Interest Rate Roundup

Friday, February 29, 2008

Muni market massacre?

Reports are circulating about a massacre in the municipal bond market. From Reuters:

"Tender option bond programs on Friday were selling "multiple billions" of dollars of U.S. municipal bonds, a money manager said, which is accelerating a market slide that experts call the worst in decades.

"Prices have dropped for the past 12 days, partly due to the problems borrowers and investors are having with short-term municipal markets.

"Two of these markets, auction rate and variable demand note obligations, have frozen because investors fear some bond insurers that backed this debt are no longer credit-worthy as a result of their bad bets on subprime mortgage investments.

"These dislocations have hurt tender option bond trusts, which buy long-term muni bonds and finance them by selling floating notes. But now they are losing money -- or are about to -- because their borrowing costs have skyrocketed.

At the same time, the value of their long-term municipal bonds has plunged."

Long bond futures have gone ballistic -- up a whopping 2 4/32 points in price at last check. 2-year note yields have plummeted 18 basis points to a cycle low of 1.63%. Meanwhile, as you can see in the chart above, yields on 30-year AAA munis are soaring -- to around 5% from a low of about 4.2% in late January.

The risk of failure(s)

You don't need me to tell you the U.S. financial industry is facing unprecedented challenges. What I still think some underappreciate, however, is that this crisis is different from ones we've seen in the past. Many past crises tended to be isolated to one or two parts of the credit market. But this time around, we're seeing major credit problems popping up in everything from residential mortgages to commercial mortgages to leveraged buyout loans to credit cards to auto loans. (And I'm probably forgetting a few!)

Let me enter into evidence the the Federal Deposit Insurance Corp.'s latest Quarterly Banking Profile (Warning: Large PDF link) This report comes out every three months, and it always has a treasure trove of information on the banking industry. The headlines and subheads tell quite a story:

"Quarterly Net Income Declines to a 16-Year Low"

"Noncurrent Rate on Mortgage Loans Reaches New High"

"Net Charge-Off Rate Rises to Five-Year High"

"Three Failures in 2007 Is Most Since 2004"

And what about the details? They're pretty awful, too ...

* In the fourth quarter, aggregate profits at the 8,533 institutions the FDIC tracks slipped to $5.8 billion. That was a drop of more than 83% from a year earlier, and the lowest absolute level of net income since the fourth quarter of 1991.

* Return on assets — a key measure of how much profit banks are generating from their assets (loans, securities, etc.) — plunged to 0.18% in the quarter, driven by problems at a few of the nation's largest institutions. That was down from 1.2% a year earlier and the worst performance since 1990.

* Provisions for loan losses — money banks add to their loss reserves when they expect credit performance to sour — soared to $31.3 billion in the fourth quarter. That's the highest level in any quarter ... EVER ... and more than triple what we saw in the same period of 2006.

* Net charge-offs — the hit banks take when they determine that nonperforming loans are essentially a lost cause (adjusted for recoveries on previously charged off loans) — surged to $16.2 billion from $8.5 billion a year earlier.

And again, it wasn't just one category of loans. Charge-offs rose 33% in credit cards ... 58% in the other loans to individuals ... 105% in the commercial and industrial loan category ... and 144% in the residential mortgage business.

Now here's the thing: On my recent trip, I spent a lot of time reading up on the last major banking crisis -- the S&L meltdown. "The Savings and Loan Crisis: Lessons from a Regulatory Failure" isn't exactly beach reading, but it's definitely a useful historical tome. It lays out the general outline of what happened back then for those of you who may not be familiar. In a nutshell:

Interest rate gyrations in the late 1970s and early 80s greatly eroded the capital of the entire S&L industry. Lenders made long-term, fixed-rate mortgages and funded them with short-term borrowings.

When short-term rates rose, their funding costs increased, but they couldn't do anything about those long-term loans. They were stuck holding old mortgages that didn't yield as much as new mortgages ... and the value of those old mortgages plunged.

Legislation then allowed the S&Ls to aggressively expand into new markets, like commercial real estate, in the mid-1980s. The intent was to help the financial firms "earn their way out" of the interest rate problems.

But tax law changes and regional economic downturns struck later in the decade, dealing a death blow to the industry. Failures surged, and we as a country ultimately had to spend around $150 billion cleaning up the mess. You can read more at the FDIC web site if you're so inclined.

Today, the question that people are starting to ask is simple: Are we facing a new rash of failures? Fed Chairman Ben Bernanke was forced to address that question head on yesterday. His answer: "There will probably be some bank failures."

Banks are much better capitalized today than they were back in the S&L days. So I do NOT expect to see as many failures this time around as we saw back then. Yet the lending and capital market problems that financial institutions face today are also more widespread, in my judgment. The decline in home prices is unprecedented in modern history too, and that's driving mortgage delinquencies and losses into uncharted territory.

The number of "problem institutions" flagged by the FDIC is already on the rise. It climbed to 76 in the fourth quarter of 2007 from 65 a quarter earlier and just 50 at the end of 2006. Problem banks are those with "financial, operational, or managerial weaknesses that threaten their continued financial viability." That is still low by historical standards, mind you. But clearly the FDIC is concerned about the trend, as indicated by the recent Wall Street Journal story chronicling how the agency is staffing up.

That brings me to some news that just broke in the last 24 hours: Troubled California S&L Fremont General just warned of additional write downs and reserve additions. This language should have us all sitting up and taking notice:

"... the Bank may need to record additional asset write-downs and reserves, which could result in further losses or, alternatively, will require the Bank to adjust downward its regulatory capital. In either case, such potential adjustments will further erode the Bank's total equity capital of $448.6 million that was reported in the Bank's Call Report publicly filed with the FDIC on January 30, 2008 for the year ended December 31, 2007. In addition, if the possible adjustments are ultimately recorded by the Bank, such adjustments could have an adverse effect on the Company's financial condition, results of operations and business."


"Fremont General also has significant liquidity risk as a result of limited sources of cash available to satisfy its obligations. At December 31, 2007, Fremont General had $21.1 million in cash and cash equivalents for payment of ongoing operating expenses, debt service and inter-company settlements. Since March 2007 when the Company and the Bank first became subject to regulatory enforcement orders, the Company's traditional source of funding (dividends from the Bank) has been disrupted. Without the ability to rely on dividends from the Bank, the Company will require funds from other capital sources to meet its obligations."

Fremont then goes on to say it has retained Credit Suisse and Sandler O'Neill to help it fix its capital deficiency problem. A company sale, or the restructuring of Fremont's senior debt and preferred securities, are options on the table. It's suspending interest payments on certain subordinated debt immediately.

I am NOT suggesting Fremont will fail (even as the stock price was recently down 66% on the day). But this kind of news just underscores how some institutions are really hurting in a way we haven't seen in a long time. In sum, I believe outright failures will be making headlines over the coming 18 months, for the first time in a long time.

The financial horror movie continues

Are you a fan of horror movies? You know, like the Friday the 13th series starring Jason Voorhees? I was more into Nightmare on Elm Street growing up, myself, but have long since stopped watching them. Or at least, I thought I did.

But these days, it's a veritable financial horror movie playing out in the markets. The credit problems -- like Jason, like Freddy -- just won't die, no matter what you throw at 'em. Fed cuts. Super-SIV bailout proposals. Interest rate freezes. Foreclosure postponement programs. Gobs of foreign capital from sovereign wealth funds. It doesn't seem to stem the bleeding.

Just look at what we're learning about this morning ...

* American International Group announced a $5.29 billion loss in the fourth quarter, the biggest quarterly flood of red ink in its 89-year history. Writedown on derivatives: $11.1 billion, pretax, though AIG maintains the mark-to-market losses are not indicative of what it will actually lose over time.

But the firm also took $2.63 billion in pre tax losses on its investment portfolio, plus $643 million in losses in one of its unit's available-for-sale investment security portfolio. The culprit: "significant, rapid declines in market values of certain residential mortgage backed securities in the fourth quarter for which AIG cannot reasonably determine that the recovery period will be temporary."

Royal Bank of Canada had its own $192 million writedown. And I'll have a post up soon about another troubling trend we'll probably be dealing with this year.

* UBS is out there with a forecast that financial companies will lose at LEAST $600 billion during this credit crisis. Bloomberg estimates there have been more than $160 billion in writedowns and credit losses to date.

* Private equity firms are starting to take their own beating, due to the decline in the value of bonds and loans tied to all the leveraged buyouts in recent years. A public buyout fund backed by Kohlberg Kravis Roberts & Co. slashed its investment in one chipmaker by 25% and a stake in a broadcaster by 27%. A stake in a German car-repair company was chopped to the tune of more than 80%.

* And how about those "walk-aways" (or the increase in "jingle mail," if you prefer)? Here's the lede from a New York Times story today (the topic was also covered in a WSJ story):

"When Raymond Zulueta went into default on his mortgage last year, he did what a lot of people do. He worried.

"In a declining housing market, he owed more than the house was worth, and his mortgage payments, even on an interest-only loan, had shot up to $2,600, more than he could afford. “I was terrified,” said Mr. Zulueta, who services automated teller machines for an armored car company in the San Francisco area.

