by Calculated Risk on 8/24/2007 03:16:00 PM

From the WSJ: New York Fed Takes Step To Bolster Credit Market

... the Federal Reserve Bank of New York clarified its discount window rules with the effect of enabling banks to pledge a broader range of commercial paper as collateral.
...
"We are comfortable taking investment-quality asset-backed commercial paper for which the pledging bank is the liquidity provider. This is a clarification of something that has become, over time, accepted practice at the Federal Reserve Bank of New York," said New York Fed spokesman Calvin Mitchell.
...
Several market sources however interpreted the action more as a change in, than a clarification of, policy. "Previously banks could not post such ABCP as collateral, that is ABCP for which the bank is a liquidity backstop," said Michael Feroli, economist at J.P. Morgan Chase, in a note to clients.

by Calculated Risk on 8/24/2007 01:58:00 PM

Please see my earlier posts on New Home sales too: July New Home Sales and More on July New Home Sales.

The Census Bureau revises the New Home sales number three times (plus annual revisions). During a housing down turn, most of the revisions from the Census Bureau are down. This is important to keep in mind when looking at a new monthly report.

Click on graph for larger image.

This chart shows the cumulative revisions for each month since sales activity peaked in July 2005 (annual revisions are not shown). The last time there was a positive cumulative revision (red column) was in September 2005.

The median change for the first revision is a decline of 1.6% (average decline of 1.8%) over the last two years.

The cumulative median change for the second revision is a decline of 3.6%.

The cumulative median change for the third revision is a decline of 4.8%. Since the last upward cumulative revision (Sept 2005), the range has been from a small decline of 0.2% in Dec '05, to a decline of almost 11% for May '06.

The new homes sales number today will probably be revised down too. Applying the median cumulative revision (4.8%) suggests a final revised Seasonally Adjusted Annual Rate (SAAR) sales number of 828 thousand for July (was reported as 870 thousand SAAR by the Census Bureau). Just something to remember when looking at the data.

by Calculated Risk on 8/24/2007 11:41:00 AM

Steven Pearlstein writes in the WaPo: Commercial Real Estate, Come On Down

Here's the next shoe to drop as a result of the bursting of the credit bubble: commercial real estate.
...
In markets like Washington, New York, Boston and San Francisco, the last four years have been among the best the industry has ever seen -- falling vacancy rates, rising rents, soaring values and a ton of new development. Now, that's all about to come to a grinding halt as financing becomes more expensive and more restrictive, the economy slows and a big slug of new inventory hits the market.

As a reminder, in a typical business cycle, investment in non-residential structures follows investment in residential structures with a lag of about 5 quarters.

Click on graph for larger image.

This graph shows the YoY change in Residential Investment (shifted 5 quarters into the future) and investment in Non-residential Structures. In a typical cycle, non-residential investment follows residential investment, with a lag of about 5 quarters. Residential investment has fallen significantly for five straight quarters. So, if this cycle follows the typical pattern, non-residential investment will start declining later this year.

Right now it appears the lag between RI and non-RI will be longer than 5 quarters in this cycle. Although the typical lag is about 5 quarters, the lag can range from 3 to about 8 quarters.

... in markets like Washington, the pace at which buildings have been leasing has slowed even as a large number of new buildings are about to come on line.

According to the latest data from CoStar Group, for example, office vacancy rates along the I-270 corridor have risen to 11.6 percent from a low of 9.7 percent a year ago. Buildings under construction will add another 5 percent to supply over the next two years, with roughly a third of it pre-leased.

The market in the Dulles corridor is also beginning to weaken. There, the vacancy rate is up to 14.2 percent from 13 percent in the past year, with nearly 4 million square feet of space under construction, equal to about 8 percent of current supply. After four years of steady growth, rents are beginning to flatten out.

Pearlstein also discusses tighter lending impacting commercial real estate (CRE). This fits with the recent survey from the Fed: The July 2007 Senior Loan Officer Opinion Survey on Bank Lending Practices

Commercial Real Estate Lending

Lending standards for commercial real estate loans were reportedly tightened further over the past three months: About one-fourth of domestic institutions—a slightly smaller net fraction than in the previous survey—and about 40 percent of foreign institutions indicated that they had tightened lending standards on commercial real estate loans in the July survey. Regarding demand, approximately one-fourth of domestic and foreign institutions reported that demand for commercial real estate loans had weakened over the past three months.

And that survey was pre-turmoil. I also suspect Pearlstein is correct and that CRE is the 'next shoe to drop'.

by Calculated Risk on 8/24/2007 10:32:00 AM

For more graphs, please see my earlier post: July New Home Sales

Click on graph for larger image.

