.

Subprime loan problems had surfaced just before and at the start of the 2001 recession but then rapidly retreated from 2002 to 2005 as the economy recovered. This pre-2006 pattern suggested that as long as unemployment remained low, so, too, would default and delinquency rates.

This interpretation ignored two other factors that had helped alleviate subprime loan problems earlier in the decade. First, this was a period of rapidly escalating home prices. Subprime borrowers who encountered financial problems could either borrow against their equity to make house payments or sell their homes to settle their debts. Second, interest rates declined significantly in the early 2000s. This helped lower the base rate to which adjustable mortgage rates were indexed, thereby limiting the increase when initial, teaser rates ended.

Favorable home-price and interest rate developments likely led models that were overly focused on unemployment as a driver of problem loans to underestimate the risk of nonprime mortgages. Indeed, swings in home-price appreciation and interest rates may also explain why prime and subprime loan quality have trended together in the 2000s. This can be seen once we account for the fact that past-due rates—the percentage of mortgages delinquent or in some stage of foreclosure—typically run five times higher on subprime loans (Chart 3). When the favorable home-price and interest rate factors reversed, the past-due rate rose markedly, despite continued low unemployment.

* Failure to appreciate the risks of nonprime loans prompted lenders to overly ease credit standards. The result was a huge jump in origination shares for subprime and near-prime mortgages.

Compared with conventional prime loans in 2006, average down payments were lower, at 6 percent for subprime mortgages and 12 percent for near-prime loans. The relatively small down payments often entailed borrowers' taking out piggyback loans to pay the portion of their home prices above the 80 percent covered by first-lien mortgages.

Another form of easing facilitated the rapid rise of mortgages that didn't require borrowers to fully document their incomes. In 2006, these low- or no-doc loans comprised 81 percent of near-prime, 55 percent of jumbo, 50 percent of subprime and 36 percent of prime securitized mortgages.

The easier lending standards coincided with a sizeable rise in adjustable-rate mortgages (ARMs). Of the mortgages originated in 2006 that were later securitized, 92 percent of subprime, 68 percent of near-prime, 43 percent of jumbo and 23 percent of prime mortgages had adjustable rates. Now, with rates on one-year adjustable and 30-year fixed mortgages close, ARMs' market share has dwindled to 15 percent, less than half its recent peak of 35 percent in 2004.

* In the absence of home-price appreciation, many households are finding it difficult to refinance their way out of adjustable-rate mortgages obtained at the height of the housing boom. Larger mortgage payments could exacerbate delinquencies and foreclosures, especially with interest rate resets expected to remain high for the next year. This suggests mortgage quality will likely continue to fall off for some time.

Surprising strength in Chicago

The Chicago purchasing managers index came in surprisingly strong -- at 56.6 in December versus 52.9 in November and expectations for a reading of 51.7. Among key subindices, prices paid cooled to 63.8 from 76.2 while new orders rose to 58.4 from 53.9 and employment declined to 49 from 54.4. There hasn't been much of a market reaction yet, perhaps because the more important report on new home sales is coming out soon.

November new home sales tank


We just got data on new home sales for November. So what did today's report show?

* Sales plunged 9% to a seasonally adjusted annual rate of 647,000 from a revised 711,000 SAAR in October (previously reported as 728,000). On a year-over-year basis, sales were down 34.4% from 987,000 in November 2006. Sales haven't been this weak since April 1995 (621,000), as shown in the chart above.

* For-sale inventory came in at 505,000 new homes. That was down 1.8% from 514,000 in October (previously reported as 516,000) and down 6.8% from 542,000 in November 2006. The peak was 573,000 units in July 2006. On a months supply at current sales pace basis, inventory was 9.3 months, up from 8.8 in October (previously reported as 8.5), and up from 6.5 a year earlier.

* The median price of a new home rose 4.2% to $239,100 in November from $229,500 in October (previously reported as $217,800). Prices were down 0.4% from $240,100 in November 2006.

I've been a housing "bear" for some time. But even I'm stunned by how awful new home sales were in November. Sales are now running at the lowest level since 1995. Moreover, inventories remain elevated. The key "months supply at current sales pace" measure came in just shy of the cycle high -- 9.4 months in August. And the number of completed new homes sitting on the market hit a fresh all-time high of 193,000.

Prices were largely stable. But the collapse in the sales rate suggests that won't last. Builders simply have to get more aggressive on pricing to clear their supply backlog and encourage buyers to step up to the plate. That's especially true now that mortgage financing has become harder to get and the job market is showing signs of weakening.

Thursday, December 27, 2007

Wednesday morning econorama

Some interesting things to talk about on the economic front this morning ...

First, mortgage applications dropped precipitously in the week ended December 21. The overall index fell 7.6%, with the refi index off 8.5% and the purchase index down 6.6%. The purchase index -- at 394.5 -- is now at its lowest since February. It's worth pointing out that the Mortgage Bankers Association figures can be somewhat volatile around the holidays due to problems with seasonal adjustments. But taken at face value, these figures suggest housing activity is downshifting again in December.

Second, jobless claims are on the rise. Initial filings rose 1,000 to 349,000 in the week ended December 22. Meanwhile, continuing claims surged by 75,000 to 2.713 million. That's a level we haven't seen since late 2005.

Third, durable goods orders inched up just 0.1% in November, versus expectations for a gain of 2%. One key measure of business spending -- nondefense capital goods orders excluding aircraft (yes, it's a mouthful!) -- fell 0.4%. A team of crack economists polled by Reuters expected to see a 0.5% rise in this key measure.

If you're looking for signs of economic weakness, you hit the trifecta today. These reports all show the economy is downshifting -- the same message we got yesterday from reports of lackluster holiday sales.

Wednesday, December 26, 2007

S&P/Case-Shiller index for October -- prices down 6.1% YOY


Good morning and welcome to that wonderful post-Christmas, pre-New Year's period where we all wish we were anywhere but work (and many of you probably are!) For those of you stuck behind a desk, however, your loyal blogger plans to be around covering the latest news. Speaking of which, the S&P/Case-Shiller figures for October were just released ... and they don't look so hot:

* The 20-city index showed prices falling 1.4% between September and October. Prices were down 6.1% from a year ago, the biggest year-over-year drop on record (the data goes back to 2001; chart above).

* The 10-city index has a longer history. It declined 6.7% from a year ago -- the worst since S&P started tracking in the late 1980s (the previous record drop was 6.3% in April 1991).

* Prices fell from year-ago levels in 17 out of 20 cities, worse than last month, when 15 metros showed a decline. Miami was the worst off (-12.4%), followed by Tampa (-11.8%), Detroit (-11.2%) and San Diego (-11.1%). The best performing cities were Charlotte (+4.3%) and Seattle (+3.3%).