"Then in January he learned about a new company in San Diego called You Walk Away that does just what its name says. For $995, it helps people walk away from their homes, ceding them to the banks in foreclosure.

"Last week he moved into a three-bedroom rental home for $1,200 a month, less than half the cost of his mortgage. The old house is now the lender’s problem. “They took the negativity out of my life,” Mr. Zulueta said of You Walk Away. “I was stressing over nothing.”

I am a huge fan of the work done by the folks behind the Calculated Risk blog, by the way. There was a good post over there recently on this topic that you can read here.

Wednesday, February 27, 2008

New home sales head south again in January

January was another rough month for the new home market. Census Bureau figures (PDF link) show:

* Sales fell 2.8% to a seasonally adjusted annual rate of 588,000 in January from 605,000 in December. From a year earlier, sales were down 33.9%. That leaves them at the lowest since February 1995.

* The supply of homes for sale dipped again to 482,000 in January from 493,000 in December and 536,000 a year earlier. However, on a months supply at current sales pace basis, inventory rose to 9.9 months from 9.5 months in December and 7.2 months in January 2007. That's the most since 1981.

* Median home prices took a large dive -- falling 15.1% to $216,000 last month from $254,4000 in January 2007.

On the other hand, some news just broke that OFHEO will soon lift caps on the growth of the portfolios of Fannie Mae and Freddie Mac. OFHEO is also close to lowering the percentage of excess capital that the GSEs are currently required to hold. Specifically ...

"Since agreements reached in early 2004, OFHEO has had an ongoing requirement on each Enterprise to maintain a capital level at least 30 percent above the statutory minimum capital requirement because of the financial and operational uncertainties associated with their past problems. In retrospect, this OFHEO-directed capital requirement, coupled with their large preferred stock offerings means that they are in a much better capital position to deal with today’s difficult and volatile market conditions and their significant losses.

"As each Enterprise nears the lifting of its Consent Order, OFHEO will discuss with its management the gradual decreasing of the current 30 percent OFHEO-directed capital requirement. The approach and timing of this decrease will also include consideration of the financial condition of the company, its overall risk profile, and current market conditions. It will also include consideration of the importance of the Enterprises remaining soundly capitalized to fulfill their important public purpose and the recent temporary expansion of their mission."

Back from Gotham

Good morning! I know I haven't put up any posts over the past few days, but there's a very good reason for that -- I was in New York City for an intensive training program. Fly in, spend all day Monday and Tuesday in classes, then fly back out. Speaking of which, has anyone reading this EVER been at JFK and not had 30 airplanes in front of them in the take-off line? Just wondering.

Anyway, a lot happened while I was out...

* MBIA and Ambac stepped back from the brink thanks to some ratings news from Moody's and S&P ... but the capital markets are still expressing skepticism about the legitimacy of the bond insurers' top-notch credit ratings.

* Fannie Mae lost a hefty $3.55 billion in Q4. That was good for $3.79 per share, excluding certain items, more than triple the $1.20 per share loss analysts expected. Many lawmakers are looking to Fannie and Freddie to help shore up the mortgage markets by expanding into "formerly jumbo" loans and otherwise filling the breach left by the exodus of private lenders. But as these figures show, the GSEs face significant earnings and credit problems of their own.

* Existing home sales in January came in slightly better than expected, but the overall trend remains the same: Sales down double-digits from year-earlier levels, with median prices falling by the mid single-digits. More importantly (and troubling, in my view) is that inventory for sale is ticking up again on both an absolute basis and a "months supply at current sales pace" basis.

Meanwhile, the S&P/Case-Shiller national home-price index plunged 8.9% year-over-year in the fourth quarter of 2007. That's the largest drop in the two-decade history of the index. The Office of Federal Housing Enterprise Oversight said its price gauge fell 0.3%, the first drop seen in 16 years.

* This Wall Street Journal story has some interesting anecdotes about recent activity in the mortgage market and the Fed's attempts to combat the disappointing trends. In short, the Fed cuts have helped some adjustable rate mortgage holders, but haven't done much for borrowers seeking longer-term fixed-rate financing. An excerpt:

"One reason home prices are falling: Builders are trying to unload their unsold houses. Stuart Kaye, founder of Kaye Homes Inc. in Naples, Fla., has been offering discounts, including price cuts and other incentives, of 20% to 30% on about 50 homes in his inventory. He has sold 18 of them in recent months. "We want to be out from underneath this inventory, and we have made a commitment we will be through it in a 90-day period,'' he said.

But the interest-rate environment has brought a near halt to refinancing activity. P.H. Naffah, a musician in Goodyear, Ariz., has a roughly $415,000, 30-year mortgage with a fixed rate of 6.25%. He figures he could cut his mortgage costs by around $250 a month by refinancing into a loan with a 5.5% rate. "I'm waiting for the interest rates to go down," said Mr. Naffah, who added the savings "would be significant" because his monthly income as a musician fluctuates.

Other borrowers have been hamstrung by tighter credit standards as lenders eliminate programs and set tighter requirements, particularly in markets where home prices are falling. Steve Walsh, a mortgage broker in Scottsdale, Ariz., says his firm is originating about 300 loans a month, but closing only about 65. Mr. Walsh says that about 100 applications fell apart because of problems with appraisals. Another 100 loans didn't close because of rising mortgage rates.

In addition to inflation concerns, rates are rising because the market for mortgage-backed securities is in upheaval, thanks to rising mortgage delinquencies and the collapse of the high-risk subprime corner of the mortgage business."

I posted about this dynamic myself several days ago, in case you missed it.

* The dollar continues to sink into the currency market abyss. It breached the $1.50-to-the-euro level, and sank to a 23-year low against the New Zealand dollar. The catalyst is the ongoing interest rate dynamic around the globe. Our Federal Reserve is slashing interest rates aggressively, while policymakers in the euro region are holding the line, and central banks in some countries -- like Australia -- are actually still RAISING rates.

This makes travelling overseas more expensive for those of us who live in the U.S. But it also has a much bigger, broader impact on the economy -- it fuels inflation. The cost of goods imported from foreign countries rises when your currency declines, no matter how much claptrap the Fed wants to spew about "contained" inflation. Just look at what happened in January ... import price inflation rocketed to 13.7%, the highest in recorded U.S. history.

* Lastly, while the job market isn't so hot nationally, one institution is hiring -- the Federal Deposit Insurance Corp.! Turns out the FDIC is staffing up for a potential wave of bank failures. I've been talking about the potential for an increase in failures for some time. I think it's all but inevitable at this point. Here's an excerpt from the WSJ piece ...

"The notion of bringing back some people who have been through it before is very smart," said William Isaac, who was FDIC chairman from 1981 until 1985. All told, the FDIC has roughly 4,600 employees, far fewer than the about 15,000 it had as recently as 1992.

"On Sunday, the FDIC ran a newspaper ad seeking companies that could service commercial loans, mortgages and student loans in the event of a bank failure. It didn't say how much a company could earn in this area.

"The FDIC rated 65 banks and thrifts as "problem" institutions at the end of the third quarter of 2007, up from 47 institutions a year earlier. Both figures are low by historical standards. At the end of 1993, there were 572 "problem" banks and thrifts. The FDIC is expected to update its data on "problem" institutions today."

Friday, February 22, 2008

CNBC reports ABK bailout plan in the works

Late news from CNBC that Ambac Financial Group may get a bailout after all. The report says something could be announced Monday or Tuesday, and it helped turn the financial markets around. Now we all get to watch and wait to see what kind of deal, if any, ultimately emerges.

UPDATE: More from the FT ...

"A group of banks is preparing to inject $2bn to $3bn into the troubled bond insurer Ambac, which is racing against time to come up with fresh capital to avoid a sharp cut in its triple-A credit rating that could trigger wider financial market turmoil.

"The money from the banks would be part of a plan to split Ambac’s operations, people involved in the discussions said.

"Ambac is also considering raising fresh equity from shareholders. It is not clear how much capital it will need, or what credit ratings the split businesses would have."

The NYT weighs in with a bailout/reform recap

I've been blogging about several of the mortgage industry bailout/reform packages over the past few months. In my humble opinion, some make sense, some don't, and some may be having hardly any impact at all. If you want a recap of those proposals and why they're on the table, here's a good piece from today's New York Times on the topic ...

"Prodded in part by some of the nation’s biggest banks, the Bush administration and Congress are considering costly new proposals for the government to rescue hundreds of thousands of homeowners whose mortgages are higher than the value of their houses.

"Not since the Depression has a larger share of Americans owed more on their homes than they are worth. With the collapse of the housing boom, nearly 8.8 million homeowners, or 10.3 percent of the total, are underwater. That is more than double the percentage just a year ago, according to a new estimate of the damage by Moody's

"Administration officials say they still oppose any taxpayer bailout for either people who borrowed more than they could afford or banks that made foolish loans during the height of the speculative bubble in housing.

"But with the current efforts to arrest the housing collapse so far bearing little fruit, Washington is being forced to explore new ideas, among them the idea of a federal mortgage guarantee for troubled borrowers.

"And policy makers are listening to proposals from industry and community groups to use government funds to purchase and refinance billions of dollars in mortgages now in danger of default."

