by Calculated Risk on 4/20/2007 05:32:00 PM

From MarketWatch: California home prices to weaken further: Goldman

Investment bank Goldman Sachs is increasingly concerned about the health of California's real estate market ...

Mortgage delinquencies jumped 46% in California last year, vs. a 5% increase nationally, Goldman said in a note to clients late Thursday.

Delinquencies on prime and subprime adjustable-rate mortgages in California soared by 78% and 60% respectively, vs. 33% and 24% across the U.S., the bank added, citing recent data from the Mortgage Bankers Association.

Median California home prices are still creeping up, and the state's strong employment trends should support the real estate market. But Goldman is worried that surging prices in the state in recent years weren't driven by traditional factors such as strong employment and income growth. Instead, the bank reckons an increase in ARM mortgages offered to borrowers who were already stretching to buy high-priced homes fueled the boom.

Now that lenders are cutting back some of these types of loans and regulators are beginning to crack down, California home prices could begin falling later this year, especially in high-price cities and towns, Goldman said.

by Calculated Risk on 4/20/2007 04:08:00 PM

UPDATE: A couple of commenters believe I misinterpreted the excerpted sentence. I agree, but I'm not sure of the correct interpretation. Apparently the writer meant that the average unemployment rate for the current decade (since 2000) is the lowest for any decade since 1970. However, doesn't the "past four decades" still include the '60s? The average for the '60s was lower than the current decade.

This article from the AP: Factory jobs: 3 million lost since 2000 contains the following claim:

"Even though manufacturing jobs have been declining, the country is enjoying the lowest average unemployment rates of the past four decades."

Click on graph for larger image.

This graph shows the monthly U.S. unemployment rate for the last four decades. The red line is the current unemployment rate of 4.4%.

At no time, during the "past four decades" did the blue line dip below the red line - or so the AP claims.

by Calculated Risk on 4/20/2007 01:30:00 PM

Here are some excerpts from Governor Frederic S. Mishkin speech today: The U.S. Economic Outlook

Regarding the housing adjustment ... At the beginning of the year, the ongoing cutbacks in starts of new homes, together with a lowered but fairly steady pace of home sales, were beginning to reduce the elevated backlog of new homes for sale. However, a further weakening in sales of new homes in January and February reversed some of the progress in reducing those inventories. As a result, cutbacks in new residential construction may well persist for a while.

Towards the end of last year, the Fed's view was that the housing market was near the bottom for this cycle. That viewed seemed to ignore housing fundamentals (like, say, record supplies and falling demand), and now the Fed is finally acknowledging that problems in housing "may well persist for a while."

More recently, developments in the subprime mortgage market have raised some additional concern about near-term prospects for the housing sector. The sharp rise in delinquencies on variable-interest-rate loans to subprime borrowers and the exit of a number of subprime lenders from the market have led to tighter terms and standards on such loans. While these problems have caused undeniable hardship for many families and communities, spillovers to other segments of the mortgage market or to financial markets in general appear to have been minimal.

The spillover is minimal if you ignore Alt-A, prime HELOCs, and C&D loans to condominium developers. As an example, here is an excerpt from Corus Bankshares' press release this morning:

"With a loan portfolio consisting, almost exclusively, of condominium construction and conversion loans, the nationwide slowdown in the residential housing market is impacting Corus' business. Evidence of this slowdown is clear from the decline in loan originations, the resulting decline in loans outstanding and an increase in problem loans. The current quarter's earnings declined as a result, and it would not surprise us to see an even greater impact on earnings over the next several quarters, or even years, depending on when the market improves," said Robert J. Glickman, President and Chief Executive Officer.

And back to Mishkin:

I should note some positive news for the housing sector. Sales of existing homes strengthened a bit during January and February, and the Mortgage Bankers Association index of applications for home purchase suggests that demand has been fairly steady through early April. Also, mortgage rates are still at historically low levels, and mortgages to prime borrowers and fixed-rate mortgages to all classes of borrowers continue to show low rates of delinquency.

