Interest Rate Roundup

Thursday, January 31, 2008

The bond insurer ratings saga continues ...

From S&P this afternoon:

"Standard & Poor's Ratings Services today lowered its financial strength, financial enhancement, and issuer credit ratings on Financial Guaranty Insurance Co. to 'AA' from 'AAA' and its senior unsecured and issuer credit ratings on FGIC Corp. to 'A' from 'AA.' Standard & Poor's also placed all the above ratings on CreditWatch with developing implications.

At the same time, Standard & Poor's placed various ratings on MBIA Insurance Corp., XL Capital Assurance Inc., XL Financial Assurance Ltd., and their related entities on CreditWatch with negative implications.

The ratings on various related contingent capital facilities were also affected.

These ratings actions, including the affirmations, take into account the ratings actions announced yesterday by our Structured Finance group concerning RMBS and CDO downgrades and credit watch actions.

The rating actions are the result of our most recent review of all the bond insurance companies' capital plans. Our review covered the scope of each plan relative to the projected losses for that company, the success each company has had to date in implementing its plan, and our assessment of the likelihood that the companies could implement the remaining components of their plans. This review is part of Standard & Poor's ongoing assessment of the potential subprime-related losses that these bond insurers might incur and how they are managing their capital positions to handle the losses. Further reviews will occur as circumstances warrant."

Marketwatch has a blurb on this as well. Of course, it should be pointed out that MBIA defended its position during a 4-hour long conference call today.

My latest thinking on ... well ... as much as I can fit in here

There's nothing like having to take care of some family business on a "Fed day." That's why you didn't see any postings yesterday, and why I'm playing catch up now. So much is happening in the markets, though, that I'm going to try to touch broadly on the latest news and give you my thinking about it ...

* What does the Fed cut mean? Well, some mortgage holders will see a smaller increase in the rates and payments on their adjustable rate mortgages. That’s because funds rate reductions are now lowering the London Interbank Offered Rate, or LIBOR, that many such mortgages are tied to.

JPMorgan analysts said that the cut could shrink the increase on subprime ARM payments to 8%, on average. Bank of America analysts note that if the Fed cuts to 2.5% eventually, payment increases could "disappear altogether." More details in this Bloomberg story.

Home equity line of credit rates will come down as well, because they’re tied to the prime rate. The prime rate essentially mirrors changes in the funds rate. On the other hand, savers will get the shaft again. That's because rates on Certificates of Deposit and money market accounts will likely fall in the wake of the latest cut. I've always respected the work does, and you can get a product-by-product update of what the Fed cut means in a series of stories that start here.

* So that's good news for mortgage performance, right? Well, it certainly doesn't hurt. But rate resets aren’t the only threat to mortgage borrowers and loan performance right now. Falling home prices are a big deal, too (see this post for more details and a link to a Boston Fed study on the matter). The more home prices fall, the further underwater borrowers become, and the more borrowers just give up and walk away from their loans.

The latest S&P/Case-Shiller report showed prices falling 7.7% from a year ago in November. That’s the worst drop on record. Prices were down in 17 of the 20 metropolitan areas the firm tracks. And even cities that were reporting nice year-over-year gains are starting to fade.

Would you rather go with the National Association of Realtors’ figures? Okay then. They show the median price of an existing home down 6% from a year ago in December. That’s the sharpest drop yet for the cycle. New homes? Prices fell 10.9%, the sharpest decline in any month since 1970.

* What about the impact on banks and other financial firms from the Fed's largesse? These cuts will help firms pick up some extra interest income. That’s courtesy of the steeper yield curve (a fancy way of saying long-term interest rates are higher than short-term rates).

But here's the problem as I see it: Unlike in past financial crises (like the S&L debacle or the Long-Term Capital Management meltdown), it's not just largely one category of loan or isolated hedge fund problem that's hurting the industry. It's a little bit of everything.

To whit: We have plenty of well-documented trouble in first-lien residential mortgages, subprime or otherwise. But we also have problems with second lien home equity loans and auto loans, as this post discusses. And the credit card news isn't so great, either.

Then there’s the whole issue of balance sheet and asset quality. In plain English, the value of many of the complex debt securities that banks are holding on their books is slumping fast.

Standard & Poor’s just put out a report suggesting losses from subprime-related mortgage securities could top $265 billion – with a “B” – at regional banks, credit unions and other financial firms. S&P also either cut ratings or put its ratings on review for a whopping $534 billion worth of mortgage bonds and so-called collateralized debt obligations (CDOs). How much is $534 billion? It’s roughly half of ALL the subprime bonds S&P rated in 2006 and early 2007!

==> At the same time, the bond insurance debacle is getting worse. MBIA, the world’s biggest bond insurer, said it lost $2.3 billion in the fourth quarter. That’s a gigantic $18.61 per share – the biggest-ever quarterly hit. A key reason: It took $3.4 billion in losses related to markdowns on residential and commercial mortgages, and CDOs.

Fitch Ratings is already starting to downgrade the bond insurers. It cut Financial Guaranty Insurance Co., or FGIC, to AA from AAA, and it recently cut its rating on another company, Ambac Financial, to AA from AAA. The larger credit ratings agencies S&P and Moody’s could be the next to cut. And that could result in billions MORE in write downs for financial firms.

How much? Oppenheimer & Co. said bond insurer downgrades could force banks to take $70 billion in fresh writedowns. And Barclays Capital said banks could be forced to go hat in hand – again – to investors in order to raise ANOTHER $143 billion in capital to shore up their balance sheets.

==> As if that weren’t enough, many banks and brokers are also stuck holding tens of billions of dollars of leveraged loans – financing used to fuel the recent corporate takeover boom. Those loans are also losing value.

Bloomberg recently reported that banks are stuck with a $230 billion pile of high-yield, high-risk debt. That includes $160 billion of leveraged loans and $70 billion of junk bonds. Meanwhile, a basket of loans that S&P monitors recently traded down to about 91 cents on the dollar. If this continues, we’re going to see yet ANOTHER batch of write-downs among the major banks and brokers.

The bottom line: We still have a real battle going on -- between regulators and monetary policymakers, who are trying to fix the credit problems by cutting rates and forwarding bailout plans ... and the housing and financial markets, which are experiencing real problems and driving losses up throughout the financial industry.

Tuesday, January 29, 2008

Q4 homeownership rate slips to lowest since 2002; Vacancy rate ties record high

The Census Bureau releases data on homeownership and vacancy rates each quarter. Given what we already know from the monthly data, it should come as no surprise that conditions deteriorated (PDF link) in Q4 2007. Specifically ...

* The U.S. homeownership rate slumped to 67.7% in Q4 2007 from 68.1% in Q3 2007 and 68.8% in Q4 2006. That is the lowest since Q2 2002 (tie). The rate hasn't been lower since Q1 2001.

* The homeowner vacancy rate, which measures how much of the housing stock for sale is sitting empty, climbed to 2.8% from 2.7% both a quarter and a year earlier. That matched the all-time high in Q1 2007. For some perspective sake, this measure never topped 1.9% until the housing bubble started deflating (see chart above).

S&P/Case-Shiller index for November -- prices down 7.7% YOY

The latest S&P/Case-Shiller figures show home prices falling (PDF link) at an ever-faster rate. In the month of November ...

* Prices fell 7.7% from a year earlier in 20 major U.S. metropolitan areas. That was worse than the 6.1% decline reported in October and the biggest drop on record.

* The 10-city index has a longer history. It declined 8.4% year-over-year. That was worse than the 6.7% drop in October and the worst since S&P started tracking in the late 1980s.

*Prices fell from year-ago levels in 17 out of 20 cities, the same as last month. The biggest declines were found in Miami (-15.1%), San Diego (-13.4%), Las Vegas (-13.2%), and Detroit (-13%). The best performing cities were still Charlotte and Seattle, but even there, the rate of appreciation is slowing. Prices in Charlotte were up 2.9%, down from a 4.3% rise a month earlier, while prices in Seattle were up just 1.8%, compared with 3.3% a month earlier.

The latest home price figures -- from the Realtors' group, the Census Bureau and S&P/Case-Shiller -- all tell the same story: Home prices are deteriorating, and the rate at which they are falling is accelerating. Even formerly strong markets appear to be weakening now as consumer confidence slumps and the mortgage market tightens up.

It's worth pointing out, however, that lower prices are exactly what we need to restore longer-term health to the housing market. Falling prices will make homes more affordable, making it so potential buyers no longer need to turn to high-risk financing to put a roof over their heads. Falling prices will also help clear the vast inventory overhang plaguing home sellers, allowing for an eventual recovery.