The first graph shows New Home Sales vs. Recession for the last 35 years. New Home sales were falling prior to every recession, with the exception of the business investment led recession of 2001. This should raise concerns about a possible consumer led recession in the months ahead.



The second graph compares annual New Home Sales vs. Not Seasonally Adjusted (NSA) New Home Sales through July.

Typically, for an average year, about 61% of all new home sales happen before the end of July. Therefore the scale on the right is set to 61% of the left scale.

At the current pace, new home sales for 2007 will probably be in the mid 800 thousands - about the same level as in 1998 through 2000. This is significantly below the forecasts of even many bearish forecasters.

If sales slow in the coming months - as I expect - New Home sales might be in the low 800s - the lowest level since 1997. My forecast is for 830 to 850 thousand units in 2007.

by Calculated Risk on 8/24/2007 10:00:00 AM

According to the Census Bureau report, New Home Sales in July were at a seasonally adjusted annual rate of 870 thousand. Sales for June were revised up to 846 thousand, from 834 thousand. Numbers for April and May were revised down.


Click on Graph for larger image.
Sales of new one-family houses in June 2007 were at a seasonally adjusted annual rate of 870,000 ... This is 2.8 percent above the revised June rate of 846,000 and is 10.2 percent below the July 2006 estimate of 969,000.


The Not Seasonally Adjusted monthly rate was 74,000 New Homes sold. There were 83,000 New Homes sold in July 2006.

July '07 sales were the lowest July since 2000 (74,000).


The median and average sales prices were mixed. Caution should be used when analyzing monthly price changes since prices are heavily revised and do not include builder incentives.

The median sales price of new houses sold in July 2007 was $239,500; the average sales price was $300,800.


The seasonally adjusted estimate of new houses for sale at the end of July was 533,000.

The 533,000 units of inventory is slightly below the levels of the last year.

Inventory numbers from the Census Bureau do not include cancellations - and cancellations are once again at record levels. Actual New Home inventories are probably much higher than reported - some estimate are about 20% higher.


This represents a supply of 7.5 months at the current sales rate.

This is another weak report for New Home sales. And the data for July is pre-turmoil. These numbers will probably be revised down, and the in-turmoil numbers for August will likely be much lower.

More later today on New Home Sales.

by Anonymous on 8/24/2007 09:21:00 AM

The Boston Globe has a story out on short sales. There is the requisite anecdote about some borrowers in trouble. The soylent details:

Jeffrey Finch spelled out the problem in a hand-written letter: He'd lost his job as a minister, and his wife's take-home pay as a teacher, $3,100 a month, did not cover their $3,300 mortgage payments. . . .

Lenders "are not in the business of owning real estate," said Fran Yerardi, president of Bay State HomeVestors in Newton, who negotiated the short sale on the Finch's behalf. HomEq and investors who held their mortgages forgave $168,500 of the couple's $440,000 total debt, allowing HomeVestors to buy their house for $271,500, renovate it, and resell it for a profit. . . .

In the case of the Finches in Jamaica Plain, it took Bay State HomeVestors three months to negotiate the discount purchase. Bay State is a franchise of a Dallas company, HomeVestors, whose stock-in-trade is buying houses in poor shape, fixing them up, and reselling them. Its yellow billboards that state, "We Buy Ugly Houses," dot the Boston area. Profits on individual deals can be anywhere from $10,000 up to, in rare cases, $100,000.

In anticipation of a declining market, Yerardi opened HomeVestors' first New England franchise last year and has about 30 short sales in progress. Franchises are now in Braintree, Worcester, Connecticut, and Rhode Island, he said. The entire company has submitted more than 200 short-sale plans to lenders this year, he said. "Two years ago, you never heard of short sales."

The Finches' undoing was a subprime refinancing with WMC Mortgage, which they used last August to take $10,000 out of their home equity for renovations. Two WMC subprime mortgages were used to refinance a 30-year fixed mortgage obtained in 2005 to buy the house from Denise Finch's mother. Their payments immediately jumped $900.

While Denise Finch lost the house in which she grew up, the couple bought a newer one -- from HomeVestors -- for $152,000 in Charlotte, N.C., where both have family.

That’s all the information about the Finches that you get in this article.