The MBA index has held up pretty well, probably due more to how their survey is conducted than any real strength in the housing market. On the existing home news, Mishkin is simply looking at the data incorrectly. And yes, delinquency rates are rising for all borrowers, including prime borrowers and those with fixed rate mortgages.

And away from housing:

The second major area of concern in the near-term outlook, and one that perhaps could pose noticeable downside risks, is business investment.

A downturn in business investment definitely wasn't a surprise since that is the normal historical pattern (non-residential investment follows residential investment). There is much more in the speech, especially concering inflation expectations.

by Anonymous on 4/20/2007 01:21:00 PM

Loyal reader Brian (thanks, I think) sent this one for today's edification. Bloomberg gives us "Subprime Brokers Seek Solace at Two-Day Loan Pep Talk (Update1)":

April 20 (Bloomberg) -- Mortgage brokers and bankers at a conference in Orange County, California, the center of the subprime lending industry, were told to prepare to make more fixed-rate loans now that lending standards are being tightened.

``Some of the underwriting guidelines just got too aggressive, that's the bottom line,'' Dale Vermillion, a Chicago-based mortgage consultant, said at the event in an area where subprime lenders including New Century Financial Corp. are based. ``The problem is the borrowers weren't thinking, the lenders weren't thinking.''

The $899 two-day seminar was being given by a lending expert who has advised more than 100 mortgage providers, including New Century, Ameriquest Mortgage Co. and ABN Amro Holding NV, on how to win more business in the housing boom. Now that at least 50 subprime mortgage lenders have closed, gone bankrupt or sought buyers, the tenor of this year's event was more subdued than previous years, some brokers said. . . .

The event was part informational, part motivational pep talk. Vermillion at one point had attendees applaud themselves because they ``are already among the leaders in the industry'' and encouraged them to help their customers buy homes because ``that is the American dream.''

Several times during the seminar, Vermillion led attendees in a call and response, and once asked for an ``amen.'' At a session following the formal presentations, Vermillion, who wears a cross-shaped earring, talked about becoming a born-again Christian in his early 30s. More than half of the attendees attended the session, which ended with a prayer.

``We as an industry provide a vital, vital service. Who here wants to be an agent of change?'' Vermillion asked during a session on company infrastructure and marketing. Hands around the room went up. ``Give me a `Yee-ha.''

``Yee-ha,'' attendees responded.

``Louder?''

``Yee-ha!''

I may change my mind on whether someone needs to "stabilize" this market.

by Anonymous on 4/20/2007 06:05:00 AM

Our last installment went into some fair detail on the old-fashioned single-class pass-through MBS as practiced by Ginnie Mae and the GSEs. These securities always had a huge advantage: they’re cheap to produce and easy to understand. Back in the days when there wasn’t much about the underlying loans that was hard to understand—you had your basic fixed rate, your basic amortizing one-year ARM—you could master the cash-flow issues over lunch.

The big drawback of the pass-through was always its prepayment and duration problems. The actual dollar yield on a bond—or a mortgage—is a matter of how long you earn interest at a given rate. If the loan prepays much earlier than you expect, you get your principal back, but you must now reinvest it somewhere else, and loans generally prepay fast when prevailing market rates are lower, putting the refinance “in the money” for the borrower and forcing the prepaid investor to buy a new lower yield. When market rates rise, prepayments slow considerably, but this extension means an investor has funds sunk in a low-yielding bond when new ones yield much more. Some investors, of course, would want to be prepaid more quickly or more slowly than average, if they were using MBS to hedge some other investment risk or just needed very high liquidity. The trouble with the single-class pass-through is that it’s just too unpredictable.

The big innovation in the MBS world was the CMO (Collateralized Mortgage Obligation, not to be confused with the CDO, or Collateralized Debt Obligation, which we’ll get to later). A CMO is also often called a REMIC (Real Estate Mortgage Investment Conduit) since that is the legal structure on which most of them are built. REMICs were developed in the 1980s, and the advantage (or disadvantage) to an issuer or investor of owning part of a REMIC has a lot to do with tax treatment of certain kinds of investment income. That is a level of detail into which I will not get. Suffice it to say that most CMOs work like REMICs even if they aren't true REMICs, and that I prefer to use the term REMIC here to keep from getting lost in the CMO-CDO confusion weeds.