RealtyTrac: Foreclosures spike in December

RealtyTrac is a California firm that tracks monthly foreclosure filings. Filings popped up to 215,749 in December from 201,950 in November. On a year-over-year basis, filings were up 96.8%. The peak (to date) for filings came in August at 239,851.

For all of 2007, filings were up 75%. Nevada had the highest rate of all states, with 3.4% of its households falling into foreclosure. Florida was #2 with just over 2%, followed by Michigan, California, and Colorado.

Durable goods blowout

Wow, where did that Mack truck come from? The December durable goods report showed a huge gain of 5.2%, versus expectations for a 1.6% rise. That was the biggest gain since July. Ex-transportation orders jumped 2.6%, vs. forecasts for a 0.1% rise. Non defense capital goods orders ex-aircraft (a business spending proxy) jumped 4.4%, the largest rise since March. I still think the economic risk here is to the downside, but that was definitely a strong print. Long bond futures are down 20/32 in reaction, while the dollar and stock futures have popped a bit.

Troubled TOUSA goes Chapter 11

The troubled Florida home builder, TOUSA Inc., finally caved and filed for bankruptcy. It listed assets of $2.3 billion and debt of $1.8 billion in the Chapter 11 filing. TOUSA builds homes under the Engle Homes, Newmark Homes, and Trophy Homes brand names. The filing doesn't include its title, home mortgage and insurance and information services divisions.

If you'll recall, I highlighted TOUSA as a builder that was facing severe pressure due to its heavy exposure to some of the weakest national housing markets, including Florida. The company missed interest payments on a combined $685 million in debt earlier this month. Noteholders and unsecured creditors will get claims on new TOUSA shares as part of the reorganization, which is being financed with $150 million in debtor-in-possession financing from Citigroup.

TOUSA has about 2,500 homes in its backlog. The company said it expects "business to continue as usual" for existing customers and new potential customers, as well as employees. However, in recent home builder bankruptcies, customers have seen disruptions and delays in the construction of amenities and homes -- as chronicled in this New York Times story on Levitt & Sons.

TOUSA is the largest builder to file for bankruptcy so far. For some perspective, it delivered just over 7,800 homes in 2006 versus just under 1,700 at Levitt. Meanwhile, the mega-builder Pulte closed on almost 41,500 homes that year, while D.R. Horton closed on 53,100 in its fiscal 2006 year.

Monday, January 28, 2008

New home sales fall sharply ... again

The Census Bureau just released its latest recap of the new home market. The data for December show ...

* Sales dropped another 4.7% to a seasonally adjusted annual rate of 604,000 from a revised 634,000 SAAR in November (previously reported as 647,000). On a year-over-year basis, sales plunged 40.7% from 1.019 million in December 2006. Sales haven't been this weak since February 1995 (shown in the chart above).

* For-sale inventory came in at 495,000 new homes. That was down 1.4% from 502,000 in November (previously reported as 505,000) and down 7.5% from 535,000 in December 2006. The peak was 573,000 units in July 2006. On a months supply at current sales pace basis, inventory was 9.6 months, up from 9.4 in November (previously reported as 9.3), and up from 6.2 a year earlier. The latest reading is a cycle high, and the worst since October 1981.

* The median price of a new home plunged 10.9% to $219,200 in December from $245,900 in November (previously reported as $239,100). Prices were down 10.4% from $244,700 in December 2006. That was the worst year-over-year decline for this cycle ... in fact, it's the worst YOY fall since December 1970 (-11.2%). The median price of a new home is now the lowest since September 2004.

I think the real estate industry would probably like to just write off 2007. I don't blame them after seeing the latest new home sales figures. We had another sharp drop in sales volume ... the worst inventory reading since 1981 ... and the biggest year-over-year decline in median home prices since 1970.

Any glimmers of hope in the numbers? Well, the sharp cutback in housing starts is starting to bring down the absolute level of home inventories (though not the "months supply at current sales pace" reading referenced above). More blue light specials from the home builders during this spring selling season should help eliminate standing inventory, too. And then there's the mortgage rate picture, which has improved for borrowers with decent credit and some money in the bank.

But this purging process will take time, given the magnitude of the inventory overhang. I wouldn't be surprised at all to see home prices decline by the mid single-digits over the course of 2008 as that plays out.

Friday, January 25, 2008

Quick hits and bullets, plus some thoughts on the mortgage cap plan

I've been very busy today, so haven't had time to post. But I wanted to highlight and comment on a few news items ....

First, the firings are starting to happen on Wall Street. Credit Suisse, Lehman Brothers, and a few other firms are reportedly letting employees go in the commercial mortgage arnea. Goldman Sachs is also jettisoning up to 5% of its employees, or about 1,500 people, though the firm is characterizing it as normal pruning of underperformers.

Second (and speaking of commercial mortgages), spreads are blowing out in the Commercial Mortgage Backed Securities (CMBS) market. Bloomberg notes that investors are demanding 244 basis points of extra yield on AAA-rated, 10-year commercial mortgage paper. That's the highest spread in history (The data -- a Morgan Stanley index -- goes back to 1996).

Here's some more perspective on what's going on there:

"While the yield on 10-year Treasury notes fell 1.43 percentage points in the past three months to the lowest since 2003 following four interest rate cuts, the cost of borrowing for apartment buildings, offices, retail properties and hotels climbed as much as 1.25 percentage points, according to David McLain, principal and chief investment officer of Palisades Financial LLC, a private equity firm in Fort Lee, New Jersey.

"The market is locked up right now because there's a huge overhang of leveraged assets of every type, development deals that won't meet projections made last year when things were rosy,'' said David Tobin, a principal at New York-based Mission Capital Advisors LLC, which was involved in $5 billion of asset sales last year. "It will end just like the residential housing market.''
"Bernanke's easing hasn't stopped the $3.2 trillion commercial market from starting a slide that mirrors the housing decline, where prices have dropped for the first time since the Great Depression. U.S. commercial property prices probably will fall 10 percent in 2008 from last year's peak after rising 60 percent since 2002, said Dan Fasulo, director of market analysis at New York-based research firm Real Capital Analytics Inc."

Frankly, I think the prices of many commercial properties rose to unsustainable heights for the same reason the price of many residential properties did: Too much risky lending, fueled by too much easy money, invested by too many firms that were chasing yield any place they could get it. And thanks to the explosion in securitization, firms had little incentive to care about the ultimate performance of the loans they underwrote (sound familiar?). Again, from Bloomberg:

"Wall Street underwriters allowed lending guidelines to slacken because they needed the mortgages to feed the $760 billion market for securities backed by commercial mortgages, said Scott Tross, a mortgage specialist and partner at the Herrick, Feinstein LLP law firm in Newark, New Jersey.

"Lending standards became more lax because people knew they wouldn't be keeping the loans on their books,'' Tross said.

Third, this idea of allowing Fannie Mae and Freddie Mac to buy bigger mortgages (and allowing FHA to insure larger ones) seems misguided to me. The idea is to help lower rates on loans that would formerly fall into the "jumbo" category, and to allow FHA to penetrate a wider range of markets (it has been essentially "priced out" of many areas because of its loan caps).

It's clear that policymakers want to be seen as doing something about the housing crisis, especially in an election year. I get that. And naturally, the real estate lobby is pleased because this will likely juice housing demand a bit.

But the agency responsible for ensuring safety and soundness at Fannie and Freddie sure isn't thrilled. This recent note (PDF link) from OFHEO lays out several reasons why this idea isn't all it's cracked up to be.

There are also questions about whether this change may actually RAISE mortgage rates in the long run. And even if it doesn't, why exactly are we rushing to subsidize such large mortgages? Why does it make sense to put more risk on FHA's shoulders -- or Fannie Mae's and Freddie Mac's? Private lenders are getting killed for taking on too much mortgage risk ... and rightfully so. Why would we want to set the stage for a similar debacle down the road ... only this time, one that could require a taxpayer-funded bailout (Do you really think taxpayers won't be called on to help Fannie, Freddie or the FHA if a serious, future delinquency crisis struck?)

Most importantly ...

The reason so many people are defaulting in the first place is because the private mortgage industry did a whole host of imprudent things to get people into overvalued homes they really couldn't afford. That drove home prices to unsustainable levels. The solution isn't to try to find ways to artificially prop up prices. It's to let the market do its thing and bring prices down to a reasonable level. That way, borrowers can buy homes with traditional mortgages ... at reasonable debt-to-income ratios ... with tolerable monthly payments and actual ... wait for it ... down payments. What a concept!

Thursday, January 24, 2008

Fannie, Freddie, FHA loan limits going up?

From Congressional Quarterly:

"An overhaul of the Federal Housing Administration’s mortgage insurance program and an increase in the size of loans that mortgage finance giants Fannie Mae and Freddie Mac may purchase will be part of the economic stimulus package, leaders said Thursday.