The housing market slump continues to drag on, with sales activity muted and home values falling. Tighter mortgage lending standards, falling consumer confidence, and a sharp drop in speculative purchases have all taken bites out of buyer demand, forcing sellers to adjust by cutting prices. That's reflected in the S&P/Case-Shiller figures, and there's no reason to expect an imminent turnaround. In fact, I expect home pries to continue to drift lower in 2008 -- by the mid single-digits nationally, with select markets faring worse.

Monday, December 24, 2007

Have a great holiday

I just wanted to take a moment to wish all of you out there a great holiday. I'm enjoying the vacation days with my family and don't plan to post much.

Friday, December 21, 2007

The M-LEC/Super SIV plan is dead: WSJ

The Wall Street Journal is reporting that the bailout ... er ... rescue plan dubbed "M-LEC" or "Super SIV" is history. An excerpt:

"The banks orchestrating a bailout of troubled investment vehicles that were hit by the subprime mortgage crisis are throwing in the towel after struggling to raise money for the planned fund, according to people familiar with the matter.

"At the behest of the Treasury Department, Bank of America Corp., Citigroup Inc. and J.P. Morgan Chase & Co. have been working since September to set up the fund, which would buy assets from so-called structured investment vehicles. SIVs have been battered by the credit crunch, with investors refusing to buy the short-term commercial paper that the funds issue to buy higher-yielding assets, in particular securities backed by subprime mortgages.

"Lack of interest has led the banks to drop the plan -- known as the Master-Enhanced Liquidity Conduit, or M-LEC. In many cases the banks, in particular Citigroup, that were supposed to sell assets to the fund have instead bitten the bullet and moved the assets onto their own balance sheets, alleviating a key rationale for the rescue fund."

You could spin this as bullish -- the crisis is abating, banks can handle taking this stuff back on their balance sheets without the Super SIV, etc. Or you could look at it as bearish -- investors don't want to participate in any SIV rescue plan because the value of the underlying paper is so opaque and questionable.

Counterparty risk -- live it and learn it, even if you don't love it

Today, we delve into the topic of counterparty risk. What the heck is that? This Wall Street Journal story today talks about if you have a subscription and can give it a read. But in a nutshell, counterparty risk is the risk that the guy on the other side of your derivatives trade can't pay up.

Say you purchase default insurance (like a credit default swap) on a $100 million pool of bonds. If the hedge fund/investment fund/bond insurance firm/whomever selling you that insurance has tons of money in reserve and plenty of liquidity, there's nothing to worry about. That counterparty can cover your loss if those bonds do in fact default. But what if the "insurer" took on too much risk? What if he can't make good on your "policy." Then you're (to use the official term) S.O.L.

That's the situation potentially unfolding with ACA Capital Holdings. As the Journal story notes:

"ACA is a stark example of the perils of counterparty risk. Earlier this year, as the subprime-mortgage debt market was melting down, some Wall Street banks rushed to offload the risk of the troubled assets they held. Few were willing to take on that risk. ACA did, writing nearly $20 billion of credit protection between April and September, according to its financial statements. Now that it has been downgraded, ACA may not be able to raise the capital to make good on those commitments.

"Yesterday, Crédit Agricole SA joined Canadian Imperial Bank of Commerce in warning that it could take further write-downs of its holdings of CDOs in light of ACA's problems and credit-rating adjustments for other bond insurers.

"ACA is scrambling to work out a solution with its 30 counterparties, who have temporarily waived their rights to demand that the insurer come up with roughly $1.7 billion in collateral to support its guarantees. It has a capital cushion of just $650 million. Its parent, ACA Capital, was delisted from the New York Stock Exchange this month and the shares now trade on the over-the-counter bulletin board.

"A company spokesman said ACA so far hasn't had to make any payouts on the CDOs it insured, and those bonds are still rated AAA by S&P.

"As the bond insurers' problems mount, more investors are focusing on the risk at banks and brokers themselves, which in turn entered into credit default swaps with hedge funds and other investors. A bond-insurer insolvency that triggers losses at financial institutions could set off a chain reaction affecting many investors.

"In recent weeks, counterparty fears have spread to other parts of the market. Some hedge funds that were using credit default swaps to bet on a further downturn in the mortgage market say they have exited some of their positions, in part because of concerns that the financial institutions on the other side of their trades may not be able to pay up."

If derivatives volume were minuscule, you could pretty much ignore this risk. In fact, that's what most investors have been doing for years. But global derivatives volume has exploded. According to the Bank for International Settlements (BIS), the notional amount of global, over-the-counter derivatives (PDF link) was $516 TRILLION in June. Yes, that's half a quadrillion dollars. It's also up roughly six-fold (this link opens a spreadsheet) from the turn of the century. CDS volume alone has more than quadrupled in only two years -- to $42.5 trillion notional from $10.2 trillion in 2005.

Now, let's be clear: "Notional value" is not a measure of actual money at risk. The glossary on page 8 of this Office of the Comptroller of the Currency PDF document explains notional value and some other buzzwords from the derivatives world, if you find you're having trouble sleeping and aren't inclined to take Ambien. But the sheer size of the derivatives business, the complexity of these contracts, and the fact we're seeing so much credit market turmoil all increase the chance of an even-bigger meltdown. Indeed, if counterparties start failing, all those "hedges" that financial firms have supposedly taken out to protect their positions could turn out to be as worthless as some of the mortgage paper itself. Interesting times for sure.

Thursday, December 20, 2007

CNBC raises an important question -- is FHASecure a flop?

Since the FHASecure loan program was announced this summer, the open question has always been "How many people will this refinance-bailout thing really help?" Here is what it says at the FHA.gov website:

"In only the first 4 months of FHASecure, more than 40,000 households have refinanced under the new housing insurance program to protect their families' investment in the American Dream. Announced by President Bush on August 31, 2007, along with HUD Secretary Jackson and Treasury Secretary Paulson, FHASecure is already helping thousands of American families, faced with the possibility of foreclosure because of rising interest rates, to keep their homes.

"More good news is that an additional 20,000 are in the pipeline and their approval is expected by the end of December. That will mean that in the first 4 months of the program, FHASecure will have helped 53,000 families and received more than 127,000 refinance applications from families whose loans are current or past due."

But CNBC has an interesting news item/posting up at their website today asking a simple question: "FHA Secure: Wait, How Do 600 Applications Become 35,000?" The gist of the item -- that HUD decided to lump ALL FHA loan applications and loan fundings that have been done since August into the tally that was supposedly FHASecure loans. Here's an excerpt from CNBC:

"Here’s the truth: FHA Secure has received about 3,000 applications from homeowners who are delinquent on their loans and has closed on about 600 since September, that answer from an official HUD staffer who gave me the actual numbers after more than one request.

"Wait, how is 600 translated into 35,000??? I know the President is prone to grammatical errors, but not usually numerical ones. (I’ll also add that another reporter was given the number 266, reportedly by HUD as well).

