by Anonymous on 9/13/2007 12:45:00 PM

Regular commenter bacon dreamz sent me the following artistic production--undoubtedly produced with his employer's equipment on his employer's time--which I hasten to share with you all.

This will either fix those of you who complain that my posts are too text-heavy, or it will not.

by Anonymous on 9/13/2007 09:17:00 AM

A lot of this we've already seen in various news reports, but since it always comes up for discussion, I thought it might be helpful to look at the various moving parts of CFC's operational changes:

Addressing liquidity and funding needs by accelerating our plans to migrate the funding of our mortgage originations to Countrywide Bank, and our borrowing of $11.5 billion under our lines of credit. Additionally, the Company recently arranged for $12 billion in additional secured borrowing capacity through new or existing credit facilities

I did an UberNerd post the other day on "origination channels," one purpose of which was to explain the difference between a mortgage banker and a bank. What CFC is doing is (attempting to) transform itself from primarily a mortgage banker (with a small bank) to a big bank. Instead of borrowing money to make mortages with in the capital markets, and selling them immediately, as a mortgage banker does, CFC is "migrating" to depository banking, using deposits and the kind of borrowing that is available to banks (interbank loans, for instance) to fund mortgages.

Materially tightening product and underwriting guidelines such that all loans the Company now originates are eligible for Fannie Mae, Freddie Mac or Ginnie Mae securitization programs, or otherwise meet Countrywide Bank's investment criteria.

This is more of the implications of moving from mortgage banking to banking: CFC will still sell loans, but only to the GSEs/Government-insured market. The "nonagency" loans will have to be "portfolio" quality (even if they do not always remain in the investment portfolio). What this excludes is, precisely, the kind of loans that you would be willing to sell but not to hold, or a big chunk of what got made in the last 5 years or so under the private-issue Alt-A/subprime rubric. That's one of the costs of being a bank. Of course, since the bottom fell out of the Alt-A/subprime market, it's not much of a "cost" today. Except that:

Taking advantage of reduced primary market competition to adjust pricing, which is expected to have a favorable impact on mortgage banking gain-on-sale margins and result in greater returns on the high-quality loans originated for our Bank's investment portfolio.

Profit margins for good old-fashioned GSE swap/portfolio hold depositories have never been quite as rich as the profit margins for high-rollin' Alt/Subprime mortgage bankers. What you are being told here is that CFC plans on being "the last man standing," and therefore to use the "pricing power" this provides to be a bank that makes money like a mortgage banker. However, that still requires something like a bank's expense load:

Announcing plans to reduce expenses in response to lower expectations for mortgage origination market volume. These plans include workforce reductions of up to 20 percent.

So. Welcome to Main Street, Countrywide. Lay off the high-flying sales force, hire tellers to take deposits, make Your Dad's Mortgage Loans, and start calculating your gain on sale and net interest margin in nickels and dimes. Just like the old fogie bankers on Elm and Maple you've been stomping all over for years. Hope it works for you. Can I get a free calendar?

by Anonymous on 9/13/2007 08:20:00 AM

The NYT has an article on prepayment penalties this morning, that almost but not quite arrives at the core issue:

The lenders say the trade-off is the only way to offer low monthly payments initially because otherwise borrowers would flee when rates adjust upward and make the loan a losing deal. The fees usually equal several months’ interest, and they decline over a few years before disappearing altogether.

The "traditional" prepayment penalty is, indeed, a way of putting an "exercise price" on the "imbedded call" in a mortgage loan. A mortgage borrower always has the right to prepay the loan (in options lingo, that's a "call"). Without a prepayment penalty, the price of that call is always par: you may refinance at any time by paying the lender just the principal due (and any accrued interest to the payoff date).

A prepayment penalty, in essence, forces you to "buy" your loan from the original lender at an above-par price. Looking at it in terms of yield, which is more a more everyday way of going at it, the prepayment penalty collects the interest that the lender gave up by making the loan at an originally discounted interest rate. If you "survive" the prepayment penalty period, the discount is in your pocket; if you don't, the lender is "reimbursed" for the discount out of the penalty interest. You give up mobility in return for lower interest costs. Is the theory.