REMICs are very complex, and so we’re just going to skim here. The basic idea is that the cash-flow from an underlying pool of whole loans—even one or more underlying pass-through MBS—can be sliced up or “tranched” into separate securities with differing cash-flow characteristics and time-to-maturity horizons. The simplest approach is “sequential pay”: a structure of classes is set up, with each tier getting its scheduled pro-rata share of the pool interest, but the top tier getting all the scheduled (and all or most of the unscheduled) payments of principal, until that tranche or class is paid off. Then the next tier gets principal payments, and so on. This lets you take an underlying pass-through with an expected maturity of 25 years and turn it into one 2-5 year bond, one 5-7 year bond, one 7-10 year bond, and so on. It also creates a “yield curve” within the REMIC, as the shorter-maturity classes earn a lower rate of interest than the longer ones. This is true even if the underlying loans are all 30-year fixed rates.

Remember that individual loans are not assigned to tranches or classes; what is being “allocated” in a REMIC is the total cash flow of principal and interest from the aggregated underlying loans. The underlying loans can be “grouped” in certain ways—they can be already securitized into pass-throughs, and you can have a group of loans or MBS assigned to a set of classes or tranches, but legally the REMIC trust owns all the underlying loans, and all underlying loans are available to pay whatever any given tranche-holder is owed.

But even a sequential-pay structure allows some unpredictability in the repayment characteristics of each tier. So most REMICs improve on the simple sequence by further refining the cash flow characteristics of each tranche. There is the “stripped” tranche: an IO strip pays interest only (on a nominal balance) while the PO strip pays principal only (the investor buys that bond at a deep discount). There are PACs and TACs (Planned or Targeted Amortization Classes) which pay principal according to a schedule that may have nothing to do with the actual amortization of the underlying loans. There are floaters and inverse floaters—tranches that pay interest that increases with a rise in an underlying index or the inverse (the yield decreases when the index rises, making these hedge vehicles). There are “accrual bonds,” which pay no cash flow for the initial years of the REMIC (the “lockout period”), although they accrue interest during that period.

There are also several kinds of “support bonds,” which is a generic term for a tranche needed to do or get the opposite of what one of the above tranches does or gets. An amortization class, for instance, generally needs a corresponding support bond that will get excess or shortfall prepayments of principal “left over” from the principal allocation to the PAC or TAC. There is always, finally, a “residual” bond, at the bottom of the whole elaborate structure, that gets whatever is left. Residuals are nearly impossible to accurately value. With a true REMIC, the residual is generally held by the security trust. (Other kinds of structured MBS can generate a residual that can trade in the junk bond market.) The expected yield on any given class or tranche can vary widely, based on how close to expectations the actual payment and prepayment characteristics of the underlying loans end up being.

Having fun yet? For our purposes, here’s the point of caring about this: first, the original idea of the REMIC is to make mortgages a more attractive investment by controlling their repayment characteristics (just as single-class pass-through MBS made mortgages more attractive by controlling their credit risk). Over time, however, tails can start wagging dogs, and some of us are firmly convinced that mortgages started to become originated in products that would make a great REMIC. Imagine trying to do a simple pass-through MBS with interest-only hybrid ARMs combined with amortizing true ARMs. Or a pass-through with Option ARMs. Or HELOCs with an initial interest-only draw period followed by an amortizing repayment period. You need, basically, an exotic security in order to successfully originate exotic loans. Or, perhaps, you need increasingly exotic loans in order to feed the increasingly exotic securitization machine.