"It seems that at some point this fall, the folks at HUD or FHA or somewhere decided to pool all loans made by the FHA under the “FHA Secure” umbrella. A rose, by any other name. So yes, since September, the FHA has backed 35,000 loans, the vast majority of which were in no danger of default, but were just normal loans, and that’s pretty close to a normal three-month period.

"As for the 300,000 families Mr. Bush said would be helped next year, well only about 60,000 of them would end up as borrowers who are in trouble on their loans. That’s still a lot, but I just want to set the record straight."

Holy cow. Have we all been snowed about the impact FHASecure might have? By the way, if you're wondering what is going on in terms of TOTAL FHA volume, the origination statistics can be found on page 20 of this mega-PDF document. You'll see refinance volume was running at about 72,000 1-4 family loans in Q3. And if you look at the monthly data, you can clearly see that FHA application volume has been increasing in 2007 due to the obliteration of the private subprime/Alt-A lending market.

The "key" to losing a lot of money? Making too many real estate loans

That seems to be the lesson from this after the bell news out of KeyCorp. The super-regional bank (the nation's 24th largest by assets as of Q2, per American Banker) announced wide-ranging losses related to its real estate lending exposure, as well as several changes to its business plans ...

* Key has a $3.7 billion portfolio of residential property commercial real estate development loans (meaning loans to developers to build homes and condos, as opposed to individual mortgages to home buyers). It said it will no longer make such loans to many home builders outside of its regional banking "footprint." It will also transfer roughly $1.1 billion of its loans to builders -- and $800 million of its condominium construction loans -- to a special asset management group. Recall that Wells Fargo recently did something similar with a portfolio of consumer home equity loans.

* Key also noted that residential real estate development loan conditions are deteriorating in places like Florida and California. That will result in net loan charge-offs of $110 million to $120 million. in Q4 Nonperforming assets are going to surge by 34% in the quarter ($195 million) from Q3 levels.

* Credit market turmoil is also hurting the valuation of commercial mortgage loans in its held for sale portfolio, and impacting the valuation of certain real estate investments. Total additional losses: $55 million to $65 million.

* The company said it would get out of the national home improvement lending business. It makes dealer-originated loans to fund improvement projects, with a portfolio of $1.4 billion.

* All told, Key plans to cut 740 jobs as a result of these actions, and leave 300 other open positions unfilled. The company's bottom-line Q4 forecast? A per-share loss of 5 cents, versus expectations for a profit of 66 cents.

Philly Fed index smells like a week-old cheesesteak

The Philadelphia Fed index of manufacturing activity stunk up the joint in December. The overall index came in at -5.7, down from +8.2 in November and much worse than the forecast for +6. That's the worst reading since April 2003 (-7). Yuck.

Thoughts on the latest credit market turmoil

I know I haven't posted much in the past day and a half. It's not for lack of desire -- or a lack of anything to write about! It's because I'm busy trying to wrap several things up in my "day job" before the Christmas holiday. But I'm going to take a few minutes now to touch on the biggest things going on, and try to explain what they mean for the markets. In no particular order ...

* Shares of embattled bond insurance firm MBIA are in free-fall (down another 20%+ at last count) again today. The catalyst is a new report from the insurer that it guarantees $8.1 billion of "CDO Squareds" -- or CDOs that repackage bits of other CDOs and securities. A Morgan Stanley analyst said he was "shocked management withheld this information for as long as it did," according to Bloomberg.

Standard and Poor's and Moody's have both lowered their outlook for several bond insurers, including MBIA and Ambac Financial. But so far they haven't cut their AAA ratings. The market, on the other hand, has clearly rendered its judgment about the validity of those ratings and/or the companies' earnings outlook. Credit default swaps are blowing out in the case of MBI, for instance, while the share prices of these firms have been more than cut in half in the past several months.

* Bear Stearns became the latest Wall Street firm to eat major losses due to worsening credit market conditions. The broker lost $854 million in the fourth quarter thanks in part to $1.9 billion in writedowns on mortgages.

* The asset-backed commercial paper market continues to shrink rapidly. ABCP dropped by $27.5 billion, or almost 3.5%, in the week ended December 19. That's the biggest decline in 16 weeks. More details on why this is happening and what it means can be found here.

* Shares of super-regional bank SunTrust Banks are slumping after the firm said it would buy up $1.4 billion in debt securities to prevent investors from taking losses in its STI Classic Prime Quality and STI Classic Institutional Cash Management money funds. It's going to take a pretax writedown of up to $250 million because of the purchases.

That's not all, either. In an 8-K SEC filing, SunTrust said:

"Deteriorating real estate values and the outlook for consumer credit have increased SunTrust's expectations for losses inherent in the portfolio. Provision expense recorded in the fourth quarter is currently expected to exceed net charge-offs by approximately $190 million which will increase the allowance for loan and lease losses to approximately 1.06% of total loans. Additionally, the Company expects net charge-offs in the fourth quarter of 2007 to approximate $170 million, or an annualized rate of net charge-offs to average loans of approximately 0.56%."

In other words, the hits just keep on coming. The U.S. Federal Reserve, and other global central banks, continue to bail like crazy and pump money into the system. But so far, it's an open question of whether the strategy is "working." I'm skeptical the Fed can prevent the housing market from slumping further, to say nothing of simultaneously putting out credit fires that are now burning brighter in the commercial real estate sector ... the credit card sector ... the auto loan sector ... and so on.

Tuesday, December 18, 2007

NYTimes: Regulators fiddled while Rome burned

What a great story from the New York Times today: "Fed Shrugged as Subprime Crisis Spread." The essential conclusion: Federal regulators were out to lunch about the mortgage crisis, failing to act early enough and aggressively enough to rein in an industry gone amok. I covered similar ground in a white paper released this past July. The timing of this Times story is no coincidence -- the Fed today is considering new rules to prevent future crises. You can read more about them here. The basic points?

Creditors would be prohibited from engaging in a pattern or practice of extending credit without considering borrowers’ ability to repay the loan.

Creditors would be required to verify the income and assets they rely upon in making a loan.

Prepayment penalties would only be permitted if certain conditions are met, including the condition that no penalty will apply for at least sixty days before any possible payment increase.
Creditors would have to establish escrow accounts for taxes and insurance.

My thoughts on November housing starts


Sorry about the delay. I was taping two Fox Business segments on the housing market this morning. They focused on the outlook and impact of today's housing starts and building permits figures. So what did the numbers show?

* Starts fell 3.7% to a seasonally adjusted annual rate of 1.187 million units. That was down from a revised 1.232 million units in October, slightly better than forecasts for a reading of 1.176 million, and ever-so-slightly above the cycle low set in September (1.182 million).

* However, building permits continued to fall, slipping 1.5% to 1.152 million units. That was down from 1.17 million units in October and the lowest level since June 1993.