The changes will allow FHA and the big government-sponsored enterprises to help save some at-risk homeowners from defaulting as their adjustable rate mortgages reset to much higher rates. It should also help spur home purchases in high-cost areas of the country such as California, New York, Connecticut and Massachusetts."

Another excerpt:

"The new limits for FHA and the GSEs will be 125 percent of the median area home price, capped at $730,000 in the country’s costliest housing markets — much higher than the administration previously supported.

"The current $417,000 conforming loan limit for Fannie Mae and Freddie Mac has made it harder and more expensive for those in high-cost markets to obtain “jumbo” loans, because the secondary market shuns mortgages not backed by the GSEs. The current FHA limit of $362,000 is also far below the amounts that many borrowers need."

Also from the AP:

"To address the mortgage crisis, the package also raises the limits on Federal Housing Administration loans and home mortgages that Fannie Mae and Freddie Mac can purchase to as high as $725,000 in high-cost areas. Those are considerable boosts over the current FHA limit of $362,000 and the $417,000 cap for Fannie Mae and Freddie Mac's loan purchases."

December existing home sales slump 2.2%

The National Association of Realtors just released its report on December existing home sales. It showed:

* Sales fell 2.2% to a seasonally adjusted annual rate of 4.89 million from 5 million in November. That was worse than economists' forecasts for a drop of 1% and it leaves combined sales (SFH+condo+co-op) at the lowest level on record. There's a longer history of data on single-family only home sales. Sales there were 4.31 million, the lowest since January 1998 (4.18 million).

Regionally, sales were down 4.6% in the Northeast, 1% in the South, 1.7% in the Midwest, and 2.1% in the West. The December sales rate was down 22% from 6.27 million in December 2006.

* For sale inventory came in at 3.905 million single-family homes, condos, and co-ops. That was down 7.4% from 4.217 million in November (previously reported as 4.273 million), but up 13.2% from 3.45 million in December 2006. On a months supply at current sales pace basis, inventory was 9.6 months, down from 10.1 months in November (previously reported as 10.3), but up from 6.6 months in December 2006.

* Median prices dipped slightly to $208,400 in December from $208,700 in November (previously reported as $210,200). On a year-over-year basis, prices were down 6% from $221,600 in December 2006. That's the biggest drop we've seen in this cycle so far.

There wasn't much holiday joy for the real estate market in December. Sales slumped to a fresh cycle low, while prices dropped by the largest margin yet. A combination of rising unemployment, declining consumer confidence, and tighter mortgage standards all conspired to keep potential buyers sidelined.

So what about the prospects for early 2008? Inventory for sale has declined a bit. But that's a normal seasonal development around the holidays. The key question is whether we'll see supply ramp up again as the spring selling season approaches. The chance of that happening is pretty high considering how many of 2007's disappointed sellers will need to give it the old college try again.

Mortgage rates have generally been falling for borrowers with good credit and down payment money in the bank. Freddie Mac's most recent survey showed 30-year loans going for 5.48%, the lowest since early 2004. The problem is that borrowers who need jumbo mortgages or who have credit problems are still facing a tighter lending environment. So the news is a mixed bag on the financing front.

Bottom line: I wouldn't look for great things from the spring selling season. Expect muted sales activity, especially if unemployment keeps rising. And over the course of 2008, we could see another mid-single-digit decline in home prices.

The "Rogue Trader" strikes again

Ah, the "Rogue Trader." The mythical character who manages to rack up gigantic losses somewhere deep in the bowels of a global bank, then tries to hide them, but ultimately is discovered and sacked. It has happened before and it'll happen again.

But the news out of France from Societe Generale today is simply astounding. It looks like some trader in this 30s, who made less than $150,000 a year, managed to rack up $7.2 billion in losses on stock index futures. That wiped out almost two years of pre-tax profit in the firm's investment banking unit.

The news would be almost hilarious ... if it weren't so terrifying. These are the same titans of global finance who are managing credit default swaps with a notional, or face, value of almost $43 trillion (Global GDP, by the way, was just over $48 trillion in 2006). Yet they can't detect one rogue trader's billions of dollars in losses until it's too late? Talk about a confidence builder.

Wednesday, January 23, 2008

Dodd discusses a mortgage bailout plan

There's an interesting proposal from Connecticut Senator Christopher Dodd today. He is floating the idea of creating a "Federal Homeownership Preservation Corp.," which would buy the most troubled mortgages out there and offer new loans (with lower balances) to the borrowers stuck with them. Those new loans would be backed by Fannie and Freddie, or insured by the FHA. The agency would be capitalized with $10 billion to $20 billion. The idea: To prevent more foreclosures.

I don't have many more details as this proposal is very new. But I've said before I wouldn't be surprised to see some form of "Resolution Trust Corp."-type bailout eventually, given the magnitude of the mortgage and housing problems.

UPDATE: Some form of potential bond insurer bailout may also be in the works. More details from Bloomberg.

UPDATE2: More details from the FT:

"The largest US banks are under pressure from New York State insurance regulators to provide as much as $15bn in fresh capital to support struggling bond insurers, people familiar with the matter said.

"Eric Dinallo, New York insurance superintendent, has met executives at the banks and has strongly urged them to provide $5bn in immediate capital to support the bond insurers, the largest of which are MBIA and Ambac, and to ultimately commit up to $15bn. A spokesman for Mr Dinallo had no immediate comment.

"Concerns about the future of MBIA and Ambac grew last week when Fitch Ratings downgraded Ambac from triple-A status. The business model of both companies depends on them keeping their top level credit rating."

30-year bond yields hit multi-decade lows

Stunning market action this morning in the bond market. The long bond traded at a 4.101% yield (down about 7 basis points) a little while ago. That's the lowest since the Treasury Department began selling 30-years regularly in 1977, per Bloomberg. Ten-year yields are closing in on the key level I mentioned in this post yesterday.

Tuesday, January 22, 2008

AmeriCredit dips into the red, drops forecast

AmeriCredit just delivered more evidence of broader credit problems. The auto lender (which specializes in subprime loans) said it lost $19 million in the December quarter, a big swing from a year-ago profit of $95 million. The firm's provision for loan losses roughly doubled to $356.5 million from $174.8 million.

In its managed portfolio, 31-60 day delinquency rates jumped to 6.8% from 4.7% in the June quarter (they were up marginally to 6.7% from year-earlier levels). Annualized net charge-offs (as a %age of average receivables) rose to 6.9% of managed receivables from 5.8% a year earlier. Finally, the company said it will earn just $170 million to $195 million in the fiscal year that ends in June. That's down sharply from a previous forecast of $295 million to $320 million. Said the firm's CEO Dan Berce:

"The December quarter was challenging on many fronts, with weaker credit performance and uncertainty in the capital markets. As a result, we have revised our operating plans to align our loan volume with available capital resources ... Over the next several months, we will bring our originations infrastructure and overhead into alignment with our revised originations target."

"Once in a lifetime" rates coming back?

When 10-year Treasury Note yields sank to the low 3s in 2003 (3.11% on June 13, 2003 was the low-water mark, per Bloomberg), there was a lot of talk about how those were "once in a lifetime low" yields. If you recall, that was when we had a 1% federal funds rate and a major deflation scare.

But if you can believe it, we're closing in on that territory again. The 10-year was recently going for 3.54%, less than 50 basis points off that 2003 low. Could "once in a lifetime" yields become "twice in a lifetime" ones? Could we take out the 3% barrier? Now, THAT would be a sight to see.
For you technically inclined types, the chart above shows how we broke the uptrend in yields in August -- and subsequently plunged. Today, we took out the last level of support before the 2003 lows. That opens the door to a "re-test" of those levels.

In the meantime, mortgage borrowers who have good credit and a decent-sized home equity position are going to be able to refinance into cheaper, longer-term mortgages if this keeps up. I'm seeing 30-year loan quotes in the low 5s now. Fifteen year mortgage rates have breached the 5% barrier. In case you're wondering, the low for 30-year rates was 5.21% in June 2003 and 4.6% for the 15-year, according to Freddie Mac.

More thoughts on today's Fed cut, market action

So the early-morning whiff of panic has been replaced by a late morning whiff of hope. The Dow was off more than 450 points right after the open ... but was recently down just 50 points or so. Long bonds have given up some of their gains ... financial stocks have rallied and so on and so forth, despite more bad news from the likes of Bank of America and Wachovia (profit declines of 95% and 98%, respectively).