Meanwhile, the saga continues at troubled lender GMAC. From Bloomberg ...

"GMAC LLC, the lender partially owned by General Motors Corp., agreed to loan as much as $750 million to its residential mortgage unit as it seeks to sell a business that finances vacation resorts.

"Residential Capital LLC borrowed $635 million under the agreement yesterday, the Minneapolis-based company said today in a regulatory filing. GMAC Chief Executive Officer Eric Feldstein has cited the resort operation as one of the company's best performing businesses.

"Pressure on Detroit-based GMAC increased today after Standard & Poor's downgraded its credit ratings and those of the ResCap home-lending unit because of difficulty in funding loans. GMAC, controlled by buyout firm Cerberus Capital Management LP, said Feb. 20 it will shut three-quarters of its North American auto-financing offices this year and cut 930 workers after a $2.3 billion loss last year."

UPDATE: FDIC Chairman Sheila Bair weighed in again on housing and mortgage market conditions, as well as the ins-and-outs of loan modifications and principal reductions. Here's a link to the California speech, if you're interested.

Thursday, February 21, 2008

An intriguing OTS idea to combat the "upside down" problem

I haven't been fond of some of the mortgage bailout/reform proposals that have been put forward. In particular, I don't like the idea of increasing the loan limits for Fannie, Freddie, and the FHA. This is happening in many geographic regions thanks to provisions contained in the economic stimulus package.

Why? Well, Fannie and Freddie have clearly seen losses and delinquencies rise as a result of the housing bust. Delinquency rates have also risen on FHA loans. But the damage has been milder than what we have seen at many private lenders. That's because Fannie and Freddie didn't/couldn't participate in some of the riskiest parts of the mortgage market. Meanwhile, FHA lost market share to private lenders willing to expose themselves to much higher risk. Many of those private lenders are now going bust or cutting back dramatically.

In short, high-risk mortgage lending proved to be a stupid gamble. Private lenders took it, and they're now paying the price for it (as they should in a capitalist economy). So why on earth would we want the GSEs and FHA to make the same mistake -- namely, go further out on the mortgage risk curve? That will only mean THEY suffer the biggest share of losses in the next downturn.

But yesterday brought some surprisingly fresh thinking from the Office of Thrift Supervision. Specifically, the OTS floated an interesting plan to keep upside-down borrowers from abandoning their homes. It would allow those who owe more than their houses are worth to refinance into new loans equal to the CURRENT value of their homes.

The original lender would get part of his original loan paid off. He would also get a "negative equity certificate" equal to the difference between the current value and the original loan balance. The lender could redeem that certificate later on if the value of the house were to rise between the time of the refinance and the time the house was eventually sold.

Confused? This CNNMoney report uses an example to clear things up:

"If a house has a $100,000 mortgage originally," said Bill Ruberry, a press spokesman for the agency, "and the fair market value is $80,000, there's $20,000 in negative equity. The lender could refinance for $80,000 and a warrant [for the $20,000 in lost value]."

If the house later sold for $100,000, the lender would collect the $80,000 mortgage balance plus the $20,000. If the sale realized more than $100,000, the certificate holder might even get interest on top of the $20,000. Any profit beyond that would go to the borrower. The warrants could be publicly traded."

Reuters says Treasury is studying the idea. There's no way to tell if or when something will be put into practice. But it seems like a win for everyone involved.

* Borrowers who want to stay in their homes, but are having trouble making payments on large mortgages and are growing hopeless because they are so upside-down, get to refinance into smaller mortgages equal to the current value of their homes. This "rewards" those willing to stick around and tough out the downturn, and potentially lowers the amount of foreclosures the country would otherwise face.

* Lenders are forced to take a hit on their existing loans, hopefully eliminating the "moral hazard/bailout" problem. But they are given something in return for their willingness to work with their borrowers -- "call options" on the future values of the underlying homes.

* Lastly, the FHA gets smaller loans that leave the underlying borrowers paying a smaller chunk of their incomes on debt service (because the principal amounts being financed would be lower on the new loans than the old loans). Such loans would be more likely to perform over time.

I would even consider going a step further -- capping the new loans at 95% of the current value of the homes in question, with the additional 5% rolled into the negative equity certificate balances. That way, the lenders take bigger penalty hits and FHA gets a bit more cushion built into the bargain.

Drawbacks? Well, a purely market-based solution to this housing mess is best. If we just let home prices fall to levels where average borrowers with typical paychecks can afford to buy homes using traditional mortgages, then true, "natural" demand for housing will return. We'll end up with a healthier housing market over the longer term.

Also, it's likely that home values will continue to fall over the next year or two no matter what the government does, intervention-wise. That means FHA could end up getting a 100% LTV loan today that ends up as a 105% or 110% LTV loan down the road. Result: The borrower defaults anyway, and FHA gets stuck with the loss ... while the original private lender just tears up his call option contract.

And let's be honest -- many homeowners are at a point where they won't even answer their lenders' phone calls. Lots of them will walk away no matter what their lenders are willing to offer. Still, kudos is due to the OTS for some innovative thinking at a time when many bailout proposals are simply misguided or unwise.

February Philly Fed another whopper of a disappointment

The February Philadelphia Fed index just came out, and like last month's reading, it was a whopper of a disappointment. The overall index plunged to -24. That's down from -20.9 a month earlier and far below the -10 reading that economists expected. It's also the worst reading since February 2001 (-29.6).

Meanwhile, the new orders sub-index came in at -10.9, versus -15.2 in January. The employment sub-index came in at +2.5, vs. -1.5, and the prices paid sub-index (a measure of inflation pressures) dipped to 46.6 from 49.8.

Wednesday, February 20, 2008

Housing starts inch higher; permits fall in January

The latest news on housing starts just hit the tape ...

* Overall housing starts climbed 0.8% to a seasonally adjusted annual rate of 1.012 million in January from 1.004 million in December (previously reported as 1.006 million). Economists expected starts to rise 0.4%, according to a Bloomberg survey. Single-family starts were down 5.2%, while multifamily starts rose 22%. On a year-over-year basis, starts were down 27.9% from 1.403 million in January 2007.

* Building permit issuance, on the other hand, dropped. It fell 3% to a SAAR of 1.048 million from 1.08 million in December. That's down 33.1% from January 2007 and the lowest since November 1991. Economists were expecting a drop of 1.7%. Single family permits fell 4.1%.

* Regionally speaking, starts rose in two out of four regions -- 18.9% in the Northeast and 12% in the Midwest. They fell 2.9% in the South and 6.2% in the West. Permitting activity fell 5.8% in the Northeast, 1.5% in the South and 14.1% in the West. Permits rose 10.4% in the Midwest.

The home building industry continues to struggle. Starts remain at depressed levels, while building permit issuance is plumbing depths not seen since 1991. Builders are reluctant to ramp up construction because of the large glut of for-sale homes on the market. They're also keenly aware that tighter mortgage lending standards are impacting demand, and that buyer confidence is low.

The Federal Reserve is attempting to light a fire under the industry by cutting short-term interest rates. Unfortunately, those cuts are coming at a time when inflation is running hot. That has bond investors spooked. They're selling longer-term paper, and that is driving longer-term mortgages rates up, rather than down.

In short, the outlook for home sales, starts and permits isn't all that encouraging. Sales and construction activity will remain muted throughout 2008 and likely into 2009.

The financial blowups will continue until morale improves

That's the lesson of the day (and the past few weeks and months, for that matter). Until and unless credit market sentiment improves, losses will continue to amount in the financial sector and "blowups" -- unexpected surprises like Credit Suisse's out-of-the-blue $2.85 billion writedown yesterday -- will continue. The latest ...

At KKR Financial (via Bloomberg) :

"KKR Financial Holdings LLC, Kohlberg Kravis Roberts & Co.'s publicly traded fixed-income fund, delayed repaying some asset-backed commercial paper and started restructuring talks with its creditors.

"The fund, which invests in corporate debt and mortgages, agreed with holders of its residential mortgage-backed securities to defer repayment a second time, KKR said in a regulatory filing yesterday. About half the debt will be due by March 3 instead of Feb. 15, with the rest owed on March 25. KKR didn't provide details of how much debt is affected.

"The talks come less than six months after the fund received a $230 million cash infusion from investors following losses on residential mortgages in the wake of the U.S. subprime crisis. The fund, led by Chief Executive Officer Saturnino Fanlo, raised a further $270 million in a rights offering with some of KKR's own partners buying shares in it, which had $19 billion of assets at the end of December.

"The picture is getting worse and worse,'' said Felix Freund, who helps manage the equivalent of $14.7 billion of fixed-income securities at Frankfurt-based Union Investment GmbH. KKR's second extension of repayment deadline "shows there is still a lot of levered investments in the credit market that we can't see,'' he said."

At a major U.K. mortgage lender (via Bloomberg): "Alliance & Leicester Plc plunged in London trading to the lowest level since going public in 1997 after the U.K. mortgage lender scrapped its profit target for this year and next because of the seizure in credit markets.