* By property type, single-family starts tanked 5.4% to 829,000, the lowest since June 1991 (shown in the chart above). Multi-family starts inched up by 0.6%. By region, starts fell in the Northeast (-16.3%), the Midwest (-1.5%), and the West (-6.9%), and rose slightly (+0.3%) in the South. As for permit issuance, single family permits dropped 5.6% to 764,000, while multi-family permits rose 7.5%. Permit issuance was down in two regions (Northeast, West) and up in two others (Midwest, South).

The numbers continue to show a subdued home construction market. We simply have too much housing supply and not enough housing demand -- and builders are responding by paring back. Some additional things to chew on:

* Builder sentiment remains in the dumps. The National Association of Home Builders index that tracks buyer traffic and sales activity held at a record low of 19 in December. It hovered around 70 during the halcyon days of 2003-2005. With traffic levels dismal and optimism on the wane, caution is going to be the watchword. In other words, builders are going to be reluctant to swing those hammers and fire up those bulldozers.

* We have too many homes for sale. If you look at the existing and new home markets together, you see we have around 2 million to 2.5 million more homes on the market than we typically had at any given time in the pre-bubble days.

Meanwhile, census bureau figures show the homeowner vacancy rate – the percentage of homes for sale that are empty – is running at 2.7%. That’s just shy of the Q1 record of 2.8%. Before the bubble popped, the vacancy rate never rose above 2% (the Census Bureau started tracking this back in 1960). That is yet another data point showing that home supply is ample to meet America's housing needs for the near-to-intermediate term.

* Lending standards are tightening. Two-thirds of banks surveyed by the Fed recently are making creative mortgages harder to get, while roughly four in ten banks are tightening lending standards on prime-credit mortgages. That’s going to make it harder for new borrowers to get financing.

The FHASecure program announced at the end of August will help about 50,000 borrowers refinance this year, preventing or postponing some foreclosures. Additional FHA reforms being hammered out in Congress right now -- plus private-sector modifications -- will also help some borrowers avoid foreclosure. But we’re still looking at 2 million potential foreclosures in the next two years (per the Center for Responsible Lending). That's another major source of supply in an oversupplied market.

One last thing to consider: Most economists are looking for starts to bottom out in the 1.1 million to 1.25 million area sometime in early 2008 -- in other words, right around where we are now. But in the previous four substantial housing market downturns since the 1960s, starts fell an average of 60% peak-to-trough. Through November, we're down about 48.2% from the peak (2.292 million starts in January 2006). Therefore, from a purely historical perspective, this downturn could have further to go. A 60% decline from the peak would leave starts in the low-900,000 area. It's not really a forecast ... more like food for thought.

Monday, December 17, 2007

NAHB rallying cry: Things aren't getting worse!

Okay, so maybe it's not the most inspiring call to arms. But I think it's appropriate for the National Association of Home Builders, which just released its latest builder sentiment survey. What did the report show?

* The overall housing market index stayed flat at 19 in December -- the third month in a row it has held at these record-low levels.

* Two of three sub-indices gained. The index measuring present sales ticked up to 19 from 18 in November, while the index measuring expectations for future sales climbed to 26 from 24. However, the index measuring prospective buyer traffic fell to a fresh low of 14 from 17 a month earlier.

* Speaking of buyer traffic, it dropped sharply in the Northeast (to 19 from 26) and held steady in the West (at 18). It climbed in the South (to 21 from 19) and and in the Midwest (to 15 from 13).

The big-picture problems remain the same for the home building industry: There's too much housing supply and not enough housing demand. That's keeping the pressure on new home builders and existing home sellers. If there's a silver lining on this dark cloud, it's that builder sentiment isn't getting worse. But that doesn't exactly get the home town fans to jump up and cheer, does it?

We'll get more important housing data tomorrow when the government releases figures on home construction. Housing starts are forecast to have dropped just over 4% between October and November to an annualized rate of 1.176 million units.

Friday, December 14, 2007

FHA expansion coming soon?

For some time, expansion of the Federal Housing Administration mortgage program has been discussed in Washington. Some officials have wanted to ease FHA's 3% down payment requirement, change the way FHA insurance fees are calculated and assessed, or increase the FHA loan limits. But reform went nowhere.

Now that the housing market is in a state of chaos and the availability of private subprime and Alt-A mortgages has tanked, momentum has shifted in the reformists' favor. The Washington Post reported today that the Senate is finally close to voting on a reform bill (one has already been passed by the House). Some details:

"The Senate bill would lower the down payment requirement to 1.5 percent and allow the FHA to insure mortgages up to $417,000, which would broaden its reach to more-expensive housing regions such as the Washington area, said four congressional aides who spoke on condition of anonymity in advance of the Senate vote.

"Last year, the FHA got nearly 680,000 applications from home buyers. This year, it is on pace to receive 1.4 million, as exotic and adjustable-rate loans have fallen out of favor among lenders.

"The FHA, part of the Department of Housing and Urban Development, does not rely on public funds to provide mortgage insurance and covers its costs by charging a fee to home buyers, normally about 1 percent of their mortgage amount. The Senate bill would raise the ceiling on that fee to 3 percent. FHA officials said the higher fee would allow them to charge more to less-credit-worthy borrowers."

Like the Paulson Plan, like the FHA Secure refinance-bailout program, and other "fixes" that will undoubtedly be proposed in coming months, FHA reform is another attempt to ease the pain of the credit contraction/housing slump. While I understand why it's happening (namely, political pressure to "do something" about the mortgage mess), I don't understand the logic behind making the FHA loan program easier. Do we really want the FHA to go down the same sorry road that private lenders did (namely, making it too easy to buy a house with barely any money down and too-weak credit)? I mean, that's why delinquencies and foreclosures are surging in the first place.

UPDATE: FHA reform bill passed 93-1 in the Senate. The Senate and House bills will have to be reconciled, and then the president will likely sign the final product.

Yet another ugly inflation surprise

Is it time to get out those "Whip Inflation Now" buttons again? Earlier this week, we learned that overall producer prices are rising at the fastest year-over-year rate since November 1981 (+7.2%) ... and that import prices are increasing at the greatest year-over-year rate in recorded U.S. history (+11.4% -- the data series goes back to 1982). Now, it turns out consumer prices are on the move, too.

The November Consumer Price Index jumped 0.8% in November, more than the 0.6% that economists were looking for. That pushed the YOY rate of consumer inflation to 4.3% from 3.5% a month earlier -- the most since September 2005 (which was impacted by the hurricanes of that year).

The "core" CPI also rose more than expected -- 0.3% against a forecast of 0.2%. That pushed the YOY rate in core inflation to 2.3%; it hasn't been hotter than that since March. Increases were widespread. Housing costs were up 0.4% ... fuels and utilities were up 1.5% ... apparel was up 0.8% ... and medical care was up 0.4%.

