by Calculated Risk on 10/10/2007 09:57:00 PM

From the WSJ: The United States of Subprime (hat tip jim)

... an analysis of more than 130 million home loans made over the past decade reveals that risky mortgages were made in nearly every corner of the nation, from small towns in the middle of nowhere to inner cities to affluent suburbs.

The analysis of loan data by The Wall Street Journal indicates that from 2004 to 2006, when home prices peaked in many parts of the country, more than 2,500 banks, thrifts, credit unions and mortgage companies made a combined $1.5 trillion in high-interest-rate loans.

... the data contradict the conventional wisdom that subprime borrowers are overwhelmingly low-income residents of inner cities. Although the concentration of high-rate loans is higher in poorer communities, the numbers show that high-rate lending also rose sharply in middle-class and wealthier communities.

The Journal's findings reveal that the subprime aftermath is hurting a far broader array of Americans than many realize, cutting across differences in income, race and geography. ...

The data also show that some of the worst excesses of the subprime binge continued well into 2006, suggesting that the pain could last through next year and beyond, especially if housing prices remain sluggish. Some borrowers may not run into trouble for years.

I'm a little confused by this analysis. The WSJ used the federal Home Mortgage Disclosure Act data to scan for "high interest loans". My understanding is that not all "high interest" loans are "subprime", some are Alt-A. And I'm not sure if this analysis included IO ARMs and Neg Am ARMs; two loan types frequently used by homebuyers in more affluent areas. Hopefully Tanta will help me understand.

But the analysis does make it clear that the bubble was widespread, and that the bust will also be widespread.

by Calculated Risk on 10/10/2007 04:37:00 PM

Ramsey Su reported on an auction in San Diego (see REO Auction in San Diego).

Here is a report on an auction in Virginia from the Washington Times: Foreclosed homes flood auction (hat tip X)

Auctioneer Hudson & Marshall sold nearly 240 foreclosed homes in the Washington area last weekend, making a small dent in a large backlog of homes abandoned by buyers who couldn't keep up with escalating payments.
...
Many sold for 20 percent below market value. About 75 of the properties offered at auction failed to sell.

Here are a couple of recent amateur videos on auctions:

Northern Virginia Auction

San Diego Foreclosure Sale Oct 3, 2007

And check out the Vandalized REO too. WARNING: Foul language on walls.

by Calculated Risk on 10/10/2007 02:40:00 PM

From Fortune Magazine: Trucking giant sees blue Christmas (hat tip Andrew)

Here are some excerpt from an interview with YRC Worldwide CEO Bill Zollars. (emphasis added)

Fortune: How is the holiday season shaping up?

Zollars: We've got a window now of about ten weeks or so where we should really see a big increase in shipment volumes as we get ready for Christmas. We have not seen that, and that's a concern. Last year's inventory buildup for Christmas was lower than historical standards, and the season ended up okay - not terrible. This year you have some easy comparisons, so you would expect to see more of a preholiday inventory buildup, but we have not seen that. Maybe it's coming later. Maybe it's not coming.
...
Fortune: Getting back to the economy, could things get worse before they get better?

Zollars: We have not felt the bottom yet. I'm still a bit nervous. Right now, if things continue to deteriorate, I'm worried we may head into a recession. [I feel that] there is a one-in-three chance of a recession. We are prepared for the worst and hoping for the best.

by Calculated Risk on 10/10/2007 10:20:00 AM

The comedians at the National Association of Realtors (NAR) revised down their forecast today for existing home sales in 2007 again. Their current forecast is for sales to be 5.78 million in 2007, down for 5.92 million last month.

Compare this to their original forecast from Dec '06 of 6.4 million units in 2007. (My forecast was for existing home sales to be between 5.6 and 5.8 million units).

The NAR forecast is still too high, even after eight straight months of negative revisions. Luckily for the NAR, they still have two more downward revisions to go.