In an environment of "traditional" underwriting in which people actually qualify for the loans they get, prepayment penalties can certainly be construed as "fair" (assuming they're fully disclosed and the penalty is no more than the value of the initial discount). The problem we have here is that the "discount" is a teaser: it crosses the line from "initial rate break" to "hook," as qualifying on the teaser rate is the only way the borrower can get the loan. Then it becomes just "back-loaded" interest payments, because these loans are structured to either force the borrower to refinance (and pay the penalty) to avoid the way above market reset, or to pay the way above market reset, which quickly "erases" the initial discount. That's some "call option."

The Nontraditional Mortgage Guidance, insofar as it put paid to qualifying borrowers at anything other than the fully-indexed, fully-amortizing loan payment, has already indirectly cut out most toxic prepayment penalties, since it takes away the incentive to artificially discount the start rate of the loan. Indeed, the 2/28 expired as a product not all that long after widespread adoption of the Guidance. From a certain perspective, this does, exactly, mean what all the industry lobbyists so plaintively warned us it would mean: the cost of mortgage credit went up in response to regulatory action.

But it is always worthwhile to look at it from another perspective, which is that the cost of mortgage credit just got smoothed out, not increased: borrowers are now paying their interest load from the beginning, at a tolerable level, rather than paying it "at the back of the loan" in a way that breaks the borrower's back. Insofar as it is still "unaffordable" to get a mortgage loan, we can return to the subject of insane home prices and lagging incomes.

We close, as does the Times article, with words of wisdom from a mortgage broker:

That is what happened to Dorinda Weisman, a social worker in Elk Grove, Calif. In 2005 she borrowed $353,000 from Pacific American Mortgage to buy a home in Sacramento with a small down payment. The prepayment penalty, of $9,000, expired in just a year.

“One of the things I always wanted was to own a house,” Ms. Weisman said in a telephone interview. “I was a single parent, and my son is a hemophiliac. I had been living in a middle-class African-American neighborhood that went downhill after the drugs came in.”

By the time the penalty expired, her house had declined in value. Refinancing was no longer possible.

Her interest rate had shot up to 9.8 percent from 4.75 percent. She says about 85 percent of what she brings home — her salary is $60,000 as a social service consultant with the state government — now goes to the mortgage.

She is trying to negotiate a new loan with the help of the Neighborhood Assistance Corporation of America, a nonprofit home ownership organization based in Jamaica Plain, Mass.

“Like a lot of people, the adjustable ate up her equity,“ said her mortgage broker, Antonio Cook of Toneco Financial. “She’s got to ride it out and sacrifice. I tell people, ‘I don’t care if you eat bologna sandwiches, just pay your bills on time.’ If she can ride it out, things start coming up good.”

by Calculated Risk on 9/13/2007 03:04:00 AM

From Bloomberg: First Data Loans Delayed as KKR, Banks Keep Talking, People Say

Kohlberg Kravis Roberts & Co. may delay the sale of loans to fund its $26 billion buyout of First Data Corp. until at least next week after failing to agree on terms with its bankers ...

KKR ... and banks led by Credit Suisse Group couldn't agree today on pricing or how much of the debt lenders will try to sell ...

Demand for LBO debt has evaporated. After buying a record $754 billion of leveraged loans this year, investors are balking at debt without covenants, or restrictions, that give them greater power over a company's finances.

by Calculated Risk on 9/12/2007 09:37:00 PM

Here is a letter today from Mervyn King, Governor of the Bank of England including, a paper titled: Turmoil in Financial Markets: What can Central Banks do?.

Here is the conclusion:

The path ahead is uncertain. There are strong private incentives to market players to recognise early and transparently their exposures to off-balance sheet entities and to accelerate the re-pricing of asset-backed securities. Policy actions must be supportive of this process. Injections of liquidity in normal money market operations against high quality collateral are unlikely by themselves to bring down the LIBOR spreads that reflect a need for banks collectively to finance the expansion of their balance sheets. To do that, general injections of liquidity against a wider range of collateral would be necessary. But unless they were made available at an appropriate penalty rate, they would encourage in future the very risk-taking that has led us to where we are. All central banks are aware that there are circumstances in which action might be necessary to prevent a major shock to the system as a whole. Balancing these considerations will pose considerable challenges, and in present circumstances judging that balance is something we do almost daily.