Obviously, energy prices were a major factor in last month's gain. But even services inflation, ex-energy, was up 0.3% (or 3.3% YOY) ... and the overall core reading was hotter-than-expected.

Citigroup's SIV drama

Late yesterday, Citigroup said it will take over seven suffering structured investment vehicles, or SIVs, assuming $58 billion in debt in the process. SIVs are these wonderful financial innovations that major financial institutions have devised (You know, like those other great products -- CDOs of CDOs, subprime RMBS and so on and so forth). They sell short-term debt and use that money to buy longer-term debt.

That works great ... until investors decide they don't want to buy SIV-issued paper. When that happens, things get ugly and SIVs can find they have to liquidate assets, driving prices lower. The Citigroup move is designed to allow the SIVs to wind down in an orderly process, rather than be forced to hold "fire sales."

So this is "good" news, right? Well, it might have been if Moody's didn't decide to spoil the party by cutting Citigroup's debt rating. Specifically, the credit ratings agency lowered Citigroup to Aa3 from Aa2. That's the fourth-highest rating.

It's not clear how this will all sort out. U.S. dollar and British pound LIBOR rates are down a bit more overnight, but Citigroup shares were recently under a bit of pressure and Euribor rates (the euro-based equivalent of LIBOR) haven't done much.

Oh and as I write, we're seeing more evidence of housing market downturn fallout. Tool maker Black & Decker is slashing its Q4 earnings target to $1.03 a share, excluding a tax settlement. Analysts had been looking for $1.60 a share. The company said "business conditions in North America have been worse than the Corporation had anticipated."

Thursday, December 13, 2007

ABCP is MIA

The plunge in outstanding asset-backed commercial paper continues, according to the latest Federal Reserve figures. Specifically, the amount of ABCP (short-term debt securities that mature in 270 days or less and that are backed by bundles of credit card loans, auto loans, mortgages, and so on) outstanding fell to just $791 billion in the week ended December 12 from a peak of $1.2 trillion in August. Why? As an economist in this Bloomberg story noted "everything with the word asset-backed included is just radioactive these days."

Retail sales strong; Wholesale inflation soars


More economic data has been rolling in. So let's get right to the figures:

* November retail sales rose 1.2%, double expectations for a 0.6% gain and the biggest rise since May. Retail sales excluding autos were also strong -- up 1.8% against expectations for a 0.6% rise. That was the biggest since January 2006. Sales at service stations were strong, reflecting the increase in gas prices. But even sales ex-gas were up 0.6% versus a 0.1% drop in October.

* But the real scary figures were on inflation. The Producer Price Index soared 3.2% between October and November. That blew away the 1.5% estimate and was the largest gain in any month going back more than 34 years. The "core" PPI (ex food and energy) jumped 0.4%, the biggest gain since February and double the 0.2% forecast. Year-over-year, producer prices are up 7.2% (the most since November 1981, shown in the chart above), while core prices are up 2%.

Further up the food chain, intermediate goods prices rose 3.7% on the headline and 1% on the core. Crude goods were up 8.7%, though core crude prices were down 0.5%.

* Jobless claims fell 7,000 to 333,000 in the week of December 8. The recent peak was 353,000 the week of November 24.

In early market reaction, stock futures are down but off their lows. Long bond futures are down almost a point, while 10-year yields are up about 8 basis points. The dollar is up a bit.

Wednesday, December 12, 2007

Late development: Security Capital put on ratings notice

Late today, Fitch Ratings put Security Capital Assurance on "rating watch negative." Fitch said the company's capital is more than $2 billion short of what's required to maintain a AAA rating. Fitch said Security Capital has four to six weeks to obtain commitments that would bolster its capital position, or it will cut the firm's rating two notches to AA. The problems stem from SCA's exposure to CDOs and RMBS (Residential Mortgage Backed Securities), including second-lien loans.

Why does this matter? Like MBIA and Ambac Financial, SCA is a bond insurance firm. If it loses its AAA rating, the impact on future business could be significant, to say nothing of the ratings on bonds that SCA insurers.

Here is SCA's comment on the matter. If you'll recall, MBIA recently announced a deal designed to bolster its capital position.

The question no one wants to ask: What about inflation?


Lost amid all this credit market anxiety -- and the debate about how much the Fed should cut rates -- is the question of inflation. We keep hearing that it's dead and buried, and that it doesn't matter. But did anyone else happen to see the import price report for November -- the one that showed prices jumped 2.7% between October and November (vs. expectations for a 2% gain) and 11.4% year-over-year? That's the biggest YOY gain in any month on record (the data series goes back to 1982).

Surely "core" prices were tame right? Well, no actually. Ex-petroleum prices were up 0.7% on the month, or 3% YOY. If you exclude all fuels, you still get a 0.5% rise (3% YOY). Moreover, prices of Chinese goods are now rising consistently. They had been falling until several months ago, and the loss of cheap Chinese imports could help pressure overall prices higher.

Meanwhile, in the commodities markets, crude oil is soaring (up more than $4 a barrel as I write). Soybeans were recently trading up to a fresh 34-year high. Wheat was recently trading limit up (meaning it rose the most permitted by the Chicago Board of Trade). Corn is closing in on its old high of $4.37 a bushel. And so on and so forth (though admittedly, the metals market is more mixed. Some metals, like gold, are up substantially while others, like copper, are down.)

More details on the Fed move, and more credit warnings

I don’t know about you. But I can’t recall a wilder ride in the financial markets -- or a crazier time in financial policy making -- than right now.

Just yesterday, Federal Reserve policymakers essentially told the market to shove it. They delivered twin quarter-point cuts in the federal funds rate and the discount rate, not the 50-point cuts that many investors were looking for. That caused the Dow Jones Industrial Average to tank by almost 300 points.

Then less than 24 hours later, the Fed skipped the “big guns” stage and reached right for a monetary policy howitzer. It said that it’s coordinating with the Bank of Canada, the Bank of England, the European Central Bank (ECB), and the Swiss National Bank (SNB) to flood the banking system with money.

The Fed will auction a minimum of $40 billion in funds to banks, and accept all kinds of collateral in return, in an effort to ease the logjam in the money markets and shore up bank balance sheets. It’s also authorizing currency swap lines with the ECB and SNB that will channel tens of billions of dollars to banks based in those central banks’ jurisdictions.

How unprecedented is this kind of thing? I haven’t seen anything like it since right after the 9/11 attacks or late 1999, when the Fed was worried the Y2K computer bug would cause the banking system to go haywire. And even those moves weren’t as aggressive as what the Fed is doing now, in my view.

Here are some more details on this plan from the Associated Press, Bloomberg, and the Wall Street Journal.