This is the side effect of the Fed's surprise 75-basis point cut, combined with a sense we finally got "the washout" everyone was waiting for. Meanwhile, Ambac Financial Group said it was talking to "a number of potential parties" about "strategic alternatives" -- corporate speak for some kind of M&A deal, a capital raising event, or something similar. That helped becalm some of the turmoil in the bond insurance arena.

Will it be yet another false bottom? Or are we finally done with this selling squall? Boy do I wish I knew the answer to those questions. But I would note that even after today's Fed cut, the federal funds rate is still at 3.5% ... vs., say, 2-year T-notes. They were recently yielding 2.13%. Three-month T-bills, for their art, are yielding 2.36%. In other words, certain market yields are still below the funds rate -- meaning you can make a case the Fed is still behind the curve.

Fed cuts rates 75 basis points in emergency move

Just announced ...

The Federal Open Market Committee has decided to lower its target for the federal funds rate 75 basis points to 3-1/2 percent.

The Committee took this action in view of a weakening of the economic outlook and increasing downside risks to growth. While strains in short-term funding markets have eased somewhat, broader financial market conditions have continued to deteriorate and credit has tightened further for some businesses and households. Moreover, incoming information indicates a deepening of the housing contraction as well as some softening in labor markets.

The Committee expects inflation to moderate in coming quarters, but it will be necessary to continue to monitor inflation developments carefully.

Appreciable downside risks to growth remain. The Committee will continue to assess the effects of financial and other developments on economic prospects and will act in a timely manner as needed to address those risks.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Charles L. Evans; Thomas M. Hoenig; Donald L. Kohn; Randall S. Kroszner; Eric S. Rosengren; and Kevin M. Warsh. Voting against was William Poole, who did not believe that current conditions justified policy action before the regularly scheduled meeting next week. Absent and not voting was Frederic S. Mishkin.

In a related action, the Board of Governors approved a 75-basis-point decrease in the discount rate to 4 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of Chicago and Minneapolis.

Note: This is the first inter-meeting cut since just after the 9/11 terrorist attacks. It is the biggest rate cut (basis point-wise) since October 1984.

Monday, January 21, 2008

Global markets crashing

I wish that language was an over-statement, but it's not. The global markets are having their worst day since right after 9/11 amid surging credit and recession fears. Our futures (regular trading is closed for the MLK holiday) were recently off more than 4%. Some details from Bloomberg:

"Stocks plunged in Germany, Hong Kong and India, and U.S. index futures dropped on mounting speculation that the global economy is slowing and company defaults will rise.

"Europe's Dow Jones Stoxx 600 Index fell the most since the Sept. 11 terrorist attacks and sank into a bear market, as Allianz SE and BNP Paribas SA slid. Hong Kong's Hang Seng Index had its biggest drop in six years after BNP Paribas said Bank of China Ltd. may write down overseas securities by $4.8 billion because of losses from U.S. subprime mortgages.

"The MSCI World Index slipped 2.3 percent to 1,405.28 at 12:43 p.m. in London, extending its decline from an Oct. 31 record to 16 percent. India's Sensitive Index lost the most since 2004, while Germany's DAX slid the most since March 2003. Futures on the Standard & Poor's 500 Index sank 4.3 percent. Trading in the U.S. is closed today for Martin Luther King Day.

"It's the worst I've ever seen," said Johan Stein, who helps manage the equivalent of about $14 billion at Nordea Asset Management in Stockholm. 'The financial system is in terrible shape, and no one knows where this will end."

UPDATE (showing global market losses by country):
India (-7.4%)
Australia (-2.9%)
China (-5%)
Japan (-3.9%)
Brazil (-6.6%)
U.K. (-5.5%)
France (-6.8%)
Germany (-7.2%)
Spain (-7.5%)
Canada (-4.3%)

U.S. Dow futures were recently off by a bit more than 500 points.

Friday, January 18, 2008

Fitch cuts Ambac ratings

Fitch just cut Ambac Financial Group's "insurer financial strength" rating to AA from AAA. Some comments from the Fitch release:

"As Fitch announced on Dec. 21, 2007, when it placed Ambac on Rating Watch Negative, the company has a modeled capital shortfall of $1 billion at the 'AAA' rating threshold. The downgrade places Ambac's operating subsidiaries' IFS rating at a level consistent with their currently modeled capital adequacy threshold without the benefit of the noted capital increase. The downgrade in the holding company debt ratings reflects greater uncertainties surrounding Ambac's future earnings and fixed charge coverage ratios, together with movement to the more typical notching used at the 'AA' IFS rating level.

"The decision to downgrade the IFS rating by two notches, coupled with the continuation of the Negative Rating Watch, reflects the significant uncertainty with respect to the company's franchise, business model and strategic direction; uncertain capital markets and the impact of Ambac's recent decisions on future financial flexibility; the company's future capital strategy; ultimate loss levels in its insured portfolio; and the challenges in the financial guaranty market overall. Fitch expects to resolve the Negative Rating Watch after the agency evaluates these various qualitative factors, and provide that feedback to the market upon the conclusion of this review."

S&P had discussed a possible ratings cut earlier in the day.

Loan modification/repayment plan updates

Wondering how the "HOPE NOW" effort to help borrowers avoid foreclosure is going? Or wondering how many borrowers are being helped? Some stats have been released over the past couple of days. Here's a statement (PDF link) from the alliance behind HOPE NOW, and here are some other figures (PDF link) from the Mortgage Bankers Association.


Nine of the largest servicers handling 4.1 million loans, or approximately 58% of
the outstanding subprime loans as of September 2007 provided the data. This
preliminary data on the subprime loan modifications and repayment plans

• The industry assisted 370,000 homeowners during the second half of 2007.
This includes 250,000 formal repayment plans and 120,000 modifications.

• Mortgage servicers were modifying subprime loans during the fourth
quarter at triple the rate of the third quarter.

• On an annualized basis, 10.4% of subprime borrowers were helped.

• 39% of delinquent borrowers were assisted in the second half of 2007.

And from the MBA:

"The mortgage industry modified an estimated 54,000 loans and established formal repayment plans with another 183,000 borrowers during the third quarter of 2007, according to a report issued today by the Mortgage Bankers Association. By comparison, foreclosure actions were started on approximately 384,000 loans, but of those foreclosures, 63 percent were cases where the borrower did not live in the home, the borrower did not respond to repeated attempts by the lender to contact them, or where the borrower failed to perform on a repayment plan or loan modification that was already in place."

Still, FDIC Chairman Sheila Bair said more needs to be done in a speech yesterday. Some specific comments:

"So, how's it going? Not as well as it should be.

"Moody's, the rating agency, says that at the end of September, just 3.5 percent of loans that reset in 2007 had been modified. That puts us way behind the curve going into the New Year. We have some 2 million loans to adjust, the bulk of them in 2008. Time is of the essence.

"We must see a pickup in the pace, and the sooner the better. It's like having your football team in the Super Bowl win the coin toss, but fumbling the ball on the kickoff and giving up a touchdown.

"You're behind at the get-go.

"To be sure, the loan modification program is no cure-all. It's part of a broader effort. But the true test of success will be whether industry can show progress in avoiding foreclosures. We'll be closely watching for progress.

"It is essential that industry reports, such as those being prepared for the states and Hope Now, show true progress. While no one likes reporting, given the current situation it's critical that industry show effective action to avoid unnecessary foreclosures.

"I urge servicers to cooperate in making these reports. It's in your best interest to do so. Working with Treasury and government regulators, the industry has tools to address this on its own. And the key is to quickly get borrowers who can afford their homes, into long-term loans they can afford to pay."

No doubt we'll hear more point-counterpoint on this issue over the coming weeks and months.

Thursday, January 17, 2008

Lehman exiting some origination businesses

Some breaking news out of Lehman Brothers -- it's suspending the wholesale and correspondent lending businesses at its Aurora Loan Services division. Aurora will still do direct lending and maintain its servicing operations. Some 1,300 employees will be let go, and facilities in CA, FL, and NJ will be closed.

Per National Mortgage News, Aurora was the third-largest Alt-A lender in the country as of Q3 2007, with $5.2 billion in volume (and $10.3 billion in the quarter before that, Q2 2007). The #1 Alt-A lender in the country -- IndyMac Bancorp, with volume of $12.6 billion in Q3 '07 and $15.3 billion in Q2 -- just announced some job cuts of its own. The firm said it would layoff just over 2,400 workers, or 24% of its total staff, and close facilities in FL, PA, MA, and SC.

Bond insurers in deep

What a wild day in bond insurance land. The "AAA"-rated companies Ambac and MBIA are getting pummeled again on news Moody's Investors Service and Standard & Poor's are increasing their scrutiny of these firms. There just may, possibly, be something not quite as credit-worthy about the companies, in the opinion of the raters.