From the NAR: Improvement in Mortgage Market Bodes Well for Housing in 2008

Existing-home sales are expected to total 5.78 million in 2007 and then rise to 6.12 million next year, in contrast with 6.48 million in 2006. New-home sales are forecast at 804,000 this year and 752,000 in 2008, down from 1.05 million in 2006; a recovery for new homes will be delayed until next spring.
...
Existing-home prices will probably slip 1.3 percent to a median of $219,000 in 2007 before rising 1.3 percent next year to $221,800. The median new-home price should drop 2.1 percent to $241,400 this year, and then increase 1.0 percent in 2008 to $243,900.

Very funny. Thanks for the laughs!

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

Of course I expect Father Market to grant absolution . . .

NEWPORT BEACH, Calif., Oct 10, 2007 /PRNewswire-FirstCall via COMTEX/ -- Downey Financial Corp. (DSL:Downey Financial Corp. announced today that it will report third quarter 2007 financial results on October 17, 2007, and, subject to finalization of results, that it expects to incur an operating loss for the quarter of approximately $23 million or $0.84 per share on a fully diluted basis. This will reduce net income for the first nine months of 2007 to approximately $52 million or $1.87 per share on a fully diluted basis.

The third quarter results are adversely affected by the continued weakening in the housing market. More specifically, the quarter will include the following pre-tax amounts:

-- An approximate $82 million provision for credit losses, which will increase the allowance for loan losses to approximately $144 million or 1.22% of loans held for investment.
-- An approximate $9 million valuation reduction to real estate held for development to reflect declines in the value of single family home lots in which the company is a joint venture partner.

Daniel D. Rosenthal, President and Chief Executive Officer, commented, "We are clearly disappointed with our third quarter results. The continued weakening and uncertainty relative to the housing market, coupled with the third-quarter disruption in the secondary mortgage markets, unfavorably impacted our borrowers and the value of their loan collateral. This has been particularly true in certain geographic areas such as the greater Sacramento and Stockton areas of Northern California and San Diego County. As a result, single family loan delinquencies, as well as losses from foreclosures, rose significantly during the third quarter and led to this quarter's large increase to the allowance for losses."

Mr. Rosenthal further stated that, "In response to recent trends and events, we have further tightened our lending guidelines, activated a loan modification group to work with borrowers on a proactive basis, and provided the necessary resources to dispose of homes acquired through foreclosure on a timely basis. Finally, despite this quarter's unfavorable results, Downey remains well positioned to continue funding quality loans because of our strong capital position and stable source of funds from our retail branch franchise."

by Anonymous on 10/10/2007 09:40:00 AM

More unattractive little snips from my unattractive spreadsheet collection (earlier posts here and here). What can I say? UberNerds don't need no steenkin' fancy formatting.

Item one gives you some sense of the size of the residential first lien securitization market since 1988.

I have been avoiding the terms "agency" and "nonagency" on this blog, but I'm breaking down and using them here. These are an established and pretty old-fashioned way of describing things inside the biz, but they are traps for the unwary. In this particular context, "agency" means Ginnie Mae (which securitizes FHA, VA, and a few other government-insured loans), Fannie Mae, and Freddie Mac, even though only Ginnie Mae is actually an agency of the government (Fannie and Freddie are GSEs, Government-Sponsored Enterprises, not actual agencies). But we used to call them all agencies, and the term survived reality by about a generation and a half, so there. "Nonagency" just means any private issuer.

The column "Issues / Originations" is simply that: one annual number divided by another annual number. That is a very, very approximate way to describe the rate of securitization of originated loans. You would get a number much closer to reality if you used quarterly numbers with a one quarter lag, but I don't have quarterly origination numbers handy. So do throw this number around with a high degree of caution.