"Alliance & Leicester said today its previous target for earnings per share growth through 2009 of at least 9 percent above inflation "is no longer appropriate'' because of a surge in funding costs and a slowdown in mortgage lending. The company said in a statement that second-half profit fell 67 percent to 73.1 million pounds ($142 million), or 17.4 pence a share.

"The Leicester, England-based company gets almost half its funds in the capital markets and now faces rising costs and declining valuations on asset-backed securities after the U.S. subprime mortgage slump. U.K. rival Northern Rock Plc is being nationalized after a bailout by the Bank of England, while Bradford & Bingley Plc reported an unexpected loss last week.

"The outlook is pretty abysmal,'' said James Hutson, an analyst at Keefe, Bruyette & Woods Ltd. in London who has a "market perform'' rating on the stock. The company's own targets "have been slashed.''

Tuesday, February 19, 2008

Report: GMAC shutting offices

There is some late news out of GMAC LLC, the troubled auto loan and mortgage lender co-owned by General Motors and Cerberus Capital Management. According to Bloomberg, it will close three-fourths of its auto financing offices around Canada and the U.S. Only one of four Canadian facilities will remain open, as well as only four of 16 in the U.S.

Cerberus, if you recall, recently admitted to having "significant concerns" about its GMAC investment, according to a leaked letter to shareholders that the Wall Street Journal obtained.

Watch those long bonds

Long bond futures prices are at an interesting level, at least from a technical perspective. We're testing an uptrend line that dates back to the start of the credit market chaos in mid-2007. How can that be? Isn't the Federal Reserve cutting interest rates?

Well, the Fed cuts have actually been counterproductive when it comes to long-term interest rates. Bond investors are getting increasingly worried that aggressive cuts now will only drive inflation higher later. They're questioning the wisdom of those cuts in the face of $95+ oil (oops, make that $99+), $900+ gold, soaring wheat prices, soaring soybean prices, the biggest rise in import costs in U.S. history, and so on. So they're selling.

That's driving longer-term interest rates up (including those charged on 30-year mortgages). This chart shows the progression of those rates over the past three months. The jump is rather striking.

Update: Long bonds futures held support, finishing the day down 31/32 at 116 1/32. Oil managed to close just above $100, however.

Housing market index inches higher in February

It's been a long time since we've gotten any positive news on the housing front. But February brought some ...

* The National Association of Home Builders' Housing Market Index rose 1 point to 20 from 19 in January. That is still down sharply from 39 a year ago, but it is the highest reading since September 2007.

* The subindex measuring present single-family home sales rose 1 point to 20, while the subindex measuring expectations about future sales dipped 1 point to 27. The big change was in the subindex measuring prospective buyer traffic -- it popped up 5 points to 19.

* Regionally, the HMI was up 3 points to 24 in the Northeast, up 2 points to 24 in the South, and up 2 points to 15 in the West. In the Midwest, the index was unchanged.

Builders haven't had much reason for optimism lately. But an uptick in buyer traffic in February could be one bright spot in a sky full of dark clouds. The well-publicized Federal Reserve interest rate cuts, coupled with some of the government stimulus efforts targeted at the mortgage industry, may have encouraged some buyers to check out what's available. Aggressive discounting may be another potential driver of traffic.

Still, we're talking about an index that remains at extremely depressed levels even after this recent bounce. Moreover, tighter mortgage market conditions will make it harder for some potential buyers to actually close. Bottom line: I would need to see a sustained period of notable improvement in several indicators before getting too excited about the housing market's prospects.

Better get a bigger container

The "well-contained" credit problems keep growing. Now there are signs of trouble ...

At Credit Suisse (from the Wall Street Journal):

"Swiss bank Credit Suisse Group, until now relatively unscathed by the credit crisis, Tuesday said first-quarter earnings will be reduced by $1 billion from mismarkings and pricing errors by traders which led to the reduction in the value of some asset-backed securities by $2.85 billion.

"The news came only a week after the company reported robust fourth-quarter profits largely free of any impact from subprime-credit exposure. The Zurich-based bank said it is reviewing whether the change in value of the securities will impact last year's earnings as well.

"In the first quarter to date, we estimate we remain profitable after giving effect to these reductions," the bank said."

At Lehman Brothers (also from the WSJ):

"Many investors have been surprised at the ability of Lehman Brothers Holdings Inc. to navigate the credit crunch, given the size of its exposure to potential land mines.

"But there are growing signs that the New York investment bank's latest quarter will be the rockiest since the mortgage crisis began. Behind the worry: Lehman is sitting on a big pile of commercial real-estate loans, and that market is deteriorating, potentially causing bigger-than-expected write-downs.

"In recent weeks, credit markets have worsened, and Lehman believes it is now facing a write-down in the $1.3 billion range, according to people familiar with the matter. That has risen from a recent estimate of $800 million to $1 billion, and from a $830 million write-down in the fourth quarter."

At Bank of Montreal (from Bloomberg):

"Bank of Montreal, Canada's fourth- largest bank, said it will report costs of about C$325 million ($323.9 million) for trading and investment writedowns in the first quarter.

"The Toronto-based bank also said in a statement today it named Thomas Flynn as Chief Risk Officer, replacing Robert McGlashan."

And in the leveraged loan market (once more from the WSJ):

"U.S. and European banks, already reeling from persistent losses on mortgage investments, are facing a new hit as the global financial crisis spreads to deteriorating corporate debt.

"UBS AG and Credit Suisse Group last week announced the write-down of a combined $400 million in the value of leveraged loans as part of their fourth-quarter earnings reports. That signals more misery right around the corner for banks that barreled into these low-rated corporate loans, which typically are issued by banks and sold to investors like junk bonds, and are stuck holding them. Leveraged loans served as buyout-related debt that fueled a merger boom until the credit slowdown.

"Credit Suisse, Switzerland's second-largest bank in stock-market value, valued its leveraged-finance portfolio of loans and bonds at a 6.3% discount as of Dec. 31. That suggests the loans and bonds have an average value of 93.7 cents on the dollar. Meanwhile, two corporate-loan credit-derivative indexes have fallen sharply in the past two weeks, indicating negative sentiment and falling demand.

"If the trend holds, analysts and investors are bracing for as much as $15 billion in leveraged-loan-related write-downs at commercial and investment banks in the first quarter, further depleting capital levels already sapped by the mortgage mess. Estimates of the markdowns range from 2% to 10%."

Indeed, U.S. banks are in such bad shape, they're tapping the Federal Reserve for massive amounts of money. Per the FT ...

"US banks have been quietly borrowing massive amounts of money from the Federal Reserve in recent weeks by using a new measure the Fed introduced two months ago to help ease the credit crunch.

"The use of the Fed’s Term Auction Facility, which allows banks to borrow at relatively attractive rates against a wider range of their assets than previously permitted, saw borrowing of nearly $50bn of one-month funds from the Fed by mid-February.

"US officials say the trend shows that financial authorities have become far more adept at channelling liquidity into the banking system to alleviate financial stress, after failing to calm money markets last year.

"However, the move has sparked unease among some analysts about the stress developing in opaque corners of the US banking system and the banks’ growing reliance on indirect forms of government support.

"The TAF ... allows the banks to borrow money against all sort of dodgy collateral,” says Christopher Wood, analyst at CLSA. “The banks are increasingly giving the Fed the garbage collateral nobody else wants to take ... [this] suggests a perilous condition for America’s banking system.”

I'm just going to go back to a long-standing message of mine -- This was NEVER just a residential mortgage problem. Lenders played fast and loose with credit in several markets, from residential real estate to commercial real estate to LBO-land. Now, they're paying the price.

Monday, February 18, 2008

More on "financial WMD"

"Financial weapons of mass destruction." That's what Warren Buffett called derivatives back in his 2002 letter to shareholders (see this pdf link, page 15). Those comments certainly seem germane today, especially in light of the almost daily headlines about more turmoil in the credit market. Many forms of complex derivatives are causing big problems in the financial industry. Some contracts can't be valued at all. And the values being put on those that can are causing widespread writedowns and headaches.

If you didn't check out the cheery New York Times story "Arcane Market Is Next to Face Big Credit Test" over the weekend, it may help better explain potential problems in one derivatives market for you. Here's an excerpt:

"Few Americans have heard of credit default swaps, arcane financial instruments invented by Wall Street about a decade ago. But if the economy keeps slowing, credit default swaps, like subprime mortgages, may become a household term.

"Credit default swaps form a large but obscure market that will be put to its first big test as a looming economic downturn strains companies’ finances. Like a homeowner’s policy that insures against a flood or fire, these instruments are intended to cover losses to banks and bondholders when companies fail to pay their debts.

"The market for these securities is enormous. Since 2000, it has ballooned from $900 billion to more than $45.5 trillion — roughly twice the size of the entire United States stock market.

"No one knows how troubled the credit swaps market is, because, like the now-distressed market for subprime mortgage securities, it is unregulated. But because swaps have proliferated so rapidly, experts say that a hiccup in this market could set off a chain reaction of losses at financial institutions, making it even harder for borrowers to get loans that grease economic activity."

Also, be sure you check out the multiple posts I've been putting up on this topic for months, including here and here, as well as this post referencing some comments from Bill Gross at Pimco

Still not concerned about financial WMD? Then sit down, grab a cup of coffee and read about a potential "correlation crisis" over at the FT ...