I can't imagine why they'd say that. I mean, it's not like MBIA just had to pay 14% interest to raise $1 billion in capital (my credit card rate, in case you're wondering, is 7.9%). It's not like Ambac just slashed the value of its credit derivatives portfolio by $5.4 billion pre-tax, or announced a "minor" quarterly per-share loss of almost $33 per share. It's not like they have exposure to all kinds of esoteric paper, rather than the low-risk municipal bonds that they insured for years and years. Oh wait ...

December housing starts plunge more than 14%

We just got our latest look at housing starts -- and the figures showed a dramatic plunge in construction and permitting activity. Here are the details:

* Overall housing starts dropped 14.2% to a seasonally adjusted annual rate of 1.006 million from 1.173 million in November (which was downwardly revised from the originally reported 1.187 million). Single-family starts were down 2.9%, while multifamily starts dropped 40.3%.

On a year-over-year basis, starts were down an eye-popping 38.2%, leaving them at the lowest level since March 1991. From the peak (2.292 million in January 2006), starts are now off 56.1%, as you can see in the long-term chart above.

* Building permit issuance also dropped -- 8.1% to a SAAR of 1.068 million from 1.162 million (upwardly revised slightly from 1.152 million). That's down 34.4% from December 2006 and the lowest since March 1993. Single family permits tanked 10.1%, while multi-family permits fell 4.1%. Permitting is now off 52.8% from its peak of 2.263 million in September 2005.

* Regionally speaking, starts fell everywhere -- 25.8% in the Northeast, 30.8% in the Midwest, 3.3% in the South and 19.6% in the West. Permitting activity fell in three out of four regions -- down 10.6% in the Midwest, down 7.8% in the South and down 11.6% in the West. Permits inched up 1.6% in the Northeast.

No two ways about it: December was a nasty month for the construction industry. Housing starts were off by more than 14% on the month ... 38% on the year ... and 56% from the market peak. In fact, we haven't seen this little construction activity since March 1991. Permits, for their part, dropped 8.1% on the month ... 34.4% on the year ... and 52.8% from their peak. The decline was geographically widespread, too. Construction fell in all four regions, while permit activity fell in three out of four.

These figures confirm that the housing recession continues to deepen. Slumping consumer confidence and tighter lending standards have already taken their toll on demand, and the broader economic slowdown we're starting to see unfold now threatens to make a bad situation worse.

That said, mortgage rates are falling for good-credit borrowers. And the deep cutbacks in home construction will ultimately help get housing inventories down. But it will be a drawn-out process. Expect another relatively weak 2008 spring selling season, and a general malaise stretching into 2009.

Wednesday, January 16, 2008

Reports: Treasury still not on board with raising the conforming loan limit

Some news out of Washington today: The U.S. Treasury reportedly still objects to allowing Fannie Mae and Freddie Mac to buy mortgages above the current $417,000 conforming loan limit -- unless it's part of a comprehensive regulatory reform package for the GSEs. Some have discussed at least a temporary increase in order to lower financing costs for jumbo mortgages. They've been driven up recently because investors are shunning most kinds of mortgage paper except for plain-vanilla, Fannie/Freddie stuff.

Here's some more coverage from Marketwatch and Reuters. And if you're a tried and true policy wonk who wants to know the potential benefits and drawbacks of raising the jumbo cap -- at least in certain high-cost areas -- then by all means click on over to the OFHEO (Office of Federal Housing Enterprise Oversight) website. You can read this study (PDF link), which explores the issue in 19 riveting pages.

NAHB index continues its sideways slide

Sorry for not blogging until now on the many news developments out there in the credit markets. I had to take care of some things and was tied up all morning. Anyway, we just got the latest read on the housing industry from the National Association of Home Builders. What did the figures show?

* The overall Housing Market Index rose 1 point to 19 from 18 in December. December's reading was revised down from 19, however. That means this indicator of builder confidence has essentially slid sideways since October.

* The subindex measuring present single-family home sales held steady at 19, while the subindex measuring prospective buyer traffic inched up to 14 from 13. Meanwhile, builders are apparently a bit more optimistic about the future. The subindex measuring expectations for future single family home sales rose to 28 from 26. That reading is the highest since August (31).

* Regionally, the HMI was unchanged in the Northeast (at 20), up 2 points in the Midwest (to 17 from 15), and up 3 points in the South (to 23 from 20), but down sharply in the West (to 13 from 18).

Housing demand remains in the dumps, according to the latest builder's survey, with current sales trends and buyer traffic anemic. But optimism about the future appears to be picking up, perhaps because the Federal Reserve has signalled it's getting ready to pull out the "big guns" and cut interest rates more sharply. It's also worth noting that the Mortgage Bankers Association's purchase mortgage application figures have perked up a bit in early 2008.

But I wouldn't break out the party hats just yet. For starters, the MBA's mortgage figures are historically volatile in the weeks surrounding the holiday season (See this post for more details). Those figures also capture APPLICATIONS, rather than APPROVALS. Fewer loan applicants are likely getting the green light from lenders, given the tighter standards now prevalent throughout the home loan industry.

The other problem with expectations about the future? They can deflate quickly if improvement doesn't manifest itself. And there's a pretty good chance builders' optimism about the next six months will prove misplaced if unemployment keeps rising and the economy slumps toward -- or into -- recession.

Tuesday, January 15, 2008

December home sales in my area

Every month, the local real estate brokerage firm Illustrated Properties posts some advance data on Palm Beach County-area home sales. It gives you a nice heads up on what the "official" Florida Association of Realtors figures may show later in the month (though the numbers never line up exactly). According to the just-updated December stats:

* Home sales dropped 36.7% year-over-year to 511 from 807.

* For-sale inventory rose 12.6% to 24,433 last month from 21,699 in December 2006. Inventory did show a seasonal dip from last month's cycle high. But using the "months supply at current sales pace metric," inventory is running at 48 months -- yes, that means we have four years of home supply on the market.

* The median price of an existing home fell 10.7% to $250,000 (a fresh cycle low) from $280,000. Average days on market rose to a new high of 154 days from 120 in December 2006.

Clearly, the housing market in this area continues to struggle. The real question is, "What will happen as the spring selling season ramps up?" Mortgage rates are falling for good-credit, conventional borrowers, with 30-year fixed rates now below 6%. But tighter mortgage standards for non-plain-vanilla borrowers, rising unemployment, and deflationary psychology among buyers ("Why buy now when I can get a house for less in six months?") are so far offsetting the positive impact of lower financing rates. We'll just have to see how this all plays out.

Retail sales sink; Dollar takes a dive

The December retail sales report was less than inspiring. Overall sales fell 0.4% on the month, vs. expectations for an unchanged reading. Sales ex-autos also fell 0.4%, vs. expectations for a 0.1% dip. The weakness was widespread: Vehicles and parts down 0.4% ... electronics stores down 1.9% ... building materials down 2.9% ... clothing down 2% ... sporting goods and books down 2%, and so on. The only standout gains were at health stores (+0.7%) and food and beverage retailers (+0.7%), not exactly suggestive of strong consumer spending.

If there's some good news out there, it's that the Producer Price Index slipped 0.1% vs. expectations for a 0.2% gain. However, the "core" PPI rose 0.2%, in line with forecasts. Further up the pipeline, the intermediate goods PPI fell 0.2% on the headline and was unchanged on the core. The crude goods PPI rose 1% on the headline and was also unchanged on the core.

Long bonds are flying on the news -- up 28/32 on the futures at last count. The dollar is also getting pasted amid expectations this means aggressive Fed rate cuts are signed, sealed, and delivered. The Dollar Index is down 33 bps as I write, with the Japanese yen breaking out to its highest against the greenback since June 2005 (yen futures chart shown above).

Citigroup's and Merrill's dash for cash

Good morning folks. As expected, both Citigroup and Merrill Lynch are announcing the details of their capital-raising hunt. Citigroup said it raised $12.5 billion by selling convertible preferred securities in a private placement.

The Government of Singapore Investment Corp is ponying up $6.88 billion. Other investments are coming from the Kuwait Investment Authority, Capital Research Global Investors, Capital World Investors, the New Jersey Division of Investment, Prince Alwaleed bin Talal bin Abdulaziz Alsaud of Saudi Arabia (who was behind the rescue of the former Citibank way back in the early 1990s and who owns about 4% of the company already), Sanford Weill (the former Chairman and CEO of Citigroup), and Timmy the neighborhood paper boy, who was asked to pony up the 50 bucks he raised this past summer (just kidding about that last one).

Citigroup is also selling about $2 billion in additional preferreds to public investors. And it's cutting the quarterly dividend to 32 cents per share from 54 cents a share. This is the second round of capital raising, following a move to raise $7.5 billion from Abu Dhabi in November.