What we learn from this spreadsheet is something like the approximate size of the segment of mortgage outstandings that have been in the news lately. The nonagency category (in these charts) includes Jumbo A, Alt-A, and Subprime, primarily first liens. (It includes some MBS that have a small percentage of second liens in them, but excludes MBS that are exclusively second liens. I complain regularly about the "lumpy" or Bridge Mix nature of recent nonagency MBS issues, and this is one reason why.) Basically, all the reporting you are seeing that is based on securitized nonagency loans is discussing around a third of securitized loans outstanding, or 19% of all loans outstanding (as of Q4 2006). Because there is so little data available on unsecuritized loans, it is extremely difficult to answer the question of the extent to which "nonagency" unsecurtized (these are mostly but not exclusively bank and thrift portfolio loans) will perform like their securitized brethren. Most of us believe that the securitized loans were written to much riskier standards than the unsecuritized loans, although as I noted yesterday in reference to the C of the C's last exasperated speech, I do believe that portfolio lending standards have loosened significantly in the last several years. You may in any case draw your own conclusions.

Item two is all the information I have on the break-out of the nonagency category. I got nuthin' on outstandings prior to 2000, but you can guess from what's here that they were rather modest in relation to total mortgage outstandings in those years.

I do not have a refi mix breakout by product for Jumbo A and Alt-A, so I didn't include it. But you can get a sense for how much of new origination is refinance (turnover in the outstandings rather than net additions to it) by comparing issues to the change in outstandings in a given year.

You can also get an idea for why people like me have been snorting derisively for years over this claim that "Alt-A" has a stellar performance history. It barely has a "history" at all. Furthermore, the definition of "Alt-A" in 1995 bears little resemblance to the definition of "Alt-A" in 2006. Remember that "Alt-A" means "alternative" to "A," and so whatever it is, its composition will change as the definition of "A" or "prime," to which it is an "alternative," changes. Back in the mid-90s, SIVA (stated income/verified asset) or--gasp!--CLTVs of 95% were the big "alternatives" and "interest only" was the sort of thing you ran into in commercial lending. Not only do you have, nowadays, IO SIVA with 100% CLTV in "A" (conforming or Jumbo), you have stuff in Alt-A that was simply unimaginable in 1995. So as "A" gets more "alty" over time, "alt" gets waaay more "alty" over time. What people are trying to get at by asking how "Alt-A" can "revert to normal" is, as far as I'm concerned, not very clear. I have no idea what other people think "normal" Alt-A is.

by Calculated Risk on 10/09/2007 10:10:00 PM

My friend Ramsey Su sent me an update tonight:

This is the 3rd San Diego REO auction of its kind in 5 months, 4th, if you count the DHI auction by the same auctioneer. Fortunately, of the 83 properties, only 7 were not previously listed in the MLS so this is an easy batch of properties to research.

I noted yesterday that unlisted REOs are one of the reasons the reported inventory level is currently too low. In this case, over 90% of the REOs were listed.

REOs are now an integral part of the real estate market. Appraisals have come down to earth and REO brokers are selling properties in record volume, though not matching the pace of acquisitions.
...
Similar to the homebuilders, as the REOs force the price down, it "impairs" the neighborhood and homeowners in default are even more likely to be foreclosed upon now.
...
"Previously Valued To"
REDC abandoned previous practice of using the last sold price as their "Previously Valued To" price. I use available tax record and recreated that value. It appears the last average list price of these properties is 81.4% of the last sold price.

Lenders are now aggressively cutting prices on REOs. The average LIST price is almost 20% off the previous selling price! Ouch. Ramsey also notes that many of these homes were previously purchased with 100% LTV, so the homeowners were substantially underwater and workouts were near impossible.

If someone is thinking the lenders are working down the REO inventory in San Diego, Ramsey Su offers the following graph:

Click on graph for larger image.

This graph shows:
NODs: Notice of Default,
NOTs: Notice of Trustee’s sale,
and
REOs: Real Estate Owned by the Lender.

After a NOD is filed, the lender must wait 3 months before filing a NOT. Then the foreclosure sale happens 3 weeks later. Ramsey has shifted the graph to account for these lags.

The graph of NODs shows where NOTs and REOs will go over the next 3 months.