The current total loan amount is $440,000, but apparently $10,000 was cash taken out in August of 2006. So we’ll assume they borrowed $430,000 in 2005 for an in-family (non-arm’s-length) transaction, buying Denise’s mother’s home for at least $430,000. If this was the home Denise grew up in, it wasn’t built in ’05. It’s possibly not surprising you’d need a $10,000 renovation loan. We aren’t told how much, if any, Denise’s mother owed on it.

If the payment on the total $440,000 is $3,300, they were paying an effective blended rate of about 8.25% on the total refinanced loan balance, assuming amortization, or 9.0% on an IO. We are told that the $3,300 payment is $900 more than the old payment on $430,000. That would imply that the old loan carried a payment of $2,400, which implies an interest rate of 5.50% on the old loan, if it was an amortizing fixed, or 6.625% if it was IO. (I’m ignoring T&I for the moment.) Damned good deal on that $10,000, huh?

If they got a 100% subprime loan to buy the new house in NC, we’ll guess they might be paying 10% on it. That would be a new house payment of $1,333.91, or 43% of their last verified income of $3,100. You can add taxes and insurance if you want to. You can assume that the new loan isn’t “subprime,” even though the borrowers now have prior mortgage delinquencies/short sale on their credit report, and you can assume they had some money for a down payment, if you want to. Hey! Maybe mom gave them some money out of the “capital gains” cookie jar! Maybe a down payment came from a builder or this HomeVestor outfit. Beats me. The problem with non-arm’s-length transactions is not just finding the “skin,” it’s figuring out what the game is.

You can assume that in the current environment such a loan would be offered at a much lower rate than 10%, if you feel like it. I think you can guarantee that the new loan involved “stated income” of the sort that involves how they need not just schoolteachers but more ministers in NC than in MA and so they pay them at least as much and so “replacement income” is virtually guaranteed you see. Or, possibly, those family members in NC are supplying “stable monthly income.” Whatever.

So one non-arm’s-length deal got replaced with a new non-arm’s-length deal. Denise’s mom and HomeVestors appear to have made profits. WMC took a nasty write-off. The Finches are on their way to being subprime borrowers for the rest of their days. I’m pretty sure they’ll get a 1099 for the taxes on $168,500, and given their track record I wouldn’t be shocked to find them going to a payday lender to borrow it. Quite the work-out, I’d say.

Please note, you workout-haters, that I am not suggesting that WMC should have modified this loan somehow, at least not based on the facts we are presented with. I merely want to suggest that I have my reasons, at times, for thinking that short sales are not these pristine rational free-market “rapid clearing” devices some folks would like to think they are. I am also, of course, hinting to a reporter (again) that it sometimes helps to try to “work out” the numbers you are given before you report on them. They might suggest a slightly different story.

In any case, I will leave you all to ponder the due diligence you would require of a servicer if you were the noteholder and you were being asked to accept a short sale. What would you want to know about the bid or bids submitted?

by Calculated Risk on 8/23/2007 10:12:00 PM

From WSJ: Home Depot Is Close to Accepting $1.2 Billion Less for Wholesale Unit

Home Depot was Thursday night close to accepting about $1.2 billion less for the sale of its wholesale distribution business to three private-equity firms ... But there were still substantial doubts about whether the deal will actually close before a Thursday deadline, as three major banks continued to balk over the financing.

The situation was becoming increasingly ugly, with some of the most senior figures on Wall Street trying to manage their exposure to a deal beset by twin crises in both the housing and credit markets. The banks -- J.P. Morgan Chase, Lehman Brothers Holdings Inc. and Merrill Lynch & Co. Inc. were last night preparing for the possibility of lawsuits over the matter.
...
Pinched by the current credit crisis, the banks are toughening their stance against the private-equity firms. With a backlog of some $300 billion of U.S. private-equity deals still to be funded, the banks are now facing significant writedowns on their balance sheets. That's why they are weighing how to extract themselves from as many buyout transactions as possible.

How many pier loans can these IBs carry? Most likely some of these deals will collapse. This is quite a haircut for Home Depot, and it is still not a done deal.

by Calculated Risk on 8/23/2007 07:45:00 PM

UPDATE: I'm not sure how appropriate my initial speculation was for this forum, so I changed the title and made some minor edits to the post. To be clear, I'm not offering investment advice and I have no position in CFC. CFC is a key player in the mortgage business, and I think they should disclose more on these convertibles.

One of the puzzling aspects of the CFC convertibles was this sentence in the 8-K:

Convertible Preferred Securities each have a Conversion Price of $18.00, which may be adjusted upon the occurrence of certain events.

What are these "certain events"?

Back in the late '90s, some very weak companies issued floorless convertibles to raise cash. These convertibles had an announced price, but when you read the details the conversion price was adjustable based on the price of the company's stock.