In other news, Citigroup took an $18.1 billion write down on various subprime-related exposures and securities. That was largely expected. What may be more significant is the deterioration in the credit quality of the company's loan portfolio. Specifically, Citi said credit costs in the U.S. consumer business surged $4.1 billion (including a charge of $3.31 billion to boost the bank's loan loss reserve due to rising delinquencies on 1st and 2nd mortgages, personal loans, credit cards, and car loans -- in other words, a little bit of everything). Net income plunged 71% year-over-year in the global consumer unit and 89% in alternative investments, while rising 27% in global wealth management.

Moving on to Merrill, the brokeage firm raised $6.6 billion by selling its own batch of preferred shares to the Kuwaiti Investment Authority, Mizuho Financial Group of Japan, the Korean Investment Corp. and various U.S. money management clients, as well as Vinnie the Fish, formerly of Bayonne, N.J., current address unkown (yes, that last one is a joke too). As you're probably aware, Merrill has already raised $6.2 billion from Singapore's Temasek Holdings and Davis Selected Advisors.

Monday, January 14, 2008

Homes at 43 cents on the dollar

William Lyon Homes is a builder that operates in California, Arizona and Nevada. It just sold Resmark Equity Partners a portfolio of 604 home sites and five model homes in a handful of Southern California communities. The properties are finished or near-finished home sites. Resmark says the homes were being carried at a book value of $210.7 million as of November 30. The firm paid $90.6 million. That's a 57% discount for those of you keeping score at home.

If you'll recall, this post noted that at least one other real estate deal was done at 40 cents on the dollar. The "good" news? Real estate buyers are stepping up and purchasing residential property. The "bad" news? They're paying dimes on the dollar for it, a sign that new and existing home prices have more room to fall.

Charges, charges, everywhere...

With my apologies to Thomas Paine, these are the times that try bloggers' souls. There is so much news in the interest rate and credit markets right now, I can hardly keep up with it. But I'll try my best to hit on some of the major announcements this morning ...

* M&T Bank said it earned just $64.9 million in the fourth quarter. That was a hefty 70% year-over-year drop. The company announced a $127 million impairment on CDO holdings. It also boosted its provision for loan losses to $101 million from $28 million a year earlier. The firm noted problems with Alt-A mortgages and loans to residential developers.

* Sovereign Bancorp, the second-largest S&L in the U.S., also announced its own hefty hit. the company said it would take $1.58 billion in charges in the fourth quarter -- $1.4 billion of which is the write down of goodwill related to two business segments. Essentially, Sovereign is saying its consumer lending business and New York-area banking business aren't worth what they once were. Or quoting from the release:

"A combination of a weakening consumer credit market, lower valuations for banking companies, and Sovereign's decision to stop originating automobile loans in the Southeast and Southwest resulted in the goodwill impairment for the Consumer segment.

"The New York Metro segment's goodwill relates primarily to Sovereign's June 2006 acquisition of Independence Community Bancorp. Earnings for this segment have been negatively impacted by the current operating environment. Consequently, revenue and deposit growth have been less than expected."

Another $180 million of the charge relates to the declining value of Fannie Mae and Freddie Mac preferred shares. Lastly, Sovereign said it would take a $27 million hit tied to fianancings Sovereign provided to two unidentified mortgage firms.

* Shares of NovaStar Financial, the struggling subprime lender that's been facing financing pressures for many months, were recently down about 38%. The company slashed 170 of its 200 workers and said it would discontinue its retail lending and mortgage brokerage operations.

That's it for now, but I'm sure there will be to come as we get into the heart of earnings confessional season.

Friday, January 11, 2008

MBIA will probably get its money, but at a hefty price

Looks like MBIA, the bond insurer, will probably get its $1 billion in capital. But it's going to pay a pretty penny to do so -- 14% interest, according to this report. Here are some more details:

"MBIA needs to sell the notes to shore up its capital position and secure funding for possible claims if there are defaults on bonds that it insures. Fitch last month threatened MBIA with a downgrade, raising questions about whether it has enough capital in the event of defaults. MBIA's cash position is threatened by its exposure to assets backed by poor quality subprime mortgages.

"Adding to the company's woes, some hedge fund operators have been shorting MBIA stock in a market bet that it will be driven into bankruptcy.

"The offering also is complicated by the fact that it consists of surplus notes, which bear some of the traits of debt and some of the characteristics of stock. Hybrid bonds are somewhat controversial in the bond industry because they can be listed either as debt of equity on balance sheets, so that also may be depressing demand.

"Surplus notes are issued mainly by the insurance industry.

"Moreover, the notes will feature a fixed rate until January 2013 and a floating rate after that. The prospect of a floating rate may not be attractive in the current nervous environment."

Of course, this whole process of ratings agencies rating MBIA and its cohorts "AAA" ... and then giving them about 800 years to raise capital, while saying "We really, REALLY mean it this time -- we might downgrade you!" ... is a little silly. I don't know about you, but I'm not familiar with many companies that are truly AAA that have to borrow money at credit card-like interest rates. The market is clearly saying the firm's credit risk is anything but minimal.

What about inflation?

Lots of other news -- the credit crunch, the big deals being discussed in mortgage-land (including a potential JPMorgan Chase-for-Washington Mutual transaction, if CNBC is to believed), and so on -- have captivated the financial markets, and for good reason. But something else is playing out in the background: Food inflation is joining energy inflation as a major bugaboo. While December import prices were unchanged on the headline, the news for 2007 as a whole was downright awful. Specifically ...

Petroleum import prices soared 50.1% last year. That was the biggest yearly increase since the 56.9% surge in 2002. Meanwhile, agricultural prices soared 23.5%. There has never been a bigger gain in the 22-year history of the import price data series.

Here's one other thing I've pointed out in previous posts: Cheap imports from China provided a nice deflationary offset to some of the inflationary forces we've faced in recent years. But now, Chinese imports are RISING in price. In fact, they gained 2.4% last year, the biggest yearly rise on record.

Bond traders have been more focused on growth than inflation in recent months. But while all Treasury prices have risen and all bill/note/bond yields have fallen, long yields have fallen a lot less than short yields. That's causing the yield curve to steepen quite a bit -- a sign that longer-term inflation concerns could come back with a vengeance once the economy stabilizes.

Merrill's $15 billion hit; UBS' surprising mortgage admission

Looks like the cost of the mortgage mess continue to mount on Wall Street. Merrill is the latest casualty, with a whopping $15 billion loss coming soon, according to the New York Times. In response, the firm will be forced to ask for more help from foreign investors or private equity firms, who have been actively bailing out companies as diverse as Citigroup and UBS in recent months. An excerpt:

"Merrill Lynch is expected to suffer $15 billion in losses stemming from soured mortgage investments, almost double its original estimate, prompting the firm to raise additional capital from an outside investor.

"Merrill, the nation’s largest brokerage firm, is expected to disclose the huge write-down when it reports earnings next week, according to people who have been briefed on its plans. The loss far exceeds the $12 billion hit many Wall Street analysts had forecast.

"To shore up its deteriorating finances, Merrill is now in discussions with investors in the United States, Asia and the Middle East, including American private equity firms, to raise about $4 billion in the coming days, these people said."

Speaking of UBS, the global bank basically admitted it has no idea how bad the U.S. mortgage market will get -- or how much money it will ultimately lose on its mortgage investments. The complete shareholder letter is available here. The excerpt I'm referring to is:

"We cannot, at this time, accurately predict the future development of US residential mortgage markets and therefore the ultimate impact on our positions in sub-prime mortgage related securities."

More on Countrywide this a.m.

Some excerpts from the Wall Street Journal's coverage of the Bank of America-for-Countrywide buyout/bailout saga -- a deal that's being confirmed this morning:

"Bank of America Corp. is near agreement to take over tottering mortgage giant Countrywide Financial Corp., in a move that could build a bulwark against the mortgage-default crisis by protecting one of its biggest casualties from collapse.

"Bank of America had insisted for months no takeover was in the works, but people familiar with the talks said a deal could come very soon. It isn't clear how much Bank of America, the largest U.S. bank in stock-market value, has offered for Countrywide, the biggest mortgage lender, whose stock had dropped 88% in the past year. It is still possible that an agreement could be delayed or fall apart. For federal approval, the deal could depend on exploiting a little-known regulatory provision to allow the merged bank to hold more than 10% of the nation's deposits."

* Was the government involved in putting this deal together? Treasury denies it in the WSJ, but clearly a Countrywide failure would have widespread ramifications for the mortgage market, as this paragraph notes:

"More broadly, a failure of Countrywide would have posed a major risk to the U.S. economy, since the lender services about one of every six loans in the country. Bankruptcy likely would have shifted huge financial risk to Fannie Mae and Freddie Mac. A spokesman for the U.S. Treasury Department said agency officials didn't encourage Bank of America to rescue the huge mortgage firm."