A funny side note: I don't know if this plan was announced sooner than the Fed wanted (because of the Dow swan dive yesterday) or not. But the PDF document with the Federal Register Notice announcing the plan has "XXs" in it. Specifically, it says (as of 11 a.m. or so on 12/12):

"DATES: The amendments to part 201 (Regulation A) are effective XXX."

and

"By order of the Board of Governors of the Federal Reserve System, XXX."

Meanwhile, in credit quality land, check out the news from ...

* BAC: Bank of America said Q4 earnings will be "quite disappointing," with credit market losses higher than the bank's $3 billion previous estimate. The bank also said that writedowns on things like Collateralized Debt Obligations, or CDOs, are "unknowable." That's encouraging, eh?

* WB: Wachovia said it will likely double its Q4 loan loss provision to $1 billion from a previous forecast of $500 million to $600 million. The firm's CEO called this the "toughest" banking environment he's seen in 32 years of banking. What a stroke of genius it was for these guys to acquire option-ARM, California-focused lender Golden West Financial around the peak of the housing bubble.

* PNC: PNC Financial Services, which is the biggest bank in Pennsylvania, said earnings per share will come in between $1 and $1.15 vs. expectations of $1.41. The bank raised its loan loss provision by $45 million due to increasing problems with real estate development loans in Maryland and Virginia. It also wrote down the value of commercial mortgages it's carrying in its held for sale portfolio and said trading results weren't up to snuff due to "unprecedented market price volatility."

Breaking news: Emergency Fed and global central bank action taken to liquify credit markets

More to come, but here's the news release just out on what the Fed and other global central banks are doing to combat the tightening credit markets:

Today, the Bank of Canada, the Bank of England, the European Central Bank, the Federal Reserve, and the Swiss National Bank are announcing measures designed to address elevated pressures in short-term funding markets.

Federal Reserve Actions

Actions taken by the Federal Reserve include the establishment of a temporary Term Auction Facility (approved by the Board of Governors of the Federal Reserve System) and the establishment of foreign exchange swap lines with the European Central Bank and the Swiss National Bank (approved by the Federal Open Market Committee).

Under the Term Auction Facility (TAF) program, the Federal Reserve will auction term funds to depository institutions against the wide variety of collateral that can be used to secure loans at the discount window. All depository institutions that are judged to be in generally sound financial condition by their local Reserve Bank and that are eligible to borrow under the primary credit discount window program will be eligible to participate in TAF auctions. All advances must be fully collateralized. By allowing the Federal Reserve to inject term funds through a broader range of counterparties and against a broader range of collateral than open market operations, this facility could help promote the efficient dissemination of liquidity when the unsecured interbank markets are under stress.

Each TAF auction will be for a fixed amount, with the rate determined by the auction process (subject to a minimum bid rate). The first TAF auction of $20 billion is scheduled for Monday, December 17, with settlement on Thursday, December 20; this auction will provide 28-day term funds, maturing Thursday, January 17, 2008. The second auction of up to $20 billion is scheduled for Thursday, December 20, with settlement on Thursday, December 27; this auction will provide 35-day funds, maturing Thursday, January 31, 2008. The third and fourth auctions will be held on January 14 and 28, with settlement on the following Thursdays. The amounts of those auctions will be determined in January. The Federal Reserve may conduct additional auctions in subsequent months, depending in part on evolving market conditions.

Depositories will submit bids through their local Reserve Banks. The minimum bid rate for the auctions will be established at the overnight indexed swap (OIS) rate corresponding to the maturity of the credit being auctioned. The OIS rate is a measure of market participants’ expected average federal funds rate over the relevant term. The minimum rate for the December 17 auction along with other auction details will be announced on Friday, December 14. Noncompetitive tenders may be accepted beginning with the third auction. The results of the first auction will be announced at 10 a.m. Eastern Time on December 19. The schedule for releasing the results of later auctions will be determined subsequently. Detailed terms of the auction and summary auction results will be available at http://www.federalreserve.gov/.

Experience gained under this temporary program will be helpful in assessing the potential usefulness of augmenting the Federal Reserve’s current monetary policy tools--open market operations and the primary credit facility--with a permanent facility for auctioning term discount window credit. The Board anticipates that it would seek public comment on any proposal for a permanent term auction facility.

The Federal Open Market Committee has authorized temporary reciprocal currency arrangements (swap lines) with the European Central Bank (ECB) and the Swiss National Bank (SNB). These arrangements will provide dollars in amounts of up to $20 billion and $4 billion to the ECB and the SNB, respectively, for use in their jurisdictions. The FOMC approved these swap lines for a period of up to six months.

Information on Related Actions Being Taken by Other Central BanksInformation on the actions that will be taken by other central banks is available at the following websites.

Bank of Canada (http://www.bankofcanada.ca/)

Bank of England (http://www.bankofengland.co.uk/)

European Central Bank (http://www.ecb.int/)

Swiss National Bank (http://www.snb.ch/)

Statements by Other Central Banks:

Bank of Japan (http://www.boj.or.jp/)

Swedish Riksbank (http://www.riksbank.com/)

Tuesday, December 11, 2007

Bernanke to market: Drop dead!

So there you have it: Federal Reserve Board Chairman Ben Bernanke and the rest of his Federal Open Market Committee cohorts cut both the federal funds rate and the discount rate by a quarter-point today. That brings the funds rate down to 4.25% and the discount rate down to 4.75%.

I have to admit that I'm surprised. I expected they'd go with a 50-point cut, if not in the funds rate then in the discount rate. While Boston Fed President Eric Rosengren voted for a 50-point funds rate cut, nine others voted for the 25-point move.

Meanwhile, the post-meeting statement was more hawkish than I expected. It talks about how "elevated energy and commodity prices, among other factors, may put upward pressure on inflation" and says that the Fed "will continue to monitor inflation developments carefully."

Another part of the statement doesn't inspire much confidence in the Fed, either. Get a load of this:

"Recent developments, including the deterioration in financial market conditions, have increased the uncertainty surrounding the outlook for economic growth and inflation. The Committee will continue to assess the effects of financial and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth."

In other words, "We're not really sure what's going on -- but we'll get back to you when we figure it out."

Maybe that's a bit harsh. But frankly, the market was looking for a shift to an easing "bias" -- or at least some leadership about the future. But this statement shows that, once again, the Fed will keep reacting to market moves, rather than getting in front of them. Consider:

The Fed failed to raise rates early enough and steeply enough to prevent the housing boom from turning into a housing bubble.

It didn't regulate the mortgage industry aggressively enough to prevent all the abuses we're hearing about now.

Then after the housing bubble popped, it kept assuring us everything was fine and that the mortgage problems were "contained" to a few subprime loans.

And now, with LIBOR rates going haywire, lenders tightening credit standards, and 2-year T-Notes yielding less than 3%, the Fed decided to go with a timid cut and no strong hint that more cuts are coming? I've been as critical as anyone about the Fed being too loose with monetary policy for some time. But I think a larger move was definitely justified here.