Second, the notion of a multi-class security is generally premised on the happy assumption of a bunch of different investors with different investment needs—fixed income, hedges, what have you—all of whom can come together, take the piece they want, and play “support bond” for each other, while the REMIC issuing trust happily takes the leftovers in the residual out of the kindness and generosity of its heart. What lurks beneath this premise—and will get crucial when we start talking about credit risk again—is that multi-class can introduce “class warfare.”

One thing you can say about the various part-owners of a big single-class pass-through is that they’re all in the same boat, since they’re all getting a pro-rata share of whatever is going on—fast prepayments, slow prepayments, high-coupon, low-coupon—in the underlying pool. In a multi-class REMIC, fast prepayments could be great for me and tough luck for you. Changes in the underlying interest rates on the loans could be tough for me and great for you. Theory says this is fine, because you are a rational informed agent, as am I, and we are buying whatever tranche we picked in order to hedge some risk we perceive, accurately, that we have. Besides the obvious retort to that—rational? bond investors?—there is the question of further, possibly quite unpleasant, effects on what the underlying mortgages have to look like to support all these harmoniously opposing classes.

In the big picture, we have a security structure that biases the mortgage market to refinances rather than modifications, and to loans that really have to refinance in practical terms (ARMs, IOs, balloons) over those that don’t (fixed rates). The structure readily accommodates exotic underlying mortgage loan structures, and hence removes “complexity risk” from the investor side (if not the mortgagor side). Very importantly, it removes investor aversion to early payoff risk—there’s always a “support bond” to profit from prepayments—eliminating a great deal of a mortgage originator’s disincentive to keep refinancing the same loan. Prepayment penalties get put on loans that are destined to prepay, given their toxic adjustments, which appears to be the only way the servicing for these securities can stay profitable.

Some people like to focus obsessively on mortgage broker and mortgage originator culpability for the mess we’re in, and certainly it never pays to underestimate that. But no broker or correspondent lender can originate an Option ARM with a shockingly high margin (the rate that kicks in when the “teaser” is gone) with no points unless some aggregator or REMIC conduit or other investor is paying 105 cents on the dollar for it. You can ask why anyone would pay so much premium for such a loan, especially given the likelihood that it will, you know, refi and pay off early.

The claim that premium pricing prevents rate predation—that the investor doesn’t “gain” by having a borrower pay an above-market rate because it pays too much premium for the loan—is a mite disingenuous in the context of structured securities. If you are buying whole loans for an investment portfolio, or for inclusion in a simple pass-through, that might make some sense. But if you are buying loans for a security in which someone will benefit from the fast prepayment of that loan—and someone else will benefit if it stays on the books—you may well be paying up for that loan precisely because it has the payment and prepayment characteristics you want, not in spite of them. There is always someone on the other side of a hedge trade. If there were no incentive for conduits to pay 105 for a loan, I can assure you that they wouldn’t pay it, or not for long. (Note to self: why did Grant Thornton just walk out on a couple of its auditees when the subject of secondary market pricing strategies came up? Are all these Wall Street-inspired conduits really paying a perfect price for this stuff? Hmmm.)

Remember the average 200 bps note rate spread in an old-fashioned GSE MBS? I just looked at a Fannie Mae 2007 issue REMIC, backed by Fannie Mae pass-throughs, with a note spread of 275 bps. A private-issue REMIC backed by non-GSE loans can easily have a total spread on the underlying loans of ten points or more, with an age-adjusted spread of 500 bps. (Remember that you must look at the age of the loans in a REMIC pool. The pass-through MBS loans are originated into a current (par) coupon, but a REMIC with flow or seasoned loans will have loans that were originated into different current coupons. A mortgage note rate is “above” or “below” market only in reference to what the par coupon was that day.) How much of the note spread in a private-issue REMIC is a question of credit quality we will deal with in the next installment. For now, just note that a GSE REMIC will have those famous fairly uniform and geographically diverse loans in its pools, so that duration—sensitivity to market rate changes—is affected by loan quality, not just note rate. By and large, GSE loans are refinanceable, whether or not they’re in the money for a refi.