* Is this a good deal for Bank of America? Only time will tell, but I'm skeptical. Here's what the WSJ has to say:

"For Bank of America, the deal would instantly allow it to realize its ambition of becoming a dominant mortgage lender. But it also would bring some ticking time bombs, whose powers to destroy value won't be clear at least until the housing market bottoms out, which may not be for a year or more.

"Bank of America has more than $100 billion in its own home-equity loans, second mortgages that have shown signs of strain as the housing crisis spreads. Bank of America would be taking on more than $30 billion in Countrywide home-equity loans. Though Countrywide has virtually stopped making subprime loans, it has exposure to its past originations. As of Sept. 30, Countrywide's savings bank held $26.84 billion of option ARMs, which allow borrowers to start with minimal payments and face far higher ones later.

"Home-equity loans and option ARMs accounted for three-quarters of Countrywide's loan holdings at the end of the third quarter. Countrywide says some of that risk is covered by mortgage insurance, but some investors are nervous about mortgage insurers' ability to pay off all the claims they face in the next few years.

"Bank of America already paid $21 billion for Chicago's LaSalle Bank over the summer, and could drain its capital more if it takes big write-downs for Countrywide's loans. That short-term hit, however, could become a long-term boon should the loans perform better than expected."

* Finally, the WSJ notes that an obscure loophole in banking law could be what allows a deal to occur. Banks are generally restricted from acquiring more than 10% of the country's deposits, but ...

"There appeared to be a big obstacle for a Countrywide takeover after the Federal Reserve approved Bank of America's acquisition of LaSalle in September. The combined bank grew to hold 9.88% of the country's deposits. Federal law prohibits a bank-holding company from controlling more than 10% of U.S. deposits after acquiring another bank.

"But the law includes an obscure caveat: The 10% limit doesn't apply to federally chartered thrifts, meaning a bank-holding company may control more than 10% of deposits in the U.S. following a thrift acquisition. Since a Countrywide subsidiary called Countrywide Bank is a federally insured thrift, that may give Bank of America room to maneuver around the deposit cap.

"Bank of America is the only bank that has ever neared the 10% deposit cap. Many seasoned banking attorneys were not familiar with the caveat, as no bank has ever tried to acquire a thrift to vault above the 10% limit.

"This could be the biggest loophole in the world," said Gilbert Schwartz a partner at Schwartz & Ballen LLP and former Fed attorney. It was unclear when or how the loophole first became known to the banks."

Meanwhile, here's what BofA has to say about the deal in their release:

"Bank of America will benefit from Countrywide's broader mortgage capabilities, including its extensive retail, wholesale and correspondent distribution networks. The Calabasas, California-based company operates more than 1,000 field offices and has a sales force of nearly 15,000. Countrywide also has a leading mortgage technology platform, a well known brand in home lending and management expertise in a number of key areas.

"Bank of America would gain greater scale in originating and servicing mortgages in the U.S. Countrywide had $408 billion in mortgage originations in 2007 and has a servicing portfolio of about $1.5 trillion with 9 million loans. The purchase also includes Countrywide's Lender Placed insurance and other businesses.

"Countrywide presents a rare opportunity for Bank of America to add what we believe is the best domestic mortgage platform at an attractive price and to affirm our position as the nation's premier lender to consumers," Bank of America Chairman and Chief Executive Officer Kenneth D. Lewis said. "Countrywide customers will gain access to a broad set of consumer products including credit cards and deposit services. Home ownership is a fundamental pillar of the U.S. economy and over time it will be a key area of growth for Bank of America."

"We are aware of the issues within the housing and mortgage industries," Lewis continued. "The transaction reflects those challenges. Mortgages will continue to be an important relationship product, and we now will have an opportunity to better serve our customers and to enhance future profitability."

"Countrywide's deep retail distribution will enhance Bank of America's network of more than 6,100 banking centers throughout the U.S. After closing, Bank of America plans to operate Countrywide separately under the Countrywide brand with integration occurring no sooner than 2009."

UPDATES (some more headlines and details on this transaction):

* S&P says it may raise Countrywide's credit ratings due to the deal. Moody's, for its part, said it may lower its rating on Bank of America. Clearly, a transaction would lower funding costs for Countrywide, and alleviate some turmoil in the debt markets. As this story from Marketwatch notes:

"Countrywide debt due in 2016 was trading at roughly 41 cents on the dollar before news of a potential deal broke Thursday, while the company's bank debt was changing hands at about 70 cents on the dollar, she said."

* BofA says it won't exceed the 10% deposit cap for the reason cited in the WSJ story. It also indicated the bank will need "a couple billion dollars" to maintain regulatory capital levels. The transaction is slated to close in Q3.

Thursday, January 10, 2008

American Express warning about the economy, earnings outlook

After the bell, credit card issuer American Express is warning about a weakening U.S. economy and boosting its loan loss reserves. Specifically, Amex said it "is seeing signs of a weaker U.S. economy" with "negative credit trends among U.S. consumers during December, particularly in California, Florida and other parts of the country most affected by the housing downturn." It's taking a pretax charge of $440 million in Q4 to boost reserves, and forecasting earnings per share from continuing operations of 70 cents to 72 cents. That's below the 73 cents the company earned a year ago. Managed portfolio delinquencies climbed to 3.2% in Q4 from 2.9% in Q3. Competitor Capital One, for its part, warned on its earnings earlier today.

Bank of America for Countrywide?

Countrywide has been on the ropes for some time. But now, the Wall Street Journal is reporting that Bank of America may buy the mortgage lender. What a fluid situation.

Bernanke weighs in on just about everything; suggests imminent rate cuts are coming

Here's the Bernanke speech, which is now online. Some excerpts (with my emphasis added):

EXCERPT #1 on the big picture:

"Since late last summer, the financial markets in the United States and in a number of other industrialized countries have been under considerable strain. The turmoil has affected the prospects for the broader economy, principally through its effects on the availability and terms of credit to households and businesses. Financial market conditions, in turn, have been sensitive to the evolving economic outlook, as investors have tried to assess the implications of incoming economic information for future earnings and asset values. These interactions have produced a volatile situation that has made forecasting the course of the economy even more difficult than usual."

EXCERPT #2 on higher-risk mortgages:

"Since early 2007, financial market participants have been focused on the high and rising delinquency rates of subprime mortgages, especially those with adjustable interest rates (subprime ARMs). Currently, about 21 percent of subprime ARMs are ninety days or more delinquent, and foreclosure rates are rising sharply.

"Although poor underwriting and, in some cases, fraud and abusive practices contributed to the high rates of delinquency that we are now seeing in the subprime ARM market, the more fundamental reason for the sharp deterioration in credit quality was the flawed premise on which much subprime ARM lending was based: that house prices would continue to rise rapidly. When house prices were increasing at double-digit rates, subprime ARM borrowers were able to build equity in their homes during the period in which they paid a (relatively) low introductory (or “teaser”) rate on their mortgages. Once sufficient equity had been accumulated, borrowers were often able to refinance, avoiding the increased payments associated with the reset in the rate on the original mortgages. However, when declining affordability finally began to take its toll on the demand for homes and thus on house prices, borrowers could no longer rely on home-price appreciation to build equity; they were accordingly unable to refinance and found themselves locked into their subprime ARM contracts. Many of these borrowers found it difficult to make payments at even the introductory rate, much less at the higher post-adjustment rate. The result, as I have already noted, has been rising delinquencies and foreclosures, which will have adverse effects for communities and the broader economy as well as for the borrowers themselves.

"One of the many unfortunate consequences of these events, which may be with us for some time, is on the availability of credit for nonprime borrowers. Ample evidence suggests that responsible nonprime lending can be beneficial and safe for the borrower as well as profitable for the lender. For example, even as delinquencies on subprime ARMs have soared, loss rates on subprime mortgages with fixed interest rates, though somewhat higher recently, remain in their historical range. Some lenders, including some who have worked closely with nonprofit groups with strong roots in low-to-moderate-income communities, have been able to foster homeownership in those communities while experiencing exceptionally low rates of default. Unfortunately, at this point, the market is not discriminating to any significant degree between good and bad nonprime loans, and few new loans are being made.

"Although subprime borrowers and the investors who hold these mortgages are the parties most directly affected by the collapse of this market, the consequences have been felt much more broadly. I have already referred to the role that the subprime crisis has played in the housing correction. On the way up, expansive subprime lending increased the effective demand for housing, pushing up prices and stimulating construction activity. On the way down, the withdrawal of this source of demand for housing has exacerbated the downturn, adding to the sharp decline in new homebuilding and putting downward pressure on house prices. The addition of foreclosed properties to the inventories of unsold homes is further weakening the market."

