by Anonymous on 10/09/2007 01:45:00 PM

Here's a classic example of why some of us are simply beyond disgusted with the mortgage industry. It comes from an American Banker (not online) article on FDIC Chairman Sheila Bair's recent proposal to a mortgage banking conference that servicers use their ability to modify loans to "freeze" endangered subprime ARMs at the start rate.

The day before the interview, Ms. Bair had done some jawboning in a speech at a New York mortgage investor conference sponsored by Clayton Holdings Inc. Her proposal is "a clear, categorical move that can be applied on a wholesale basis by servicers," she told nearly 100 professionals at the conference. "I don't think servicers have the time or the resources to go through these case by case, renegotiate, [and] restructure every single one."

Moreover, "if the industry doesn't do it themselves, either Congress is going to do it for them, or a bankruptcy judge is going to do it for them," she said, a reference to legislative proposals to allow bankruptcy courts to modify mortgages. "I'm trying to make one suggestion at least for a certain category of loans where I perceive these to be more sympathetic borrowers, and show policy makers that the industry is working to find a solution."

But questions from the audience revealed a reluctance in some corners to cut subprime homeowners much slack.

"The behavior of a subprime borrower, the reason they became subprime, is because they get themselves into [a] credit issue," one audience member told Ms. Bair. "If you, in turn, fix a liability that they have, they will max out their credit card. There will be another event that they will put themselves in trouble, in default. You're just going to postpone" the inevitable and, "in a declining housing market, just make things worse."

See, this is how it all started:

Dude with "credit issues" wanders into a branch of Subprime R Us, wanting a loan to buy a house. Loan officer looks at the fact that Dude has a history of getting into credit messes, and says, "there will just be another event you will put you in default. By buying a house and adding to your living expenses, you are just going to end up inevitably in foreclosure. Loan application denied."

Oh, it didn't happen that way? OK, so Dude got the purchase money loan. Then the credit card bills started racking up, just like the loan officer didn't predict would happen.

Dude goes back to Subprime R Us, wanting a cash-out refi to consolidate debt. Loan officer looks at the fact that Dude has a history of getting into credit messes, and says, "there will just be another event you will put you in default. By fixing a liability that you have by giving you a cash-out, I would just allow you to max out your credit card again. It would just be postponing inevitable default. Loan application denied."

Oh, it didn't happen that way? OK, so Dude got the cash-out refi. Then the combination of the expensive mortgage and the credit card bills started racking up, just like the loan officer didn't predict would happen.

Dude calls up mortgage servicer, because Subprime R Us has apparently filed for bankruptcy and does not answer phone calls. Dude asks for a workout of loan terms. Servicer says . . . sorry. We only make loans to people we know will default when home prices are rising. Now that home prices are falling, the fact that we "know" that you will just max your credit cards out later is relevant. The fact that it used to be irrelevant is immaterial.

You listen to these people and you get the impression that subprime loans are kind of like the Messiah: an immaculate conception and a virgin birth. No lender was apparently involved the first time; the borrowers just made these loans to themselves. Now that reality has intervened to show how stupid some of these lending practices are, it's time to remember that we "know" what subprime borrowers will do if you lower their monthly payments.

Yeah, sure we "know" that. That's why you find so many mortgage servicers advocating outlawing subprime mortgage lending, on the grounds that they know it never works out.

by Anonymous on 10/09/2007 11:52:00 AM

John Dugan, Mr. I Hate Stated Income and also Comptroller of our Currency, is on the warpath again:

San Diego, CA – Comptroller of the Currency John C. Dugan said today that banks need to strengthen their underwriting standards, particularly on loans sold to third party investors.

“I am here to say that bank underwriting standards for these products, in many cases, moved too far away from what they would have been if the bank had held those loans on its own books,” Mr. Dugan said in a speech to the American Bankers Association’s Annual Convention.

Mr. Dugan noted the many positive aspects of the “originate-to distribute” model, but said there can be negative effects on underwriting standards, including relaxing significantly the incentives to use caution and prudence in underwriting loans sold to third parties.

“When a bank makes a loan that it plans to hold, the fundamental standard it uses to underwrite the loan is that most basic of credit standards that I’ve already talked about: the underwriting must be strong enough to create a reasonable expectation that the loan will be repaid,” the Comptroller said. “But when a bank makes a loan that it plans to sell, then the credit evaluation shifts in an important way: the underwriting must be strong enough to create a reasonable expectation that the loan can be sold—or put another way, the bank will underwrite to whatever standard the market will bear.”