The key objectives remain, first, the continuous pursuit of the inflation target to maintain economic stability and, second, ensuring that the financial system continues to function effectively, including the proper pricing of risk. If risk continues to be under-priced, the next period of turmoil will be on an even bigger scale. The current turmoil, which has at its heart the earlier under-pricing of risk, has disturbed the unusual serenity of recent years, but, managed properly, it should not threaten our long-run economic stability.
emphasis added

by Calculated Risk on 9/12/2007 05:40:00 PM

From Law.com: Real Estate Deals Are Feeling the Credit Pinch (hat tip Vader)

The sudden queasiness of lenders has cast a pall over the once-robust real estate market in the last six weeks, [Stephen Cowan, a DLA Piper real estate partner] and other lawyers report. Deals have been interrupted mid-stride. Some have been re-jiggered and others have just died.
...
The up-and-down nature of the real estate practice is nothing new. What is new, lawyers say, is the quickness with which this dip descended.

"I've been through cycles in the '70s, '80s and '90s -- this was a very sudden change," said DLA's Cowan. "It caught everyone off guard -- even though everyone was saying, 'It's coming, it's coming.' It was like an earthquake."

The landscape has shifted. The CRE slump is here.

by Anonymous on 9/12/2007 03:33:00 PM

Normally I see very little point in reading press releases, but this one caught my eye. Worried about lenders using those AVMs to value real estate in mortgage lending transactions? Worry no more! You can now buy a cheap piece of software to "test" the results of your cheap piece of software! It will either still be cheaper than sending an appraiser out to look for foundation cracks, which will mean no one will ever look for foundation cracks, or it will be even more expensive what with running both kinds of software, in which case, we'll pass that "savings" on to you, the consumer, and still not use professional appraisers! You have to love simple solutions to regulatory policy changes.

Is it happy hour yet?

AUSTIN, Texas, Sep 12, 2007 (BUSINESS WIRE) -- FirstClose, a service of First Lenders Data, Inc. (FLDI), an Austin, Texas-based provider of bundled mortgage settlement services, announced today that it has developed a comprehensive approach to back-testing Automated Valuation Models (AVMs), entitled ValueTest(TM).

The ValueTest(TM) program is designed to help lenders satisfy recent regulations and guidelines from Fannie Mae, Freddie Mac, the OCC, the NCUA, and other regulatory bodies that have imposed requirements or guidelines on lenders to "back test" AVMs regarding their accuracy. Utilizing a vast array of the mortgage industries top AVM companies and collateral risk assessment tools, ValueTest(TM) provides lenders with a simple, easy, and inexpensive way to satisfy regulatory requirements.

"We are excited about offering an inexpensive, yet comprehensive solution to our mortgage lending customers to help them satisfy regulatory requirements," said Tedd R. Smith, Chief Executive Officer of First Lenders Data, Inc. "Back Testing AVMs has been an ongoing concern of our customers since regulatory inception and no one seems to be able to provide a safe and inexpensive solution until now."

According to Fannie Mae's Perspective on Automated Valuation Models (AVMs), "It is critical that users of AVMs design an appropriate use and implementation strategy that considers the overall credit risk of the loan and reflects the specific strengths and weaknesses of the particular AVMs they use, particularly the property data supporting those products." The ValueTest(TM) program works well for any mortgage lender offering both first and second mortgage loans. As part of quality control checks and balances, the ValueTest(TM) program can be custom designed to fit any lenders needs and requirements.

Oh, the vendor of this wildly exciting product also sells "settlement services," meaning it has a vested interest in seeing to it that closings don't get cancelled because of those pesky "valuation" problems. Surprise! Could that be why this is so "inexpensive," or is it just some PlaySkool My First Laptop-quality version of everyone's favorite game, Regulatory Evasion? Or both?

