by Calculated Risk on 8/08/2007 05:04:00 PM

From the Financial Times: Toll warns on deepening housing slump

The chief executive of Toll Brothers said buyer interest in its homes was at the lowest in 20 years in the last quarter, as the largest luxury home builder warned on Wednesday that the US housing slump might get even worse.

Six weeks in the earlier part of the quarter, which ran until the end of July, saw the "lowest traffic on a per community basis that we have ever had", said Robert Toll, meaning that the company's housing developments had received on average less visitors than at any time since it went public in 1986.
...
[Toll] cautioned that increasingly tight lending standards for mortgages would deepen the crisis.
...
“We are now in the 23rd month of a down housing market,” Mr Toll said.

He added: “Surely it can go on for another year to a year and a half with no problem at all.”

Toll's comments about this being the lowest buyer interest in the company's history are interesting.

by Calculated Risk on 8/08/2007 01:22:00 PM

From Bloomberg: U.S. MBA's Mortgage Applications Index Rose 8.1% (hat tip Rich)

Mortgage applications in the U.S. rose last week by the most since January, as cheaper borrowing costs encouraged more Americans to seek loans for home purchases and refinancing.
...
A resilient labor market and lower home prices may support sales and eventually help reduce the glut of unsold properties, economists said. A report last week showed Americans signed more contracts to buy previously owned homes in June, a sign the weakness in the housing market may not get much worse.

"We're at the bottom right now in housing," said Mark Vitner, senior economist at Wachovia Corp. in Charlotte, North Carolina. "The biggest declines are over."

Uh, no.

Back in May I pointed out why the MBA Index is now useless: Is the MBA Index Currently Useless? Several analysts have noted that the relationship between housing sales and the MBA index has broken down. One reason is more borrowers are applying multiple times. From David Berson at Fannie Mae (note: this is a few months old, but the analysis is good): If purchase applications are stable, why are home sales so soft?

Click on graph for larger image.

One likely explanation [of the breakdown between sales and the MBA Index] is that the stricter guidance of depository institution regulators over the past year with respect to mortgage loans has made it more difficult for some households to qualify for a loan. As a result, those households have had to make multiple applications in order to get a mortgage loan -- thereby pushing up purchase applications without increasing home sales.

But I suspect the main reason for the breakdown in correlation between applications and sales is how the MBA survey is conducted. According to the MBA:

The survey covers approximately 50 percent of all U.S. retail residential mortgage originations, and has been conducted weekly since 1990. Respondents include mortgage bankers, commercial banks and thrifts.

Since another wave of lenders have recently closed shop, more potential buyers may be applying for loans from the lenders covered by the MBA survey. As an example, suppose 1000 people applied for loans in a given week from 10 lenders.

Lender 1: 250
Lender 2: 150
Lender 3: 100
Lender 4-10: remaining 50 applications each.

The MBA survey covers "approximately 50 percent of all U.S. retail residential mortgage originations", so in this example the MBA would only need to survey the top 3 lenders. Now if lender 10 closed shop (with 50 applicants), and the applicants all applied in equal proportions to the other lenders, the MBA index would increase 5% without any increase in overall activity.

This is most likely what happened last week.

Right now the MBA Index is not useful, and analysts that rely on the index are most likely wrong.

by Calculated Risk on 8/08/2007 11:18:00 AM

From the National Association of Realtors (NAR): Near-Term Home Sales to Hold in Modest Range

Existing-home sales are forecast at 6.04 million in 2007 and 6.38 million next year, below the 6.48 million recorded in 2006. New-home sales are expected to total 852,000 this year and 848,000 in 2008, down from 1.05 million in 2006.

Last month, the NAR forecast was for 6.11 million existing home sales and 865,000 new home sales.

This current forecast appears absurd. Existing home sales through June were 2.929 million units. And in a typical year, about half the sales happen by the end of June. So the NAR is forecasting sales will pick up in the 2nd half of 2007 - something that seems very unlikely with the most recent changes in lending standards.

by Calculated Risk on 8/08/2007 10:09:00 AM

"In absolute numbers, third-quarter cancellations, at 347, were the lowest in a year, although our third-quarter cancellation rate (current-quarter cancellations divided by current quarter signed contracts) was 23.8%, compared to 18.9% in the previous quarter and the high of 36.7% in FY 2006's fourth quarter."
Joel H. Rassman, chief financial officer, August 8, 2007

The cancellation rate is rising again for Toll, although still below the cycle high. However, with the most recent changes in lending standards, the cancellation rate will probably rise significantly in the coming quarters.

But luckily for Toll, business is declining so fast, that the "absolute number" of cancellations is the "lowest in a year".

by Anonymous on 8/08/2007 08:04:00 AM

Boy howdy, things had really calmed down there for a while on the purple prose front. It's been a few days since I've seen anything like this:

The credit default swaps market is an immature market, prone to irrational swings as a sudden spike in uncertainty can breed fear among traders. Such fears have spread like wildfire as evidence mounts that credit defaults in the so-called subprime lending market are spilling over into consumers with stronger credit histories, calling into question the reliability of credit ratings on which investors have relied.