"The world of synthetic collateralised debt obligations is suffering as the cost of protecting corporate debt against default via credit derivatives – from which these CDOs are created – continues to be pushed higher.

"But there is another problem building, and some fear it could lead to a repeat of the correlation crisis of 2005, which saw hedge funds and investment banks suffer hundreds of millions of dollars worth of losses.

"The problem then was that investment banks and hedge funds had built up large exposures to the riskiest equity tranches of synthetic CDOs, which pay the highest returns but bear the first losses from any defaults in an underlying pool of credit derivatives.

"When sentiment changed suddenly after the shock downgrades of US carmakers GM and Ford, these investors found that there was no market for the risk they held.

"Now a similar correlation pattern has emerged as hedge funds have loaded up on the same risk by selling protection on equity tranches."

On the up side, it is a holiday here in the U.S. (at least for SOME people, grumble, grumble) So if you don't feel like worrying about an alphabet soup of derivatives and structured finance securities, by all means, turn off your computer and go enjoy yourself. I'm sure there will be a new crisis to worry about tomorrow at the rate things are going!

Friday, February 15, 2008

Losses, delinquencies, and foreclosures, oh my! Plus, fugly economic data

Forget lions, tigers, and bears. The news in mortgage-land this morning is about losses, delinquencies, and foreclosures. A few tidbits:

* Countrywide Financial reports data every month about the performance of the loans in its servicing portfolio. It's worth following the numbers because CFC's portfolio is so large -- roughly $1.48 trillion. In January, the delinquency rate (as a percentage of unpaid principal balances) surged to 7.47% from 4.32% a year earlier. That was also up from 7.2% in December. The rate of foreclosures pending almost doubled to 1.48% from 0.77% in the year-earlier period (and 0.70% in December 2007).

* The third-largest mortgage insurer in the U.S., Radian Group, announced a $618 million loss in the fourth quarter. The report follows MGIC's bad news from the other day. In the quarter, Radian's provision for losses jumped more than eight-fold to $688 million from $84 million a year earlier.

* Meanwhile, did you get a load of those economic stats out this morning? They were, to borrow a phrase from one of my friends "F-ugly." You can figure out what that means for yourself. January import prices soared 1.7%, more than three times the 0.5% rise that was expected. That pushed the year-over-year import inflation rate to 13.7% -- the highest ever recorded in the U.S. (the data goes back to 1982).

Was it all just oil? No. Import prices, ex-petroleum, rose 0.6% on the month. And if you strip out all fuels, you still get a 0.7% rise. That's good for a 3.6% ex-oil YOY inflation rate, the highest since October 2005, which itself was the highest since the mid-90s. Of particular note: China is going from a deflationary force to a potentially inflationary one. The price of imports from China surged 0.8% in January, up from 0.1% a month earlier and the biggest one-month gain back to January 2004, the earliest for which I have data.

On the growth side of the ledger, the Empire Manufacturing index plunged to -11.7 in February from 9 a month earlier. That was far worse than the 6.5 reading that economists polled by Bloomberg expected and the lowest since April 2003 (-16.5). The index tracking prices paid surged to 47.4 from 40.2 in January, while the index measuring new orders dropped to -11.9 from 0, and the index measuring employment fell to -2.1 from 2.4.

UPDATE: A few more economic reports have come out this a.m. Industrial production was up 0.1% in January, right in line with expectations. Capacity utilization held at 81.5%, slightly above the 81.3% that economists were looking for. The University of Michigan's consumer confidence index plunged to 69.6 in February, versus expectations for a drop to 76 from 78.4 in January. That's the lowest reading this indicator has registered since February 1992 (68.8)

Thursday, February 14, 2008

Long bonds getting massacred;FGIC ratings cut

In other interest rate news, long bonds are getting massacred in late trading. I'm showing the long bond futures off 1 23/32 at last count, a drop of 1.46%. That's good for an 11 basis point surge in yields to 4.65%. Short-term yields are up just a bp or two, meaning the yield curve is steepening dramatically.

Meanwhile, the stock market took a quick dip this afternoon after Moody's Investors Service came out and cut FGIC's ratings. The holding company's senior debt rating was lowered to Ba1 from Aa2, while the insurer financial strength rating of its operating subsidiaries was cut to A3 from Aaa. In announcing the move, Moody's said:

"These rating actions reflect Moody's assessment of FGIC's meaningfully weakened capitalization and business profile resulting, in part, from its exposures to the US residential mortgage market. These ratings remain on review for possible downgrade, reflecting continuing uncertainty about the firm's strategic and capital plans. An unfavorable outcome in those areas could lead to a lower financial strength rating most likely to the Baa level."

If you're not familiar with the ratings scale, this Moody's backgrounder might help you. Suffice it to say Aaa is better than Aa, which is better than A. Within those letter grades, there are numerical subgrades -- 1 is better than 2, which is better than 3.

Fitch: Auto delinquencies hit 10-year highs; Plus, an update on commercial real estate

Lots of news flying around. One such update from Fitch Ratings just hit on the performance of prime and subprime auto loan Asset Backed Securities (ABS). The firm says its 60 day+ delinquency index for prime auto loans in ABS securitizations climbed to 0.77% in January. That's up 44% from a year ago and the highest in 10 years. The subprime auto loan delinquency rate hit 4.03%, up 43% from a year ago and the highest since late 1997.

One other item that caught my attention: Reed Construction Data said the value of non-residential construction starts fell 13.1% year-over-year in January. Commercial starts fell 26.2% and industrial starts dropped 56.8%, with office starts running at the lowest level in almost two years. Only military facilities, parking garages, and hotels saw increases.

It'll be interesting to see when the government's non-residential construction data starts to roll over. Nonresidential construction spending has increased every month since September 2006, but the December rise was miniscule (+0.04%). And the Wall Street Journal recently noted that signs of weakness are emerging. Certainly, the degree of tightening in commercial real estate financing points to a tougher funding environment for commercial developers.

NAR: Q4 prices fall in a record number of metropolitan areas

Every quarter, the National Association of Realtors releases figures on metropolitan area home prices. The Q4 2007 numbers (PDF link) were just released today, so let me take a minute to go through the key highlights:

* Prices fell in 77 (51.3%) of the 150 metropolitan areas that the NAR tracked. That was the most since the group began collecting this information in 1979. It's also up from 36% in Q3 and 34% in Q2.

* The decline for single-family homes across the U.S. came to 5.8% year-over-year. Prices fell the most in the West (-8.7%) and the least in the Midwest (-3.2%).

* Which markets fared the worst? Lansing-E.Lansing, MI saw prices fall 18.8%; Sacramento-Arden-Arcade-Roseville, CA witnessed an 18.5% decline; Riverside-San Bernardino-Ontario, CA was off 16.8%; Jackson, MS was down 16.8%; Decatur, IL was down 15.9%; and Los Angeles-Long Beach-Santa Ana, CA experienced a 13.1% drop. Other markets in Florida and the Midwest were also weak.

* The best performing metros were Cumberland, MD/WV at +19%, Yakima, WA at +18%, Binghamton, NY at +14.8%, Kennewick-Richland-Pasco, WA at +14%, and Bismarck, ND at +13.5%.

The spreading credit crunch and the winding down of the housing and mortgage boom continue to drive house prices lower in a wider range of U.S. markets. The speculative buyers that fueled large price gains in places like California and Florida are now trying to sell, or being foreclosed on. Meanwhile, economic weakness and job losses in certain areas of the U.S. are hurting values there.

The Federal Reserve is trying to blunt the impact of the bust by cutting interest rates. We have also seen other forms of aid targeted at borrowers who face ARM rate resets and borrowers who need "jumbo" home loans. But for-sale inventory levels remain high. Lending standards are still being tightened. And home prices are still -- even now -- out of line with underlying incomes in many markets. As a result, prices will likely slump further in 2008.

Bernanke, Paulson on the Hill...

In case you weren't aware, both Federal Reserve Board Chairman Ben Bernanke and Treasury Secretary Henry Paulson are speaking before the Senate Banking Committee this morning about the state of the economy and the financial industry. You can read Bernanke's prepared remarks here. And you can watch a live webcast by going to this Committee page.

Wednesday, February 13, 2008

S&P cuts mortgage insurer outlooks; Fitch survey finds credit pessimism widespread

Some news out of S&P this evening ...

"Standard & Poor's Ratings Services said today that it took rating actions--mostly unfavorable--on several U.S. mortgage insurers and their core and dependent foreign subsidiaries ...

"These changes resulted from a reassessment of our expectations for the sector," explained Standard & Poor's credit analyst James Brender. Deterioration in the housing markets and performance of all types of mortgages (prime, Alt-A, and subprime) has caused Standard & Poor's to revise its expectations for all U.S. mortgage insurers' loss costs from mortgages originated in 2005, 2006, and 2007. We also have concerns that the 2008 vintage could be unprofitable because of falling home prices and a high percentage of new insurance written from mortgages with loan-to-value (LTV) ratios of more than 95%. Mortgage insurers have announced pricing and underwriting initiatives to address this issue, but Standard & Poor's believes it is still something that should be closely monitored."