Comptroller Dugan outlined what needs to be done. “I am here to say that banks need to strengthen their underwriting standards so that they move back towards the fundamental principle of maintaining a reasonable expectation that loans will be repaid, even if the loans are to be sold to third parties – and that goes for mortgage loans, leveraged loans, or any other syndicated credit,” Mr. Dugan said.

What Dugan neglects to mention--or at least, what isn't in the reported summary of the speech--is the vicious feedback loop that goes on with this model. The problem is that for many years, banks often used a standard for determining an "investment quality loan" based on what secondary market investors--traditionally, Fannie and Freddie--would purchase. So when the GSEs and private investors relax standards for what counts as "capacity to repay," banks find themselves with a widening gulf between their own portfolio standards and "what the market will bear." This begins to suggest to portfolio managers that internal credit standards are "too tight," and so the banks don't just lower standards for loans they intend to sell, they lower standards for their own portfolio production.

(Hat tip FFDIC)

by Anonymous on 10/09/2007 10:04:00 AM

More stuff from the spreadsheet collection. This one looks at characteristics and some performance measures of securitized subprime loans from 2000-2006. Unfortunately, there is very little publically available data on unsecuritized subprime.

Comments:

1. Total MBS issued on this chart is mostly, but not exclusively, first liens. (It includes securities that have some second liens, but excludes securities that are exclusively second liens.)

2. The average loan amount is based on first liens.

3. WAC is weighted average coupon or "interest rate" in English.

4. "Reported" DTI simply means that's what was reported. While I have some doubts about the accuracy of that number when the full doc percentage is dropping, do notice that it is climbing even so. The historical maximum acceptable DTI for conforming agency-quality loans was 36%.

5. Historically, subprime was a refinance business, not a purchase money business. This chart shows that very clearly.

6. "Serious Delinquency" means 60 or more days delinquent, FC, REO, or BK. Because this is calculated on the current balance of these securities, this number will be much higher than what you see reported based on original balance. You should be aware that the remaining current balance of these older vintages is very low; the average "pool factor" or balance remaining for 2000, for instance, is around 5%, as opposed to 83% for 2006.

7. "Default" is a very specific technical measure here. A loan is reported as a default in a month when its balance is reported as zero and its last reported status was in foreclosure, REO, delinquent more than 150 days, or any other status and a loss of more than $1000 was recorded at payoff. In other words, "default" is the final disposition of a loan, and it includes things like short sales and short refis as well as foreclosures. It does not include active modifications or forbearances, since these loans still have a reported balance. It is a loss measure, and because it involves the final disposition of a loan, it is always much lower for new issues than for older issues, even if they are performing equally.

8. Cumulative loss is based on the original security balance, and is equal to default times severity.

Now, about that FICO average. On the one hand, the fact that the average FICO is rising can be filed under "I sure as hell hope so." When you look at the steadily rising risk factors of CLTV, documentation level, DTI, and so on, you would certainly expect that higher FICOs were being required as some kind of risk offset.

On the other hand, those average FICOs are getting awfully close to near-prime or even prime territory, depending on your definition (620-660 being the usual floor for prime). That means that a lot of these loans have FICOs clearly in prime range. In order to rule out the possibility of predatory steering, you have to trust that the subprime industry has been scrupulous about giving subprime loans to higher-FICO borrowers only when the other loan characteristics are clearly non-prime. This question cannot be solved by looking at averages or even really good stratifications; it takes loan-file-level reviews to really understand what's going on. As those loan-file-level reviews were, apparently, not done by aggregators and raters and investors, they are now being done by servicers and courts.

by Calculated Risk on 10/09/2007 02:08:00 AM

From the LA Times: Slipping imports reflect slowing economy

Cargo containers crammed with foreign-made goods that were supposed to set a record in August at major U.S. ports took an unexpected turn, with imports sinking 1.4% in another sign of the slowing of the economy.
...
The slump in oceangoing imports unloaded at the 10 largest U.S. container ports in August was the first drop since Global Insight began its monthly Port Tracker report in 2005. The number stunned some port watchers.

"When I first saw these numbers, I called the researchers and asked them if they had left a column out of the spreadsheet. I thought it was a typo," said Craig Shearman, vice president of the National Retail Federation, which pays Global Insight to conduct the trade research.

by Calculated Risk on 10/09/2007 12:25:00 AM

From the NY Times: A Bank Bet on Condos, but Buyers Want Out.