A private-issue REMIC backed by jumbos, Alt-A, subprime, reperforming, scratch & dent, or a mixture thereof can require exceptionally complex prepayment calculations, as these loans may be less sensitive to market rate changes alone. In the “old days,” the cruddier the credit, the longer the loan stayed on the books, since there were fewer refi options. Then we went through this period where there was a REMIC for every loan, cruddy or not, and so sensitivity calculations all of a sudden got “counter-intuitive.” One definition of a “credit crunch” is a giant blow-up in durations. When the music stops, everybody has to take a chair and then sit there. If you didn’t get a chair, you default, the lender forecloses, and losses are dealt with somewhere. But if you did get a chair—and I continue to think that most prime borrowers will get one—you will, if it makes you feel any better, possibly be sticking it to some bondholders just by paying your loan back as agreed.

Whether all of these REMICs were structured carefully enough that they can fully survive a “crunch” is a good question. But it also depends on how REMICs deal with credit risk once we get away from the GSE ones and into the private-issues, where there is no GSE to guarantee the investor against principal loss. That part of the “musical chairs” game awaits the next installment.

by Calculated Risk on 4/20/2007 12:15:00 AM

From the WaPo: 'Upside Down' Home Sellers Owe More Than They Get

Jeffrey Taylor and his wife bought their dream home in Purcellville for $538,000 last August. Now they have to sell it because they are getting divorced and neither one can afford the mortgage alone.

The most they could get for it was $430,000. After paying all the real estate commissions and taxes, they will still owe the bank $118,000.

These stories are similar to the one I posted last month: Escrow to Seller: "Bring Money".

by Calculated Risk on 4/19/2007 08:42:00 PM

From Reuters: Capital One's profit dives, outlook falls

Chief Financial Officer Gary Perlin said mortgage banking posted a "modest" loss in the first quarter amid "unusually weak conditions" in the market to sell some nonconforming loans, including "Alt-A" loans - or "Alternative-A" loans, which often go to borrowers who cannot provide full documentation of income or assets.

by Anonymous on 4/19/2007 04:24:00 PM

Long-time readers of Calculated Risk will no doubt remember that the Nontraditional Mortgage Guidance promulgated by all the major regulators and supervisors of depository lenders was issued on September 29, 2006.

Since then we have posted occasionally on lender updates to their mortgage guidelines, in an attempt to measure the tightening impacts of the regulation as well as the general prospects for a credit crunch.

This morning, the mortgage guideline fairy sent us a copy of an announcement sent by Bear Stearns to its correspondent loan originators. We thought it was interesting. Here are a few highlights:

Please note, current guidelines/matrices will expire at the end of business on May 4th, 2007, all loans underwritten using the current guidelines/matrices must be delivered in purchasable formby June 4th, 2007.

QUALIFYING RATES AND PAYMENTS FOR MORTGAGE LOANS WITH INTEREST-ONLY
AND NEGATIVE AMORTIZATION FEATURES

BSRM will now require borrowers with non-traditional product loans to qualify based on the fully indexed rate and fully-amortizing payment. A non-traditional product is defined as any product that has an interest-only and/or a negative amortization feature.

Bear Secure Option ARM and Bear Option ARM

The qualifying payment, reserve requirements and payment shock will be calculated at a) a rate equal to the greater of the fully indexed rate or the Note rate, and b) a payment based on full amortization assuming a loan balance equal to the applicable negative amortization cap multiplied by the original loan balance.

Negative Amortization Cap has been reduced to 110%

BSRM will reduce the Maximum Negative Amortization Cap from 115% to 110%.

Alt A & Subprime Programs– Interest-Only

The qualifying payment, reserve requirements and payment shock will be calculated at a) a rate equal to the greater of the fully-indexed rate or the Note rate, and b) a payment based on full
amortization using the original loan balance.