The actions vary from insurer to insurer, with most firms either placed on CreditWatch with negative implications or suffering an outlook downgrade to negative from stable.

Meanwhile, a Fitch Ratings survey of institutional investors found some interesting things -- namely that money managers are fairly pessimistic about the outlook for the credit markets in 2008. Here's a summary and some excerpts:

"Stability in the U.S. credit markets is not expected to return until third quarter-2008 or later, while stability in the housing market is likely even further off, according to the latest Fitch Ratings/Fixed Income Forum Survey of institutional investors. This survey is conducted by Fitch semi-annually in partnership with the Fixed Income Forum and received responses from 88 institutional investors.

"Viewed as most critical to restoring stability to the credit markets was 'confidence in financial disclosure of mark-to-market losses.' 'Investors are clearly concerned about financial firms exposure to the current downdraft in securities prices, and want clarity as to the market losses experienced to date,' said Managing Director James Batterman. Also viewed as important were 'home price stabilization' and 'further fed easing', while 'government driven remedies' were viewed as potentially harmful or simply not important.

"A weakening economy is viewed as the greatest risk to the credit markets among U.S. institutional investors. Other risk factors include 'housing market disruptions', failure of a financial institution or hedge fund, and geopolitical risk. The results are a significant reversal of investor sentiment since Fitch's June 2007 survey when shareholder-friendly activities were cited as the biggest threat, and the broader economy was not generally considered to be a large risk factor.

"Respondents were nearly unanimous (99%) in their belief that the risk of a U.S. recession is either moderate or high, while fully 100% of respondents expect the default rate to increase at least moderately in 2008, with about half of these expecting the rate to move significantly higher. This is an abrupt change from the 2007 mid-year survey, in which a very small minority expected to see a significant increase in defaults. 'Softening economic growth and the credit crunch are weighing heavily on the minds of investors and understandably so,' said Managing Director and head of Credit Market Research Mariarosa Verde. 'Investors realize that current gloomy conditions, especially if prolonged, will provide more than enough fuel for rising defaults.'"

January home sales tank in my neck of the woods

Every month, we get a smattering of reports on home sales in various regions before the "official" data comes out from the National Association of Realtors. The sales news out of Southern California from Dataquick, for instance, was downright awful. Home and condo sales there plunged 45% year-over-year in January, sinking below the 10,000-unit mark for the first time on record (DQ data goes back to 1988).

In my neck of the woods, a real estate brokerage firm called Illustrated Properties releases some numbers on local sales. The latest figures show that January was yet another rough month for housing here:

* Sales fell 45.3% YOY to 383 units from 700 in January 2007.

* The inventory of homes for sale rose 7.3% to 24,550 from 22,888. That means we had roughly 64 months (or more than 5 years) of supply on the market -- a truly staggering sum.

* What did prices do in response? They tanked. The median price of an existing home fell 19.2% YOY, or $57,000, to a new cycle low of $240,000.

The question as we head into the spring is whether or not lower interest rates from the Federal Reserve, the government stimulus package, the expansion of the role of Fannie Mae, Freddie Mac, and FHA in mortgage lending, and other measures can finally help revive the moribund housing market. Only time will tell.

Morgan Stanley swinging the axe at its mortgage ops

Morgan Stanley just announced that it will scale back its U.S. mortgage business and cease all residential mortgage operations at Advantage Home Loans, its U.K. lending arm. The moves will lead to 1,000 layoffs. The company said it plans to continue servicing loans through its Saxon unit and will also continue to offer home loans to its retail brokerage clients.

In other news, the yield on the 2-year Treasury Note is setting a new low for the cycle of 1.87%, off about 4 basis points on the day. For some perspective sake, the modern low for 2-year notes was 1.08% on June 13, 2003.

Now THAT's a loss...

MGIC Investment is the top U.S. mortgage insurer, the one that recently announced that it was cutting back its exposure to certain mortgage products in certain locations. And boy did it just report a whopper of a loss in the fourth quarter. Some details:

* The company's net loss was an astonishing $1.47 billion, or $18.17 per share, compared with a year-earlier profit of $121.5 million, or $1.47 per share. Even if you exclude investment losses, you see the firm lost more than twice as much per share as analysts expected.

* Claims from bum mortgages skyrocketed to $1.35 billion from $187.3 million a year earlier. Cure rates are low, while loss severities are high.

* MGIC also said it has hired an advisor to help it look into boosting capital.

For some other interesting reading, check out "Fed Interest-Rate Cuts Fail to Lower Borrowing Costs" at Bloomberg. This quote sums things up rather well:

"It's the clogging up of the credit markets that worries me most,'' Harvard University economist Martin Feldstein said in an interview in New York. "The Fed has done a lot of cutting, the question is whether it's going to get the traction that it did in the past.''

And if you missed it, here's another gem "Americans Selling Homes See Prices Go Below Mortgage." A key excerpt:

"By the end of this year as many as 15 million U.S. households may owe more on their mortgages than their homes are worth, according to an estimate from Jan Hatzius, chief U.S. economist of New York-based Goldman Sachs Group Inc. That may fuel an increase in foreclosures, erode prices, and increase mortgage bond losses, he said in a Feb. 1 report.

"If borrowers who are underwater go into foreclosure, the properties are likely to be sold at discount prices and will further depress the price of housing,'' said Robert Engle, a Nobel laureate in economics who teaches at New York University's Stern School of Business in Manhattan. "It becomes a spiral.''

Tuesday, February 12, 2008

More on Project Lifeline

The news already leaked yesterday, but here are some more details on the Project Lifeline plans announced today ...

From Bloomberg:

"Bank of America Corp., Citigroup Inc. and four other U.S. lenders agreed with Treasury Secretary Henry Paulson to take new steps to help borrowers in danger of foreclosure stay in their homes.

"Paulson and the banks offered a 30-day freeze on some foreclosures while loan modifications are considered. The Treasury chief, with Housing and Urban Development Secretary Alphonso Jackson, said today at a news conference in Washington that "Project Lifeline'' would help stabilize communities disrupted by mortgage defaults.

"If someone is willing to make a call, to reach out, there's a chance they can save their home,'' Paulson said. "As our economy works through this difficult period, we will look for additional opportunities to try to avoid preventable foreclosures.''

"The program is designed to help a broad range of homeowners, not just subprime debtors who borrowed more than they could afford. Still, it won't help everyone, Paulson said. The U.S. housing correction "is not over'' and "the worst is just beginning'' for subprime borrowers who face higher interest rates in the next two years, he said.

"In a statement, the banks said the program would start with a letter to homeowners more than 90 days delinquent on payments that lays out procedures for them to "pause'' the foreclosure process. The homeowner has 10 days to respond to the notice and give additional financial information so the lender is able to weigh new payment options."

Here's more coverage from the AP. Here is the statement from Treasury Secretary Henry Paulson on the plan. Here is how the HOPE NOW alliance folks say it'll work (PDF link):

"The program will begin by servicers sending a letter to seriously delinquent homeowners. This program reaches all loans, Prime, Alt a, Subprime and second liens. The servicers will reach out to homeowners with the following straightforward steps that may qualify them for a loan modification:

1. Call your mortgage servicer

2. Tell the servicer you received a letter, you want to stay in your home and you are willing to seek counseling, if necessary

3. Provide updated financial information so the servicer can explore a suitable solution

4. If appropriate, any pending foreclosure will be ‘paused’ for up to 30 days during the review process until a formal decision is made and a plan is created

5. If a workout plan is established and the homeowner follows the plan for three consecutive months, their loan will be formally modified as they have demonstrated their ability to meet the requirements"

Monday, February 11, 2008

Reuters: Foreclosure postponement plan coming

From Reuters this afternoon ...

"Six of the largest U.S. mortgage lenders on Tuesday will announce a program to identify seriously delinquent borrowers and halt any foreclosure process while they try to work out a new payment scheme, sources familiar with the plan said on Monday.

"The lenders will unite under the program, dubbed 'Project Lifeline,' to identify borrowers more than 90 days delinquent and stall any foreclosure proceedings while they try to develop new loan terms, the sources told Reuters.

"A source had earlier said the plan was only available to borrowers who have missed payments for 60 days."

One other key point:

"Lenders do not imagine an open-ended freeze on foreclosure proceedings but rather would offer a reasonable period of forbearance so that lenders can determine if a borrower could manage new loan terms, a source familiar with the plan said."

Another mortgage insurer stepping back from high-LTV loans

Interesting nugget out of PMI Mortgage Insurance in an 8-K filing just now ...

"As disclosed in our Quarterly Report on Form 10-Q for the quarter ended September 30, 2007, our U.S. mortgage insurer, PMI Mortgage Insurance Co. ("PMI") initiated pricing and underwriting guideline changes in 2007 with respect to, among other loan products, loans with loan to value ratios in excess of 97.00% ("Above 97s"). These pricing and underwriting guideline changes were based upon PMI's review of its portfolio and in response to substantially higher demand for mortgage insurance coverage of Above 97s. As a result of these changes, the percentage of Above 97s in PMI's new insurance written declined in the fourth quarter of 2007 to 21%, compared to approximately 32% of PMI's primary new insurance written for the full year of 2007.