Here is a definition of a death sprial or floorless convertible:

Used by companies that are in such bad shape, that there is no other way to get financing. This instrument is similar to a convertible bond, but convertible at a discount to the share price at issuance and for a fixed dollar amount rather than a specific number of shares. The further the stock falls, the more shares you get. Popular in the mid to late 1990s. Also known as toxic convertibles or death spiral convertibles.

And there is this story from Dow Jones: OCC: BOA Can't Convert Countrywide Secs Into Cmn Stock

Bank of America Corp. (BAC) can't convert its $2 billion investment in Countrywide Financial Corp. (CFC) into common stock, the Office of the Comptroller of the Currency said in its letter approving the investment.

"Our conclusion is subject to the condition that (Bank of America) will not exercise the right granted to holders of the Securities to convert the Securities into common stock of (Countrywide) so long as the Securities are held by (Bank of America) or any subsidiary" of Bank of America, OCC chief counsel Julie Williams wrote Wednesday in a letter obtained by Dow Jones Newswires.

Williams said this condition was enforceable under the law. The letter was addressed to Bank of America general counsel Timothy J. Mayopoulos.
...
Williams also said that Bank of America's investment would not "confer voting rights" as long as the "yield is current and the issuer is not attempting to alter the holders' rights under the instrument."
...
The OCC said that despite the investment being labeled as a purchase of preferred securities, the agency would treat it as a purchase of debt instruments....

added: Hopefully these "certain events" are unrelated to the stock price. Also, it's hard to imagine that BAC would invest in floorless convertibles. I believe CFC should disclose the "certain events" as mentioned in the 8-K.

by Calculated Risk on 8/23/2007 06:16:00 PM

The BLS recently released the Business Employment Dynamics (BED) report for Q4 2006 (hat tip jg). The BED is another measure of employment and is based on state unemployment insurance.

According to the BED, overall construction employment (seasonally adjusted, Table B, page 3 of report), declined by 26,000 jobs in Q4 2006. This is close to the BLS estimate of 41,000 construction jobs lost for Q4.

In Q3 2006, the BED showed 77,000 construction jobs lost, compared to the BLS reporting 34,000 jobs gained (both seasonally adjusted).

Click on graph for larger image.

This chart compares the change in construction jobs as reported by the BLS establishment data and the BED. The BED is only available through Q4 2006.

Note this is all construction jobs, not just residential construction.

One of the possible answers to The Residential Construction Employment Puzzle is that the BLS missed the turning point in construction employment. Since housing completions fell off the cliff in Q1 2007, it will be interesting to see if the BED shows more construction jobs lost than the BLS in Q1 and Q2 2007.

Of course another explanation for the lack of job losses is that some construction employees have moved from residential to commercial work, but they are still being reported as residential construction employees to the BLS. (see here for more possible explanations). The BED will not shed light on that possible error, since the BED only reports total construction jobs.

The second graph compares the quarterly change in employment estimate of the BLS establishment data vs. the BED starting in 1993 (three month centered average to smooth data).

In the second half of 2006, the establishment data showed an increase of 1.137 million jobs (SA), and the BED showed only 0.535 million jobs (SA). This has led many analysts to expect the annual revision of the establishment data to show significantly fewer net jobs created over the last four quarters.

by Calculated Risk on 8/23/2007 02:27:00 PM

From the WSJ Econ Blog: Fresh Looks at Housing Slump.

“We have made further concessions to our housing forecasts given turmoil in the mortgage market. ... We now expect starts to fall to about 1.2 million by the end of next year ... We now expect OFHEO home prices to fall 2.5% next year and NAR and Case-Shiller home prices to fall between 3% and 5%.” – Lehman Brothers Economics

It's taken some time to make these "concessions", but these forecasts are getting closer to the mark.

Regarding this next quote, I wish we could come up with some better phrasing than "pre-" and "post-" turmoil. But I suppose we are stuck with it:

“Friday’s data on new home sales are clearly ‘pre-turmoil’ but should nonetheless be shockingly weak, underlining that the housing market was continuing to meltdown even before the credit crunch of recent weeks.” – BNP Paribas Fixed Income

Actually the credit crunch has been building all year. The 'turmoil' was a liquidity crisis on top of the building credit crunch.

The BNP quote is a good reminder that the New Home sales data tomorrow is pre-turmoil (for July). Also BNP mentioned that cancellations have picked up again, so Census Bureau reported sales will be overstated (and inventory increases understated).