“We’re at the riskiest point of the condo lending cycle as these projects are being completed,” Jefferson L. Harralson, a bank analyst at Keefe, Bruyette & Woods, said. “In the coming weeks and months, we’re going to find out what the demand for these condos really is.”
...
Today, developers owe Corus $4 billion, $3.7 billion of which, or 92 percent, is in condominiums. Of that, about 25 percent of them are in projects in the Miami area and 9 percent are in Las Vegas, according to regulatory filings. More than $2.15 billion of its outstanding loans are due by the end of this year. Nationwide, the number of condos completed this year will be up 45 percent — 232,933 vs. 160,239 — from 2006, according to data tracked by Marcus & Millichap Real Estate Investment Services, a real estate investment brokerage based in Encino, Calif.

Note: Many of these are the kind of condo units that don't show up in the Census Bureau's New Home report. Some quotes from the article:

“I don’t want to take possession of it.”

“I can go a whole week without seeing a neighbor.”

Not only are there many unsold units, but some buyers are trying to break their contracts, or are thinking about walking away from their deposits.

by Calculated Risk on 10/08/2007 06:59:00 PM

The story this morning on distressed home sales in Orange County reminded me that all inventory isn't counted in either the Census Bureau's New Home, and the NAR's Existing Home, inventory reports.

Note: Distressed homes are usually homes that will sell for less than the amount owed (including tax liens). This includes properties in foreclosure and short sales. Some people also include 'must sell' properties (divorce) or seriously damaged properties. I prefer the first definition.

Let's start with New Homes. During periods of changing cancellation rates, the Census Bureau may overestimate or underestimate the actual changes to the inventory. Currently my estimate - based on an analysis of public builder's cancellations rates - is that the Census Bureau is underestimating New Home inventory by 77K units.

Another problem with the New Home data (both inventory and sales) is that some condos are not included. It appears town home style condos (with no neighbor above or below) are included in the New Home report, but high rise condos aren't included. Look at this marketing piece: First Condo Auction in D.C. Suburbs Offers Prices Not Seen in a Decade. The press release calls these "two story condos" and it appears from the picture that these are side by side type condos, so they are probably included in the New Home report as inventory. From the Press Release:

"There are currently about 19,000 unsold condominiums actively marketing in the Washington metropolitan area, with at least 16,000 new units coming on the market in the next 36 months," said William Rich, Vice President of Delta Associates.

Why a marketing piece would want to remind buyers of the excess inventory is a different issue, but some of these 35,000 units - if they are multiple story units - might not be included in the New Home report.

For existing homes, some distressed properties are not included in the Existing Home inventory report. Some bank REOs (Real Estate Owned) are not listed - and some REOs are. So it's difficult during periods of high foreclosure activity to accurately estimate the total inventory for existing homes.

The Census Bureau and NAR numbers are useful in comparing to prior periods, but this is just a reminder that the current reported inventory numbers are probably lower than actual.

by Calculated Risk on 10/08/2007 05:51:00 PM

From Fannie Mae chief economist David Berson's Weekly Commentary

"... lenders reported a lack of investor demand for high credit quality jumbo mortgages and other mortgages not eligible for agency purchase. This dislocation pushed the cost of prime jumbo financing significantly higher relative to rates on conforming loans. Figure 1 shows the spread between rates being offered by lenders on prime jumbo and prime conforming 30-year fixed-rate mortgages. In mid-August this spread spiked to above 90 basis points after fluctuating between 15 and 25 basis points for the prior year-and-a-half (about equal to its historic spread). This spread has moderated somewhat over the past couple of weeks, however, and fell below 80 basis points in late September, suggesting some modest improvement in the market conditions for prime loans with balances above the conforming loan limit. Even so, the spread remains historically wide -- suggesting that the prime jumbo market remains in distress."

The key sentence: "the spread remains historically wide -- suggesting that the prime jumbo market remains in distress."

by Calculated Risk on 10/08/2007 12:18:00 PM

In a research note released today, titled "Time to Buckle Up the Seat Belts", Credit Suisse argues that consumer spending was weaker than expected in September, and they believe this may be "a sign of what's to come" in the 4th quarter.

In an earlier post, I noted that growth in real consumer spending was around 3% annualized in Q3 using the two month estimate (based on the first two months of the quarter). Usually I go with the two month estimate, however I think Q3 2007 might be an exception and real PCE growth could have slowed sharply in September.

UPDATE: From Ryder Press Release:

Economic conditions have softened considerably in more industries beyond those related to housing and construction.

On a related note, from MarketWatch: Ryder lowers quarterly, yearly profit outlook (hat tip Al, Brian)

... the truck leasing company warned that soft demand for its commercial rentals, lower used-vehicle prices and higher costs would yield lower third-quarter earnings than earlier forecast.