Who among us cannot relate to the image of the CDS as the hormonally turbo-charged adolescent, moodily breeding--

Uh, no. Let's not go there. Stick to fears spreading like wildfire as defaults spill over like water--

No. No. We'll go with uncertainty spiking as evidence mounts.

by Calculated Risk on 8/08/2007 12:14:00 AM

Mathew Padilla at the O.C. Register reports on comments from Impac Mortgage CEO Joseph Tomkinson:

Tomkinson said regulators need to let the GSEs buy loans greater than the $417,000 conforming loan limit today. The market needs liquidity and the limit doesn’t reflect current home prices, he said. He’d like to see it raised to somewhere in the range of $500,000 to $550,000.

Perhaps the conforming limit "doesn't reflect current home prices" because the prices are too high, and are based on the excessive speculation of the last few years. Here are the historical conforming loan limits including the higher limits for certain high cost areas.

And from the WSJ: Big Fans for Fannie, Freddie

Sen. Christopher Dodd (D., Conn.), chairman of the Senate Banking Committee, yesterday called on the companies' regulator to consider raising the caps placed last year on the amount of mortgages and related securities Fannie and Freddie can hold, as a way of ensuring that plenty of money is available to fund mortgage loans.

Sen. Charles Schumer (D., N.Y.) also called for higher caps. Both Fannie and Freddie are pushing for the same move. A spokeswoman for their regulator, the Office of Federal Housing Enterprise Oversight, or Ofheo, said the agency will respond to the senators shortly.

Are Fannie and Freddie really "pushing for the same move"? I don't think so (see Freddie's Syron's comments)

And this suggestion does not make economic sense. House prices in many areas are currently unrealistic when compared to incomes, and the sooner prices return to more normal levels, the better for the economy.

As Tanta noted in Conforming Loan Limits: The Subprime Excuse

"... it's also a question of mission or mandate for Fannie, Freddie, and FHA: these government-sponsored enterprises and agencies have always been mandated to provide liquidity to the low-to-moderate (moderate meaning "average") housing market, not its high end."

Back to the WSJ:

Joshua Rosner, an analyst at the New York research boutique Graham Fisher & Co., describes as "mass delusion" the idea that they can save the day for investors exposed to billions of dollars of ill-advised home loans now heading toward foreclosure. For one thing, he says, Ofheo has required Fannie and Freddie to follow stricter standards, recently imposed by banking regulators, in assessing borrowers' ability to repay. So they can't buy up loads of reckless loans to speculators or people failing to pay bills.

Richard Syron, chief executive of Freddie, agrees that there are limits to what his company can do. "Neither we nor anyone else can buy at par loans that probably shouldn't have been made in the first place," he says.

I think Syron is correct, these are loans that "shouldn't have been made in the first place" - and there is no reason to bail out the investors who bought those loans - or the lenders who made them.

It might be reasonable to have different limits for different areas, based on the median income for each area. As an example, a low to moderate income in California is much higher than a low to moderate income in Mississippi, and the loan limit should probably reflect the median income in each local Metropolitan Statistical Area (MSA). This might be something worth discussing over the next few years as house prices decline, but I suspect that will mean lowering the limit in Missisippi, not increasing the limit in California.

by Calculated Risk on 8/07/2007 08:45:00 PM

From Mathew Padilla: S&P puts 207 classes of Alt-A loans on negative watch

Standard & Poor’s Ratings Services today placed its ratings on 207 classes of securities backed by first-lien Alt-A mortgages, or loans to people with mid-range credit profiles, on “CreditWatch with negative implications.”
...
The agency cited a rising level of loan delinquencies and said it expects losses to “exceed historical precedent and may exceed our original expectations.”

by Calculated Risk on 8/07/2007 06:00:00 PM

This is an attempt to forecast how much further housing starts will decline.

Over the first half of 2007, housing starts averaged a 1.46 million unit annual pace. (data from Census Bureau: Housing Starts)

Over the same period, New Home sales have averaged a 0.87 million annual pace. (data: New Home sales)

This brings up a key point: New Home sales come from a subset of housing starts. Housing starts also include owner built units, rental apartments, and other units that would still not be included, if sold, in the New Home sales report. So when we try to forecast the decline in housing starts, based mostly on the dynamics of the new home market, we are assuming that starts for the other units will remain steady.

Click on graph for larger image.

This graph shows total starts, starts of single unit structures, and new home sales since 1970.

During some periods (early and late-70s, mid'80s) there was a surge of apartments being built (think baby boomers leaving the nest in the '70s). But in all periods, you can't compare starts (either total or one unit structures) directly to new home sales.

Definition: New Home sales

Another key point: the new home sales estimate reported by the Census Bureau includes only new single-family residential structures that include both the structure and the land. The Census Bureau defines single-family homes as either fully detached structures or certain attached homes with an unbroken ground-to-roof separating wall. This definition includes some condominiums (side by side units), but does not include condominium units with another unit above or below.