As for the market impact of today's move, the Fed's actions remind me of that famous New York Daily News headline: "Ford to City: Drop Dead!" In other words, stock traders did NOT get what they wanted. So the Dow is tanking. The yen (an anti-risk currency) is surging. And long bonds are flying, with the futures up almost two full points at last count.

Some more warnings ...

Last night, it was Washington Mutual. This morning, more credit crisis casualties are 'fessing up about problems in their businesses...

* H&R Block said it lost $136 million, or 42 cents per share, in the fiscal second quarter. That's worse than the year-ago $121 million, or 38 cents per share, and worse than the 35-cent estimate of analysts. That's a continuing operations loss, by the way. H&R Block is in the process of shutting down much of its Option One subprime mortgage business. Including discontinued ops (such as $252 million in losses on the sale of whole mortgage loans), the company's net loss more than tripled.

* Genworth Financial, formerly part of GE, said it'll miss 2008 profit forecasts do to housing-related losses. It's expecting operating earnings of $2.65 a share to $3.10 a share, below the average estimate of $3.28 a share. Genworth is the nation's fifth-largest mortgage insurer. Said CEO Michael Fraizer: "We did not expect the speed or degree of the unprecedented turn of the housing market."

Meanwhile, in early trading, shares of Washington Mutual are getting whacked, down almost $2. But all is not necessarily grim. Many troubled institutions have been successful at getting capital infusions -- albeit at a high cost. And it looks like pieces of more U.S. banks could potentially be sold off to cash-rich foreign buyers, if you believe some of the comments coming out of the Middle East region.

Monday, December 10, 2007

Thank you sir, may I have another?

Why yes, I'd be more than happy to tell you about yet another capital raising. Glad you asked. After the market closed, Washington Mutual dropped the following bombs:

* First, it's going to sell $2.5 billion in convertible preferred stock to raise capital.

* Second, it's slashing its quarterly dividend to 15 cents per share from 56 cents per share.

* Third, it expects industrywide mortgage originations to plunge 40% in 2008 to $1.5 trillion from $2.4 trillion this year. To prepare for that, it's going to completely halt subprime lending ... close 190 of its 336 home loan centers and sales offices ... shutter nine processing and call centers ... eliminate 2,600 home loan jobs and 550 corporate/support positions. It's also shutting its WaMu Capital institutional broker-dealer business and its mortgage banker warehouse lending ops.

* The firm will take a $1.6 billion charge to write down goodwill tied to the home loan business. It also said that due to rising loan delinquencies and losses, it will take a Q4 loan loss provision of $1.5 billion-$1.6 billion and a Q1 2008 provision of $1.8 billion-$2 billion. For comparison sake, Wamu's Q3 provision was only $967 million, while its Q2 provision was just $372 million. Talk about a change in fortunes.

Another day, another capital infusion

We're seeing so many of these deals, it's hard to keep up. The latest: Bond insurance firm MBIA is getting up to $1 billion from private equity firm Warburg Pincus. Here's the important stuff ...

"MBIA Inc., the holding company for MBIA Insurance Corporation, today announced that it has entered into a definitive agreement with Warburg Pincus, the global private equity firm, which will commit to invest up to $1 billion in MBIA through a direct purchase of MBIA common stock and a backstop for a shareholder rights offering.

"MBIA said the investment will, among other things, increase MBIA’s already substantial capital and claims-paying resources and enable MBIA to grow its business profitably at a time when market conditions present it with attractive opportunities.

"Under the agreement, Warburg Pincus will make an initial investment of $500 million in MBIA through the acquisition of 16.1 million shares of MBIA common stock at a price of $31.00 per share, which represents a 3 percent premium to the $30.00 a share closing price of MBIA common stock on the New York Stock Exchange on Friday, December 7, 2007. Subsequent to its initial common stock purchase, Warburg Pincus will backstop a shareholder rights offering of up to $500 million that the Company expects to undertake during the first quarter of 2008. In connection with its investment and backstop commitment, Warburg will receive warrants to purchase 8.7 million shares of MBIA common stock at a price of $40 per share and “B” warrants, which, upon obtaining certain approvals, will become exercisable to purchase 7.4 million shares of common stock at a price of $40 per share. The term of the warrants is seven years. In addition, all of the securities purchased by Warburg Pincus are subject to significant transfer restrictions for a minimum of one year and up to three years."

Meanwhile, MBIA shared some more details about potential losses related to the mortgage mess. The company said that "as a result of continued deterioration in the performance of residential mortgage-backed securities, in particular, prime home equity lines of credit and closed-end second mortgage-backed securities the Company currently estimates that it will establish case basis loss reserves of between $500 million and $800 million in the fourth quarter related to those exposures."

And MBIA talked about the impact of the CDO deterioration on its portfolio: "The Company has observed a further widening of market spreads and credit ratings downgrades of collateral underlying certain MBIA-insured CDO tranches. As of October 31, 2007, the pre-tax change in fair value of insured derivatives (“mark-to-market”) from September 30, 2007 was approximately $850 million. As a consequence of continued spread volatility, including a substantial widening in commercial mortgage-backed security spreads and the deterioration of credit ratings in collateral underlying multi-sector collateralized debt obligations (CDOs), the Company expects to have a mark-to-market loss in the fourth quarter of 2007 significantly greater than that of the third quarter. The ultimate mark-to-market for the fourth quarter will depend on future market developments."

Pending home sales inch higher in October

The National Association of Realtors just released its pending home sales index for October. Let's get right to the numbers ...

* Pending home sales rose 0.6% between September and October, compared to expectations for a decline of 1%. On a year-over-year basis, sales were down 18.4%.

* Sales rose 16% in the Northeast and 8.4% in the West, while they fell 1.4% in the Midwest and 7.8% in the South.

The good news is that pending sales aren't getting any worse. The bad news is they're still at depressed levels. We'll likely see fewer pending contracts actually close, too, given the renewed bout of credit contagion we're dealing with.

So where do we go from here? Well, we have opposing forces at work in housing. The Federal Reserve is lowering interest rates, with another 25 or 50 basis points in cuts coming tomorrow. The federal government is also trying to combat the foreclosure wave with interest rate freezes and looser FHA lending policy.

Unfortunately, private lenders are continuing to tighten their mortgage standards. And we're still dealing with a mountain of excess for-sale inventory. The end result is that the housing market should remain weak, with prices gradually falling and sales remaining lackluster, through late 2008, and possibly into 2009.

UBS' $10 billion whopper; Societe Generale's SIV bailout

Looks like European mega-bank UBS had a little bit of a problem with its mortgage book. Overnight, the company announced ...