"Effective March 1, 2008, PMI will institute additional underwriting guideline changes which will, among other things, preclude future mortgage insurance coverage by PMI through its primary flow channel of Above 97s."

This fits with the MGIC announcement the other day.

AIG says "Oops, my bad"

Yes, that's a tongue-in-cheek reference to the movie Clueless. Unfortunately, the subject matter isn't quite so funny. Global insurance giant American International Group announced in an 8-K filing earlier today that it is having some issues related to the value of its portfolio of certain derivatives. The language in the filing is extremely complex (see the excerpt below about such everyday, household items as the "Binomial Expansion Technique" model).

But the impact of the announcement is significant on the market -- AIG shares were recently down more than 11% and the long bond futures are flying -- up a full point on this news. And it's not like the credit markets were stable coming into today's U.S. session anyway.

"In connection with the preparation of its 2007 financial reports, American International Group, Inc. ("AIG") has recently concluded that AIG should clarify and expand its prior disclosures relating to the methodology and data inputs used to determine the fair values of the super senior credit default swap portfolio in respect of multi-sector collateralized debt obligations ("CDOs") of AIG Financial Products Corp. and AIG Trading Group Inc., including their respective subsidiaries (collectively, "AIGFP"). As disclosed in AIG's Quarterly Report on Form 10-Q for the quarter ended September 30, 2007 (the "Form 10-Q"), AIGFP values its super senior credit default swaps using internal methodologies that utilize available market observable information and incorporate management estimates and judgments when information is not available. In doing so, it employs a modified Binomial Expansion Technique ("BET") model that currently utilizes, among other data inputs, market prices obtained from independent sources, from which it derives credit spreads for the securities constituting the collateral pools underlying the related CDOs. The modified BET model derives default probabilities and expected losses from market prices, not credit ratings. The initial implementation of the BET model did not adequately quantify, and thus did not give effect to, the benefit of certain structural mitigants, such as triggers that accelerate amortization of the more senior CDO tranches."

Later on in the filing, AIG also notes the following:

"The fair value of the super senior credit default swap portfolio for the year ended December 31, 2007 will reflect continuing refinements, if any, of AIG's valuation methodologies and additional market data. AIG has been advised by its independent auditors, PricewaterhouseCoopers LLC, that they have concluded that at December 31, 2007, AIG had a material weakness in its internal control over financial reporting and oversight relating to the fair value valuation of the AIGFP super senior credit default swap portfolio. AIG's assessment of its internal controls relating to the fair value valuation of the AIGFP super senior credit default swap portfolio is ongoing, but AIG believes that it currently has in place the necessary compensating controls and procedures to appropriately determine the fair value of AIGFP's super senior credit default swap portfolio for purposes of AIG's year-end financial statements."

WSJ: The credit problems are not "well contained" to the residential mortgage arena

I've been saying for quite some time that credit market problems are not isolated to residential mortgages. We saw too many silly private equity deals and too much aggressive LBO lending in recent years, as well as dumb commercial real estate behavior. And now, as the Wall Street Journal notes:

"A widening array of financial-market problems threatens to trigger a new phase in the global credit crunch, extending it beyond the risky mortgages that have cost banks and investors more than $100 billion in losses and helped push the U.S. economy toward recession.

"In the past few days, low-rated corporate loans -- the kind that fueled the buyout boom of recent years -- have plummeted in value. As a result, banks are expected to try to unload some of those loans this week at fire-sale prices.

"Nervous buyers also have retreated in recent days from the market for securities backed by student loans and municipal bonds, roiling some corners of the short-term money markets. Similarly, investors have recoiled from debt backed by commercial real estate, such as office buildings."

Can the Fed plug all these holes in the dike with its aggressive interest rates cuts? That's the question before Wall Street. My sense is that we need a longer purging process -- meaning more write-downs, more capital raisings, and so on -- before the stage can be set for a healthy recovery in the financial system.

Thursday, February 07, 2008

Long Bonds get Punk'd

Just a quick note in between sessions -- the long bond auction today was decidedly punk. The Treasury sold $9 billion of 30-year notes at a yield of 4.45%. That was above the 4.42% that traders had anticipated. Indirect bidders purchased just 10.7% of the bonds sold, the lowest reading since sales of 30-yr. paper started up again in February 2006.

As one observer told Bloomberg:

"The auction went as poorly as one could imagine," said Andrew Brenner, co-head of structured products in New York at MF Global Ltd., the world's largest broker of exchange-traded futures and options contracts. "There isn't a lot of demand for bonds at these levels."

December pending home sales dip

The National Association of Realtors just released its latest pending home sales figures. Pending sales fell 1.5% on the month, or 24.2% from year-ago levels. Economists polled by Bloomberg expected a 1% decline. The index fell in three out of four regions of the country, losing 1.7% in the Northeast, 3% in the South, and 3.1% in the West. By comparison, sales popped
3.4% in the Midwest. The pending sales index, at 85.9 in December, is just off its low of 85.5 in August.

On the road...

I'm in Orlando for a conference right now, so any blog posts will likely be short and sweet (or at least short!). One thing to note this morning: The credit crunch/constriction continues. Take a look at what mortgage insurer MGIC just announced, as chronicled in a Bloomberg story:

"MGIC Investment Corp., the largest U.S. mortgage insurer, said it is scaling back coverage in 18 states, including all of California and Florida, to reduce losses on loans to the riskiest borrowers.

"MGIC will also limit protection to homebuyers with the lowest credit scores and whose loans account for the highest percentage of the property's total value, the Milwaukee-based company said today in a regulatory filing. The changes will become effective on March 3.

"Mortgage insurers, which reimburse lenders when borrowers don't repay debts, have been pummeled by the worst housing slump in 25 years. MGIC posted its first-ever loss in last year's third quarter and cut its dividend by 90 percent. Florida had the second-highest foreclosure rate in December after Nevada, where MGIC is also scaling back. California ranked fourth, according to RealtyTrac."

In short, the Fed can cut rates in an attempt to pump money into the banking system and the economy. But if lenders tighten standards and companies like MGIC step back from insuring certain mortgages in certain locales, the impact from Fed cuts on Main Street borrowers will be muted.

Tuesday, February 05, 2008

Disastrous ISM Services reading

It looks like the Institute for Supply Management's figures for January may have leaked early, according to CNBC. Whether that was the case or not, the group upped the release time to a few minutes ago from the customary 10 a.m. time. And the results were anything but good ...

The overall ISM sank to 41.9 from 54.4 a month earlier. That was the worst reading since October 2001, right after the 9/11 attacks. The subindex for new orders tanked to 43.5 from 53.9 -- also the lowest reading since October 2001. And the subindex for employment dropped to 43.9 from 51.8 -- the lowest since February 2002.

The CDO ratings knife may be coming out again soon

From Bloomberg this morning...

"Collateralized debt obligations may be downgraded as many as five levels as mortgage-related losses force Fitch Ratings to review its criteria.

"The biggest cuts will be to AAA rated CDOs that are based on credit-default swaps and aren't actively managed, according to ratings guidelines proposed by Fitch today. CDOs that package high-yield assets may be cut as many as three levels for the portions first in line for losses.

"Ratings firms are responding to criticism that they failed to react quickly enough as rising defaults on subprime mortgages in the U.S. caused a plunge in the value of CDOs, securities that package other debt. Fitch cut ratings on $67 billion of mortgage- linked CDOs in November, slashing some AAA rated debt to speculative grade, or junk."

For details on Fitch's latest action, you can go here. You can also read about many of the other recent ratings actions in MBS and structured finance in this post.

Monday, February 04, 2008

Fed survey: Lending standards tightening across the board

Every quarter, the Federal Reserve conducts a study of bank loan demand and underwriting standards. The "Senior Loan Officer Opinion Survey on Bank Lending Practices," in the words of the Fed, is designed to shed some light on "changes in the standards and terms of the banks' lending and the state of business and household demand for loans." The latest survey (PDF Link) was conducted in January; 56 domestic banks and 23 foreign banks with operations here in the U.S. responded.

The results are reported in terms of "net tightening/loosening." Specifically, the Fed adds up the percentage of banks that either "tightened considerably" or "tightened somewhat" in a given loan category and nets that out against the percentage of banks that "eased somewhat" or "eased considerably." On this page, which has historical data, a positive percentage figure means more banks tightened than loosened; a negative percentage figure means more banks loosened than tightened.

So what did the latest survey show? That lenders are tightening standards across the board. Specifically ...

* A net 32.2% of lenders tightened standards on commercial and industrial (C&I) loans to large- and mid-sized customers in Q1 2008. That was up from 19.2% in the prior quarter and 0% a year earlier. This measure hasn't been higher since Q1 2002 (45.4%). Moreover, 43.6% of those surveyed were increasing the interest rate premium they charged C&I borrowers above and beyond their cost of funds. That's up from 34.6% a quarter earlier and the highest reading since Q4 2001 (58.9%).

* What about commercial real estate (CRE) loans? Fasten your seat belt. A whopping 80.3% of lenders tightened standards there. That's up from 50% in Q4 2007 and 26.3% a year earlier. Not only that, but it's also the highest reading since the Fed began reporting figures in 1990. Incidentally, demand for CRE loans is tanking -- 46.5% of those surveyed reported falling demand for CRE financing, the worst reading since Q4 2001 (-51.8%).