As soon as I finish development of HorseHockeyTest™, I'm going to quit blogging and get rich. You have been warned.

by Calculated Risk on 9/12/2007 02:12:00 PM

From DataQuick: SoCal home sales at 15-year low, prices edge down

Home sales in Southern California dropped to their lowest level since 1992 as buyers, sellers and lenders held back in an environment of market uncertainty. Prices are off their peak, markedly so in lower cost neighborhoods, a real estate information service reported.

A total of 17,755 new and resale houses and condos sold in Los Angeles, Riverside, San Diego, Ventura, San Bernardino and Orange counties last month. That was down 0.6 percent from 17,867 for the previous month, and down 36.3 percent from 27,857 for August last year, according to DataQuick Information Systems.

Last month's sales were the slowest for any August since 1992, when 16,379 homes sold, the lowest for any August in DataQuick's statistics, which go back to 1988. The strongest August was in 2003, when 39,562 homes sold. The August sales average is 28,160.

For existing homes August typically has more sales than July, so on a seasonally adjusted basis, this report is worse than it appears.

On prices:

The median price paid for a Southland home was $500,000 last month, down 1.0 percent from $505,000 in July, and up 2.7 percent from $487,000 for August last year.

When adjusted for shifts in market mix (i.e. fewer lower-cost homes selling now), year-over-year price changes went negative in January and are now 3.5 percent below year-ago levels.

On foreclosures:

Foreclosure resales accounted for 8.8 percent of August's sales activity, up from 8.3 percent in July, and up from 2.2 percent in August of last year. Foreclosure resales do not yet have a marketwide effect on prices, although foreclosure discounts appear to be emerging in some local Inland Empire and High Desert markets.

by Calculated Risk on 9/12/2007 01:05:00 PM

From the WSJ on Orange County, CA: Troubled Lenders May Chill Once-Hot Market

The subprime-mortgage industry crisis and Orange County's economic tailspin are likely to have a chilling effect on nearly all types of commercial real estate in this formerly go-go market, some analysts say.

A number of shrinking mortgage companies are already dumping office space on the market. The area's weakening job and housing market will also pinch consumer spending ...

...many office landlords are trying hard to win tenants with deals of free rents and other concessions that have masked the downward pressure ... Asking rents on premium space that now average about $35 a square foot are likely to fall as much as 15% over the next 18 months as building owners face the double whammy of a drop in demand and a surge of new speculative construction coming on line, Mr. Ingham says.

The CRE story: falling demand, rising supply.

In the previous story on shopping centers, Orange County was consider one of the strong areas:

In metropolitan areas with strong population growth, like Phoenix and Orange County, Calif., new shopping centers are easily attracting tenants, according to a report by the CoStar Group, a research company in Bethesda, Md. But new centers in several other metropolitan areas — Memphis, Cleveland, Indianapolis, Tucson, Southwest Florida and Nashville — are having trouble leasing space, CoStar said.

Phoenix and Orange County are the strong areas? Oh my ...

by Calculated Risk on 9/12/2007 12:03:00 PM

More on CRE.

From the NY Times: Shopping Centers Begin to Feel Ripples of Housing’s Ills (hat tip vader)

... shopping centers have been caught in the credit squeeze that has transformed the capital markets. Private buyers, who were once able to finance 95 percent or more of the cost of a transaction, are being driven out of the market because such high leverage is no longer available.

According to investors, brokers and analysts, deals are taking longer to complete, and prices — at least for the second- and third-tier properties — are declining by as much as 10 percent.
...
While demand for space remains strong at the high-end regional malls, the average vacancy rate at strip malls, which are generally anchored by supermarkets, has been creeping up for more than two years, even though relatively little new space has been developed, according to Sam Chandan, the chief economist for Reis, a New York research company.

Mr. Chandan said the vacancy rate stood at 7.3 percent at the end of June and was expected to rise to 7.6 percent by the end of the year, its highest level since 1995.

In the second half of the year, he said, about 26.2 million square feet in strip malls will be completed, which would contribute to an oversupply. “That’s the highest level of completions we’ve seen in many years, and it coincides with the slowdown in the underlying drive for space,” he said.

Rising vacancy rates, falling prices, increasing supply and tighter credit: a prescription for a CRE slump.