EXCERPT #3 on financial engineering and structured credit:

"As you know, the losses in the subprime mortgage market also triggered a substantial reaction in other financial markets. At some level, the magnitude of that reaction might be deemed surprising, given the small size of the U.S. subprime market relative to world financial markets. Part of the explanation for the outsized effect may be that, following a period of more-aggressive risk-taking, the subprime crisis led investors to reassess credit risks more broadly and, perhaps, to become less willing to take on risks of any type. Investors have also been concerned that, by further weakening the housing sector, the problems in the subprime mortgage market may lead overall economic growth to slow.

"However, part of the explanation for the far-reaching financial impact of the subprime shock is that it has contributed to a considerable increase in investor uncertainty about the appropriate valuations of a broader range of financial assets, not just subprime mortgages. For example, subprime mortgages were often combined with other types of loans in so-called structured credit products. These investment products, sometimes packaged with various credit and liquidity guarantees obtained from banks or through derivative contracts, were divided into portions, or tranches, of varying seniority and credit quality. Thus, through financial engineering, a diverse combination of underlying credits became the raw material for a new set of financial assets, many of them garnering high ratings from credit agencies, which could be matched to the needs of ultimate investors."

EXCERPT #4 on jumbo mortgage loans and credit market tightness:

"Importantly, investors’ loss of confidence was not restricted to securities related to subprime mortgages but extended to other key asset classes. Notably, the secondary market for private-label securities backed by prime jumbo mortgages has also contracted, and issuance of such securities has dwindled. Even though default rates on prime jumbo mortgages have remained very low, the experience with subprime mortgages has evidently made investors more sensitive to the risks associated with other housing-related assets as well. Other types of assets that have seen a cooling of investor interest include loans for commercial real estate projects and so-called leveraged loans, which are used to finance mergers and leveraged buyouts."

EXCERPT #5 on the banking system:

"Although structured credit products and special-purpose investment vehicles may be viewed as providing direct channels between the ultimate borrowers and the broader capital markets, thereby circumventing the need for traditional bank financing, banks nevertheless played important roles in this mode of finance. Large money-center banks and other major financial institutions (which I will call “banks,” for short) underwrote many of the loans and created many of the structured credit products that were sold into the market. Banks also supported the various investment vehicles in many ways, for example, by serving as advisers and by providing standby liquidity facilities and various credit enhancements. As the problems with these facilities multiplied, banks came under increasing pressure to rescue the investment vehicles they sponsored--either by providing liquidity or other support or, as has become increasingly the norm, by taking the assets of the off-balance-sheet vehicles onto their own balance sheets. Banks’ balance sheets were swelled further by non-conforming mortgages, leveraged loans, and other credits that the banks had extended but for which well-functioning secondary markets no longer existed.

"Even as their balance sheets expanded, banks began to report large losses, reflecting the sharp declines in the values of mortgages and other assets. Thus, banks too became subject to valuation uncertainty, as could be seen in their share prices and other market indicators such as quotes on credit default swaps. The combination of larger balance sheets and unexpected losses also resulted in a decline in the capital ratios of a number of institutions. Several have chosen to raise new capital in response, and the banking system retains substantial levels of capital. However, on balance, these developments have prompted banks to become protective of their liquidity and balance sheet capacity and thus to become less willing to provide funding to other market participants, including other banks. As a result, both overnight and term interbank funding markets have periodically come under considerable pressure, with spreads on interbank lending rates over various benchmark rates rising notably. We also see considerable evidence that banks have become more restrictive in their lending to firms and households. More-expensive and less-available credit seems likely to impose a measure of financial restraint on economic growth."

EXCERPT #6 on the "TAF" system:

"Based on our initial experience, it appears that the TAF may have overcome the two drawbacks of the discount window, in that there appears to have been little if any stigma associated with participation in the auction, and--because the Fed was able to set the amounts to be auctioned in advance--the open market desk faced minimal uncertainty about the effects of the operation on bank reserves. The TAF may thus become a useful permanent addition to the Fed’s toolbox. TAF auctions will continue as long as necessary to address elevated pressures in short-term funding markets, and we will continue to work closely and cooperatively with other central banks to address market strains that could hamper the achievement of our broader economic objectives."

EXCERPT #7 on the economy:

"Although economic growth slowed in the fourth quarter of last year from the third quarter’s rapid clip, it seems nonetheless, as best we can tell, to have continued at a moderate pace. Recently, however, incoming information has suggested that the baseline outlook for real activity in 2008 has worsened and the downside risks to growth have become more pronounced. Notably, the demand for housing seems to have weakened further, in part reflecting the ongoing problems in mortgage markets. In addition, a number of factors, including higher oil prices, lower equity prices, and softening home values, seem likely to weigh on consumer spending as we move into 2008.

"Financial conditions continue to pose a downside risk to the outlook for growth. Market participants still express considerable uncertainty about the appropriate valuation of complex financial assets and about the extent of additional losses that may be disclosed in the future. On the whole, despite improvements in some areas, the financial situation remains fragile, and many funding markets remain impaired. Adverse economic or financial news has the potential to increase financial strains and to lead to further constraints on the supply of credit to households and businesses. I expect that financial-market participants--and, of course, the Committee--will be paying particular attention to developments in the housing market, in part because of the potential for spillovers from housing to other sectors of the economy."

EXCERPT #8 on the Fed's possible interest rate response:

"Monetary policy has responded proactively to evolving conditions. As you know, the Committee cut its target for the federal funds rate by 50 basis points at its September meeting and by 25 basis points each at the October and December meetings. In total, therefore, we have brought the funds rate down by a percentage point from its level just before financial strains emerged. The Federal Reserve took these actions to help offset the restraint imposed by the tightening of credit conditions and the weakening of the housing market. However, in light of recent changes in the outlook for and the risks to growth, additional policy easing may well be necessary. The Committee will, of course, be carefully evaluating incoming information bearing on the economic outlook. Based on that evaluation, and consistent with our dual mandate, we stand ready to take substantive additional action as needed to support growth and to provide adequate insurance against downside risks.

"Financial and economic conditions can change quickly. Consequently, the Committee must remain exceptionally alert and flexible, prepared to act in a decisive and timely manner and, in particular, to counter any adverse dynamics that might threaten economic or financial stability."

Fed Chairman Ben Bernanke's speech illustrates that he "gets" what is behind the problems in the economy and the financial markets. That's good -- for the longest time, this Fed has been underestimating the housing market problems, underestimating the mortgage market problems, and underestimating the threat of economic weakness. His comments strongly imply that an interest rate cut is imminent, and that the Fed will even act between scheduled meetings if necessary. I wouldn't be surprised to see a half-point cut before the January 29-30 gathering if financial markets fail to stabilize.

A reasonable question to ask, though, is: "Why didn't you just go ahead and cut rates if you believe conditions are deteriorating?" Another one worth posing is: "Will Fed rate cuts be enough to 'solve' the financial market's problems?" They certainly won't hurt, in my view. But they can't fix everything.

They can't prevent home prices from declining further, given the massive supply overhang in both the new and existing home market. They won't inspire banks and investors to go crazy with credit again, because they're still nursing their wounds from higher-risk real estate and leveraged finance loans. And they probably can't prevent the U.S. economy from sliding into recession, or getting darn close, in 2008.

In short, we've just experienced an extraordinary housing and credit bubble. It will take time to repair the damage and sleep off the hangover.

UPDATE on the Q&A:

Bernanke took a pass on a question regarding legislation that would allow bankruptcy judges to restructure mortgages in the court system.

Asked about whether we were going to have a recession, he talked about how dating/forecasting a recession is tough. Then he said the Fed is not currently forecasting a recession, but stands ready to cut rates if necessary.

He said politics won't affect decision making in this election year.

Then he said that fiscal stimulus is being discussed, but that those discussions are in the early stages, and that he wanted to see what emerges from that.

Finally, he talked a bit about the proposals the Fed has out for comment pertaining to mortgage advertising. And he pointed out that the Fed and other regulators have issued revised guidance about how to do subprime lending right.

UPDATE on market reaction:

Stocks surged initially, but the Dow has since dipped slightly into negative territory. Long bonds are down pretty sharply, -26/32 on the futures recently. The yield curve has steepened -- 30-year rates have risen by about 6 basis points, while 2-year yields have dropped more than 6 bps. The dollar is getting spanked, with the Dollar Index off about 51 ticks. And gold is up sharply -- about $13.

Site Meter