The company blamed a slowdown in the housing and construction industries for the lower outlook, a situation that Ryder said was likely to persist through the end of the year.
...
Though transportation fundamentals have been weak for the last couple of quarters, Ryder's case is surprising because it's been considered to have a more stable outlook as most of their business is contractual, said Todd Fowler, analyst with Keybanc Capital Markets.

by Anonymous on 10/08/2007 11:30:00 AM

I've been updating some old spreadsheets of mine, and I thought some of you might be interested in having some of the numbers. Data like the following, which involve national averages over entire years, are awfully blunt instruments for a lot of analytical purposes; I'm not offering these as "proof" of any particularly detailed claim about the world, nor am I suggesting that any particular set of numbers in this table can "explain" any other set in completely reliable ways.

Nonetheless, broad-brush numbers like these do provide a kind of context for certain discussions of the mortgage market. I tend, personally, to cringe a lot when certain numbers are reported in the press, because I possess a sense of context that, frankly, non-insiders don't have. It is second nature to me, for instance, to distinguish between origination volume and level of loans outstanding at the end of a period, but you will find press reports moving back and forth from originations and outstandings in blithe disregard of the issues.

So make of this what you will. A few nerdly observations about the data:

1. Total originations are hard to pin down; there's often a lot of vapor as well as volatility in those numbers. I pick what I think is the most reliable, but you should know that data collection and reporting practices change over time, and so a lot of the older numbers are pretty approximate. That's one reason why I don't care to go back before 1988.

2. The ownership rate statistical calculation changed significantly in the early 90s. The pre-1993 numbers should be thrown around with even more caution than the 1993-2006 numbers.

3. There are a lot of different rates you can use to establish an average mortgage interest rate. I chose the FHFB conforming fixed contract rate because it can be considered an index of "refinance incentive."

4. Mortgage FOR is a statistical measure of mortgage debt, property taxes, and insurance divided by disposable personal income for all homeowners with a mortgage. As a level, it's not particularly helpful, but it does help establish trends, and it is certainly more consistently calculated than DTI.

5. Refinance percent is all refinances. I am not yet ready to try to sort out the cash-out issue over this time period, and I may never be. But general refi share is a useful bit of context for those changes that you see in the other numbers.

A couple of general observations I would make about this data:

1. Notice the volatility of origination volume compared to mortgage outstandings. A large part of some of the knotty issues we've talked about on this blog, like use of brokers, barriers to entry (or the lack thereof) for mortgage originators, and historical changes in quality of mortgage origination personnel (including loan officers and appraisers), has to do with that volatility. The short version is that originators staff up and staff down in the cycle, and that loan quality (not just borrower credit quality, but accuracy of paperwork, depth of documentation, clarity of disclosures) zigs and zags along that cycle. In the early part of those big booms, for instance, you can see a lot of novice work. In the troughs, you can see a lot of desperate commission-paid people doing desperate things. That's something to take into account when you look at, say, vintage charts of loan performance. I believe, for instance, that a lot of the problems with the (in)famous 2001 vintage had to do with a huge crop of brand-new brokers and loan officers and appraisers getting into the business to cope with the volume. A lot of the problems with the 2000 vintage is that a bunch of originators who had been, in the past couple of years, making plenty of money off the refi boom started scraping the bottom of the barrel when volume dropped off. The 1993-1994 period had a similar problem.

2. There has always been much more stability on the servicing side; the problems there in terms of expertise are more a function of technological "productivity" changes and outsourcing reducing the cadre of gray-haired veterans of past crises. The thing to notice here is the level of turnover in the outstandings. In 2003, for instance, around a third of the outstanding mortgage book turned over in refinances. Mortgage sevicers can do a lot of work to stay in the same place, let alone to grow a servicing portfolio.

3. Whatever generalizations you want to make about earlier periods, the 2004-2006 period confounds them.

by Calculated Risk on 10/08/2007 10:39:00 AM

Jon Lansner writes at the O.C. Register: Distressed properties 12% of O.C. housing supply

Market watcher Steve Thomas at Re/Max Real Estate Services in Aliso Viejo notes the impact of distressed properties in his biweekly summary of housing supply ...

After finding a new way to search for short sales and foreclosures on the market and in escrow, the new findings are disconcerting. Currently, short sales and foreclosures in Orange County account for 12% of the active inventory and 15% of all escrows opened within the prior month.

Thomas also calculates “market time,” a benchmark of how many months it theoretically takes to sell all the inventory in the local MLS for-sale listings at the current pace of pending deals being made. This index shows the inventory-to-selling ratio continuing to erode. By this Thomas logic, it would take 15.17 months for buyers to gobble up all homes listed for sale at the current pace of deals vs. 14.73 months two weeks earlier and vs. 7.10 months a year ago.