* $10 billion in total write-downs related to the subprime mortgage mess. The company now expects to lose money in the fourth quarter; previously, it had predicted a profit. In announcing the write-downs, UBS Chief Executive Marcel Rohner said:

"Conditions in the U.S mortgage and housing markets have continued to deteriorate, and we have updated our loss assumptions to the levels implied by the current distressed market for mortgage securities ... In our judgment these write-downs will create maximum clarity on this issue and will have the effect of substantially eliminating speculation."

* The value of some mezzanine CDO investments were marked down to 45 cents on the dollar, according to Bloomberg.

* UBS also sought to raise capital in the wake of its write-downs. It's exploring the sale of 36.4 million shares previously scheduled to be cancelled. The company is also selling convertible notes worth about $11.5 billion to the Singapore government's investment arm and an unidentified Middle Eastern investor. The notes carry a coupon yield of 9%. In other words, like Citigroup, Fannie Mae, and Freddie Mac, UBS is being forced to pay up to shore up its capital base.

Meanwhile, the largest bank in France, Societe Generale, is bailing out its structured investment vehicle, or SIV. The $4.3 billion Premier Asset Collateralized Entity, or PACE, fund got whacked by the subprime mortgage meltdown. So SG is taking its assets onto its balance sheet, including $387 million in bonds backed by subprime loans.

Thursday, December 06, 2007

Still more Paulson Plan details

There is so much being said about the Paulson Plan, that you probably don't need me to point everything out. A few key points to expand on/clarify what I said earlier about who's eligible:

* Loans must be subprime ARMs with an initial fixed period of less than 36 months (that'd be your 2/28s and 3/27s). Borrowers had to have obtained subprime ARMs between 1/1/2005 and 7/31/2007, and have rates that will increase between 1/1/2008 and 7/31/2010.

Only borrowers with FICO scores below 660 and less than 3% equity in their homes qualify (though anyone who "fails" the FICO test may still be eligible for an alternative modification). It has to be a primary residence. Borrowers must not have been more than 60 days delinquent at any time in the last year, and they must not be more than 30 days late currently. An evaluation of the potential rate and payment reset must determine that the payment will increase by more than 10%. Complete details can be found at this American Securitization Forum web site (PDF link).

* Some more details on the scope of the reset problem were delivered in a speech by FDIC Chairman Sheila Bair:

"The FDIC's calculations, based on owner-occupied subprime mortgages included in private MBS, indicate that about 1.7 million hybrid loans worth $367 billion are scheduled to undergo their first reset during 2008 and 2009. Of these, over 200,000 loans are already 90 days or more past due or in some stage of foreclosure prior to reset. For loans that remain current or less than 90 days delinquent, only 2.9 percent show both a loan-to-value ratio below 80 percent at origination and a debt service-to-income ratio below 30 percent -- attributes that might indicate a high probability of remaining current even after reset. Based on these criteria, our numbers suggest that the group of loans scheduled to reset that are current but may not remain so after reset are on the order of at least 1.4 million loans."

* Paulson's statement can be read here. Comments from the Homeowneship Preservation Foundation, which operates the 888-995-HOPE hotline, can be found here.

* Not clear how the ratings agencies will evaluate modifications. Some preliminary thoughts from Fitch Ratings are available here, with an excerpt below:

"Fitch Ratings believes that on balance, by mitigating the impact of ARM resets on borrower default rates, the framework can help to reduce the risk of principal loss on senior subprime RMBS. Increased refinancing opportunities via FHA and other programs are also important to stabilizing default rates. The implications for subordinated RMBS classes are unclear, as they may be exposed to a complex interaction of variables that can be difficult to analyze. Implementation of the proposed data reporting will aid analysis of the impact of streamlined modifications, and analysis of loan modifications generally."

Standard & Poor's, for its part, said it may need to cut ratings on certain mortgage bonds to account for the program's changes, though the freeze may help mitigate foreclosures overall.

Delta Financial going broke

A quick note in case you missed it: Subprime lender Delta Financial has announced it will file for bankruptcy. This firm has been around longer than many of its competitors -- 25 years, in fact. But as I mentioned a few weeks ago, the company was having significant trouble due to the mortgage and housing market downturn.

MBA delinquency, foreclosure rates surge in Q3


Nobody who follows the mortgage and housing markets should have expected anything different. But let's be clear about the Q3 delinquency and foreclosures figures that were just released by the Mortgage Bankers Association: They were awful -- across the board. Here are the key points:

* The overall mortgage delinquency rate jumped to 5.59% from 5.12% in Q2 2007 and 4.67% in Q3 2006. This is the worst late payment rate going all the way back to 1986.

* The subprime DQ rate jumped again -- to 16.31% from 14.82% in Q2 2007 and 12.56% in Q3 2007. But it's NOT just subprime loans that are souring. The prime delinquency rate rose to 3.12% from 2.73% in Q2 2007 and 2.44% in Q3 2006.

* The worst deterioration was evident in adjustable rate loans. Prime FRM DQs only rose to 2.54% from 2.25% quarter-over-quarter, while prime ARM DQs jumped to 5.14% from 4.15%.

* Meanwhile, the DQ rate on FHA loans climbed to 12.92% from 12.58% in Q2 2007 and 12.8% in Q3 2007. The DQ rate on VA mortgages rose to 6.58% from 6.15% in Q2 2007 -- but was unchanged from 6.58% a year earlier.

* Mississippi had the worst loan delinquency rate at 10.6%, followed by Michigan (8.34%), Georgia (7.93%) and Indiana (7.88%). Several western states had the lowest DQ rates, including Hawaii (2.68%), Montana (2.79%) and Oregon (2.82%).

* What about foreclosures? More bad news there. The percentage of mortgages entering the foreclosure process climbed to 0.78% in Q3 from 0.65% in Q2 and 0.46% a year earlier. The percentage of overall loans in any stage of foreclosure climbed to 1.69% (shown in the chart above) from 1.4% in Q2 and 1.05% a year earlier. These are the worst readings on record.

* Foreclosure inventory was the worst in Ohio (3.72%), Indiana (3.28%), and Michigan (3.07%). Florida was also relatively high at 2.19%, with Illinois (2.15%) and Nevada (2.15%) not far behind.

What do these numbers show? That mortgage loan performance is awful. The combination of falling home values, tightening lending standards, overextended borrowers, and a slowing economy have all combined to drive delinquencies and foreclosures skyward. We shouldn't be surprised -- over-easy monetary policy, a "hands off" regulatory approach, reckless real estate speculation, and the complete abandonment of prudent lending practices by the mortgage industry created a housing bubble. Now, that bubble has burst -- and we all have to deal with the consequences.

The "Paulson Plan" is an important step that may help some borrowers. So is FHA reform. But ultimately, only the passage of time, less home construction, and gradually falling prices will allow housing supply and demand to come back in line. I suspect we won't see a meaningful rebound in the housing market -- and a noticeable improvement in mortgage credit quality -- until late 2008 or sometime in 2009.


 
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