Alt A ARM Programs –Interest-Only

• < 3-Year Fixed Period (Interest Only) – The qualifying payment, reserve requirements and payment shock will be calculated at a) a rate equal to the greater of the fully-indexed rate or the Note rate + 2%, and b) a payment based on full amortization using the original loan balance.
• > 3-Year Fixed Period (Interest Only) – The qualifying payment, reserve requirements and payment shock will be calculated at a) a rate equal to the greater of the fully-indexed rate or the Note rate, and b) a payment based on fully amortization using the original loan balance.

MODIFICATIONS TO DEBT-TO- INCOME RATIOS

DTI for loan amounts less than or equal to $1,000,000:
• Alt A Programs
• Change DTI from 50% to 55% for loans that meet both of the following criteria:
o Primary and Secondary residences only
o CLTV < 80%

• Investment properties-Increased to a maximum 50%

• Bear Secure Option ARMs and Bear Option ARMs
• Increase DTI from 45% to 50% as per Program Matrices

“No Doc” and “No Doc w/Assets” doc types are being capped at 80% LTV/CLTV. Primary and secondary residences may be considered up to 90% LTV/CLTV in accordance with the program matrices if all of the following criteria can be met:
o Borrower is not retaining current residence (not allowed at any CLTV)
o Borrower is not a first-time home buyer.
o Payment shock does not exceed 150%.
o Borrower must provide a 24-month mortgage history with 0 x 30.
o Borrower meets traditional trade line requirements.
o A Field Review will be required.

Glad to see Wall Street finally getting around to updating its underwriting guidelines. May I be forgiven for pointing out that I predicted, lo these many months ago, that if they were forced to increase the qualifying payment they'd increase their DTI maximums to compensate?

It does put Richard Syron's comments about these "other market participants" into some perspective, doesn't it?

by Calculated Risk on 4/19/2007 02:29:00 PM

From Reuters: D.R. Horton orders down 37 pct, spring sales weak

D.R. Horton Inc., the largest U.S. home builder, said on Tuesday orders for new homes tumbled 37 percent last quarter and the spring selling season has been slower than usual, suggesting the U.S. housing market has not yet hit bottom.

Chairman Donald Horton said conditions remain tough in most markets because of high inventories of unsold new and existing homes. He also said "the spring selling season has not gotten off to its usual strong start."

Click on image for larger picture.

This photo of a Bloomberg screen this AM (hat tip Brian) really tells the tale.

Market not "stabilizing". Mortgage market is having "liquidity crisis". CEO says "disappointed" in quarterly sales. CEO sees "continued softness in 2008".

And much more.

More simply, housing is being crushed, and there is no bottom in sight.

by Anonymous on 4/19/2007 01:14:00 PM

From testimony before the House Financial Services Committee:

We want subprime borrowers to have a fair shot at homeownership. We think simple, straightforward, fixed-payment mortgages generally are the best products for these borrowers.

So Fannie Mae should not walk away and say the market turmoil is not our problem. We are concerned about a liquidity crunch in the subprime segment -- the risk that as the turmoil shakes out, the flow of capital to finance subprime lending could slow to a trickle. Some may ask, why would that be a problem? Don't we want to cut off financing for this segment? The answer is no -- that would only make it more difficult and costly for the least fortunate borrowers who depend on this lending to finance or refinance their homes. Robert Gnaizda of the Greenlining Institute said, "[A]rbitrary and artificial tightening of credit & may be counterproductive -- that is, it may dry up credit for members of minority groups, the poor, and the 70 percent of Americans who live from paycheck to paycheck." Economic history has a way of punishing the most vulnerable first and last -- we should try to avoid that as the lasting effect of the subprime clean-up.

We should also seek to get ahead of the problem and help borrowers who are not yet in trouble. This is the more immediate problem of borrowers facing imminent "payment shock," homeowners with adjustable-rate loans that are scheduled to reset at higher rates. We want to help prevent further disruption of the subprime market, which would make it tougher for these borrowers to refinance into better, safer loans.

That is where we are concentrating our efforts today. We believe the best way to influence the subprime market, and be part of the solution, is to stay engaged and provide funding for conventional loans to these borrowers that are affordable over the long term.