* The residential mortgage business is in even worse shape. The Fed has only been reporting separate net tightening figures for prime mortgages, "nontraditional" mortgages, and subprime loans since Q2 2007. Some 71.5% of lenders were tightening standards in subprime, while 84.6% were tightening standards in the nontraditional market (think Alt-A loans here). Those were the highest readings yet.

More importantly, a net 52.9% of lenders surveyed were tightening standards on PRIME mortgages. That's up from 40.8% a quarter earlier and the highest the Fed has ever found. If you use the historical data series, the previous peak tightening reading for residential mortgages was 32.7% in Q1 1991.

* Last but not least, the percentage of lenders tightening standards on credit card loans jumped to 9.7% from 3.2% in Q4 2007. That's the highest since Q2 2003 (a tie). The tightening percentage for other consumer loans is now running at 32.1%, the highest since the Fed began collecting data on that category of loans in 1996.

My take on these figures:

Bankers have gone from exceedingly giddy to extremely grim in a span of just a few quarters. It's easy to see why. They were already facing substantial -- and rising -- losses on residential mortgages. Now, the economy is weakening and the threat of recession is very real. As a result, the credit quality of their commercial real estate, credit card, and auto loan portfolios are starting to deteriorate.

The Federal Reserve is clearly trying to combat this newfound stinginess by cutting interest rates. But it remains to be seen how bankers will react ... or how long it will take to re-liquefy the credit markets.

Ratings agency loss estimates keep ratcheting higher

In what has become an almost-daily occurance, another ratings agency has increased its loss estimates for securities tied to the housing market. The latest move by Moody's covers Collateralized Debt Obligations with mortgage exposure. I've excerpted a few of these recent statements so you can get a sense for what these guys are saying:

From Moody's on CDO loss estimates, 2/4/08:

"Moody's Investors Service today announced that effective immediately it is revising its expected loss assumptions used for surveillance of ratings of Structured Finance CDO transactions (SF CDOs) holding 2006 vintage subprime residential mortgage-backed securities (RMBS). The announcement was made in light of expectations for continued performance deterioration among 2006 vintage subprime RMBS, as detailed in a Moody's special report published earlier this week, "Moody's Updates Loss Projections for 2006 Subprime Loans".

"Moody's stated that for purposes of monitoring its ratings of SF CDOs with exposure to 2006 subprime RMBS it will rely on certain projections of the lifetime average cumulative losses for 2006's quarterly vintages of RMBS set forth in the recent Moody's Special Report. That report illustrated average loss results for the 2006 quarterly vintages under five distinct loss projection scenarios. Moody's explained that it will utilize the range of loss projections set forth in Scenarios 2 and 3 based on deal performance and quarterly vintage to modify its prior assumptions of the expected loss inputs when monitoring SF CDO ratings. The scenarios each consist of several components and are progressively more stressful, as explained in the Special Report."

From Fitch Ratings on mortgage performance, 2/1/08:

"With U.S. subprime mortgage performance deteriorating markedly over the last several months, Fitch Ratings has adjusted its subprime RMBS loss projections accordingly. Fitch attributes this deterioration to accelerating home price declines which are in part due to the dramatic contraction in the mortgage origination and securitization markets. Fitch has also increased its loss expectations for U.S. subprime RMBS backed predominately by first-lien mortgages originated in 2006 and the first half of 2007. The average cumulative loss expectations, as a percentage of the initial securitized balance, are now 21% and 26%, respectively. Accordingly, Fitch has placed approximately $139 billion, of 2006 and 2007 subprime RMBS (comprised of 2,972 rated classes) on Rating Watch Negative. Fitch will be releasing updated ratings through the course of February and anticipates that its rating review of these securities will be substantively completed by Feb. 29, 2008.

"Fitch's new loss expectations are based on projection of three major variables:

--The percentage of delinquent loans that are expected to default;
--The percentage of currently performing loans that are expected to default; and
--The severity of loss upon liquidation of defaulted loans.

"Mortgage performance in each of these areas has deteriorated. In Fitch's opinion the contraction in the mortgage markets has contributed to an acceleration and deepening of home price declines, and has eliminated the option to sell or refinance a home to avoid foreclosure for many borrowers. Additionally, the apparent willingness of borrowers to 'walk away' from mortgage debt has contributed to extraordinarily high levels of early default, which is particularly noticeable in the 2007 vintage mortgages. As Fitch has described in recent research reports, this behavior appears to be largely attributable to the use of high risk mortgage products such as 'piggy-back' second liens and stated-income documentation programs, which in many instances were poorly underwritten and susceptible to borrower/broker fraud."

From Moody's on 2006 RMBS lifetime losses, 1/31/2008:

"Moody's Investors Service announced today that it has revised its expectation of lifetime losses on loans backing 2006 vintage residential mortgage-backed securities (RMBS) to a range of 14% to 18%.

"We are updating our views on the possible loan losses on the 2006 subprime vintage in response to current performance that is proving to be much worse than in prior years and is demonstrating a progressive deterioration," said Moody's Chief Credit Officer Nicolas Weill.

"The rating agency, however, cautioned that there remains significant uncertainty around the ultimate losses for these loans, which will depend in part on the rate of loan modifications, the impact of 2008 interest rate resets, and the future state of the US economy.

"Such losses are also likely to take some time to materialize. Cumulate loan losses to date on 2006 subprime RMBS are under 1.5%."

And of course, there was the M.O.A.D. (Mother of All Downgrades) from S&P on 1/30/08:

"Standard & Poor's Ratings Services today announced that it has placed on CreditWatch with negative implications or downgraded its ratings on 6,389 classes from U.S. residential mortgage-backed securities (RMBS) transactions backed by U.S. first-lien subprime mortgage collateral rated between January 2006 and June 2007. At the same time, it placed on CreditWatch negative 1,953 ratings from 572 global CDO of asset-backed securities (ABS) and CDO of CDO transactions.

"The affected U.S. RMBS classes represent an issuance amount of approximately $270.1 billion, or approximately 46.6% of the par amount of U.S. RMBS backed by first-lien subprime mortgage loans rated by Standard & Poor's during 2006 and the first half of 2007. The CDO of ABS and CDO of CDO classes with ratings placed on CreditWatch negative represent an issuance amount of approximately $263.9 billion, which is about 35.2% of Standard & Poor's rated CDO of ABS and CDO of CDO issuance worldwide."

What drove said downgrades? This data on the performance of 2006-vintage loans ...

"Monthly performance data reveal that delinquencies and foreclosures continue to accumulate at an increasing rate for the 2006 vintage. Since July 2007, cumulative losses on all U.S. subprime RMBS transactions issued during 2006 are 1.13%, an increase of 156%. At the same time, total and severe delinquencies have increased by 49% and 66%, respectively. As of the December 2007 distribution date the total delinquency rate had increased to 28.79% and severe delinquencies were 18.83%.

"This delinquency trend, together with loan level risk characteristics and continuing deterioration in the macroeconomic outlook, has caused us to increase our lifetime loss projection to 19% from the 14% we projected at mid-year 2007 based on performance up to that date. At that time, the range for expected losses was 12%–16%, but this range has now increased to 18%–20%."

... Plus the ugly stats for 2007-vintage loans:

"The transactions issued during the first half of 2007 have what we consider to be an established trend of poor delinquency performance and have already realized losses. Many of these transactions closed with approximately 1%–3% of loans already seasoned by several months. Since July 2007, cumulative losses on the subprime RMBS transactions issued during the first half of 2007 have increased to 0.25% from approximately 0.01%. At the same time, total delinquencies have grown to 20.40% from 7.43% and severe delinquencies have grown to 11.51% from 2.48%. As of the December 2007 distribution date, the total delinquency rate had increased to 20.4% and severe delinquencies were 11.51%. We are projecting lifetime losses for these transactions to be around 17%, with a range of approximately 16%–18%.

"Our loss projections on the 2007 vintage are based on an analysis of the loan characteristics and relative vulnerability to property value declines. Credit scores, loan-to-value (LTV) ratios, and combined loan-to-value (CLTV) ratios are comparable to mortgages sold in 2006. The pools from the first half of 2007 have a higher percentage of fixed-rate loans, a lower percentage of 2/1 adjustable-rate mortgages (ARMs), a lower percentage of low-doc or no-doc loans, and a lower percentage of loans used for purchase. Data analysis shows that these differences yield an overall lower risk profile for the H1 2007 vintage.

"Moreover, an analysis of the S&P/Case-Shiller National House Price Index shows that price declines from 2006 are larger than the declines experienced since the first half of 2007, on average, by approximately 2%. By comparing the index change from 2006 to the October 2007 reported index, we note that prices have declined about 6% on average. Similarly, comparing the index change from the first half of 2007 to the October reported index, prices have declined about 4% on average. Thus, loans from the 2006 vintage are secured by properties that have suffered greater declines on average than the properties backing the 2007 vintage. As a result, we believe the projected losses will be slightly lower than those for 2006."

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