Although large multi-story condominium projects account for a small percentage of housing starts in the U.S., it is important to note that sales and inventory for these units are not included in the New Home sales report, but that the starts are included in the housing starts report. Based on anecdotal evidence, there is a large number of these units currently for sale - and it is probably reasonable to assume that starts will decline significantly for these large condominium projects.

For data junkies, the Census Bureau provides a quarterly report that breaks down the data by many of the above definitions: Quarterly Housing Starts by Purpose of Construction and Design Type

One more point: the National Association of Realtors (NAR) reports total units sold for existing homes, including all condominiums and co-ops. These different definitions can be confusing.

Inventory

This brings us to the inventory data reported by the Census Bureau. This inventory is for new single-family residential structures as defined above and therefore does not include some condominiums and co-ops. Also cancellations aren't included in the data and this can skew the inventory numbers during periods of significant changes in cancellations. See: How does the Census Bureau handle cancelled sales contracts in the published estimates of New Home Sales?

The Census Bureau breaks down the inventory as Completed, Under Construction, and Not Started. The following chart shows the inventory levels, and months of supply, excluding the "Not Started" category.


The median months of supply for hard inventory (competed or under construction) is just under 5 months since 1974. To reduce the inventory to the median (assuming sales stay steady) would mean an inventory decline of around 100K units. Some estimates suggest there might be another 100K+ completed units due to cancellations, so let's call it 200K units of excess inventory.

If the builders worked off the 200K excess units over 2 years, then starts would need to fall to 1.36 million units per year.

Other Excess Inventory

In addition to all the assumptions above, there are two additional problems with the above estimate: 1) sales will likely fall further due to tighter lending standards, and 2) there is substantial excess inventory that is coming back on the market from desperate sellers and foreclosures.

We can use the Residential Vacancies and Homeownership report from the Census Bureau to estimate the excess inventory.

Click on graph for larger image.

The first graph shows the vacancy rate of homeowner units for sale since 1956. From the Census Bureau: "The homeowner vacancy rate is the proportion of the homeowner inventory that is vacant for sale." A normal rate for recent years appears to be about 1.7%. The small decline in Q2 leaves the homeowner vacancy rate almost 1% above normal, or about 750 thousand excess homes.

Rental units are competing products for new homes too. The rental vacancy rate has been trending down for almost 3 years (with some noise). This was due to a decline in the total number of rental units in 2004, and more recently due to more households choosing renting over owning.

It's hard to define a "normal" rental vacancy rate based on the historical series, but we can probably expect the rate to trend back towards 8%. This would suggest there are about 600 thousand excess rental units in the U.S. that need to be absorbed.

This approach would suggest there are between 750K (homeowner units only) and 1.35 million excess housing units in the U.S. Perhaps the excess rental units will keep pressure on other areas of Starts, and we should just focus on the excess homeowner units. To work off 750K units over two years - assuming sales stay steady (unlikely) - housing starts would have to fall to about 1.1 million units per year. This housing is "permanent site" and isn't transportable, so some regions may have a shortage of units and other areas may have more excess inventory - so as a reminder, this is just a rough estimate for the aggregate national market.

There are several significant assumptions in this approach, but my expectation is that starts will fall to around the 1.1 million units per year level; a substantial decline from the current level.

UPDATE: BusinessWeek has some more on the excess inventory: Another Reason For Those Empty Houses (hat tip James)

by Anonymous on 8/07/2007 02:55:00 PM

I'm not sure if this would be better before or after lunch. I would suggest putting down your drink.

From CNN Money, "A last chance to get rich in real estate?":

At a recent seminar at a Hilton in Phoenix, Fix 'n Flip - a daylong course in the art of the fixer-upper - was standing room only. So was Creative Financing, in which students learned how to tap their retirement savings and their home equity for money to invest. Between classes, throngs of students flocked to the lobby to booths featuring affiliates of Nouveau Riche. Save Our Scores (or SOS, as it is called) helps high-risk borrowers boost low credit scores so that they can borrow more money at lower rates. (Fees range from $600 to $1,200.) Investor Concierge, the real estate brokerage firm owned by Piccolo and his associates, helps students buy houses and condos, arranges financing, then provides management services for their far-flung properties. (The firm's slogan: "Click a mouse, buy a house.") Meanwhile, the Nouveau Riche University Store did a brisk business in polo shirts, plus jackets with the college logo, a stylized eagle.

Read the rest at your own risk. (Thanks, HCC!)

by Calculated Risk on 8/07/2007 02:10:00 PM

Fed Statement:

Economic growth was moderate during the first half of the year. Financial markets have been volatile in recent weeks, credit conditions have become tighter for some households and businesses, and the housing correction is ongoing. Nevertheless, the economy seems likely to continue to expand at a moderate pace over coming quarters, supported by solid growth in employment and incomes and a robust global economy.

Readings on core inflation have improved modestly in recent months. However, a sustained moderation in inflation pressures has yet to be convincingly demonstrated. Moreover, the high level of resource utilization has the potential to sustain those pressures.

Although the downside risks to growth have increased somewhat, the Committee's predominant policy concern remains the risk that inflation will fail to moderate as expected. Future policy adjustments will depend on the outlook for both inflation and economic growth, as implied by incoming information.

emphasis added