Ramsey adds this comment:

719 REOs in San Diego during the last 4 weeks, comparing to just 1,239 sales reported so far by the MLS for September, are we going to see over 50% REO prevalence next quarter?

It's about to get ugly.

by Calculated Risk on 10/09/2007 09:37:00 PM

From the WSJ: Strip-Mall Vacancies Hit 7.4%

U.S. strip-mall vacancies only inched up in the third quarter, but still hit a 5½-year high ... Rentals of retail space in weak housing markets are getting hit disproportionately hard, as consumers rein in their purchases.

The retail sector has been a pillar of the commercial real-estate industry -- and the overall economy -- for the last seven years ...

The strip-mall vacancy rate rose to 7.4% in the third quarter, from 7.3% in the second quarter and 7% in the year-earlier period. Along with the first quarter of 2002, when the vacancy rate was also 7.4%, that level was the highest in 11 years, according to a survey of 76 U.S. retail markets by Reis.
...
Shopping-mall vacancies have shown no impact from the housing problems yet. Because of malls' long lease terms, economic problems typically take 18 months to 24 months to show up in vacancies and rents.

The CRE slowdown is here.

UPDATE (from an earlier post): 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.

by Calculated Risk on 10/09/2007 04:07:00 PM

From San Francisco Fed President Janet L. Yellen: Recent Financial Developments and the U.S. Economic Outlook. Here are some excerpts. Housing was turning down before the credit turmoil:

... forward-looking indicators of conditions in housing markets were pointing lower even before the financial market turmoil began. Housing permits and sales were trending down. Inventories of unsold new homes remained at very high levels, and they will need to be worked off before construction can begin to rebound. Finally, most measures of house prices at the national level fell moderately. Notably, despite these declines, the ratio of house prices to rents—a kind of price-dividend ratio for housing—remains quite high by historical standards, suggesting that further price declines may be needed to bring housing markets into balance. This perspective is reinforced by futures markets for house prices, which expect further declines in a number of metropolitan areas this year. The downturn in house prices would likely be intensified by a simultaneous decline in employment, should that occur, since significant job loss would weaken demand for housing and raise foreclosures.

And on the impact of the housing bust on consumer spending:

Beyond the housing sector’s direct impact on GDP growth, a significant issue is its impact on personal consumption expenditures, which have been the main engine of growth in recent years. Indeed, data on consumption spending in the last few months have continued to show strength. The nature and extent of the linkages between housing and consumer spending, however, are a topic of debate among economists. Some believe that these linkages run mainly through total wealth, of which housing wealth is a part. Others argue that house prices affect consumer spending by changing the value of mortgage equity. Less equity, for example, reduces the quantity of funds available for credit-constrained consumers to borrow through home equity loans or to withdraw through refinancing. The key point is that, according to both theories, a drop in house prices is likely to restrain consumer spending to some extent, and this view is backed up by empirical research on the U.S. economy.

Indeed, in the new environment of higher rates and tighter terms on mortgages, we may see other negative impacts on consumer spending. The reduced availability of high loan-to-value ratio and piggyback loans may drive some would-be homeowners to pull back on consumption in order to save for a sizable down payment. In addition, credit-constrained consumers with adjustable-rate mortgages seem likely to curtail spending, as interest rates reset at higher levels and they find themselves with less disposable income.

Repricing of risk will be "contractionary":

Many of the liquidity problems afflicting banks and other financial market participants are gradually being resolved, but it’s not clear that all markets will return to “business as usual,” as defined by conditions in the first half of this year, even after that occurs. For one thing, many of the structured credit products that became so widely used may prove to be too complex to be viable going forward, and this would more or less permanently reduce the quantity of credit available to some risky borrowers. Moreover, as I mentioned, if financial intermediation that was routinely conducted via asset securitization and off-balance sheet financing vehicles ultimately migrates back onto the books of the banks, borrowing spreads and lending terms are likely to remain tighter given current limitations on bank capital and the higher costs of conducting intermediation through the banking sector. Most importantly, the recent widening of spreads appears to reflect a return to more realistic pricing of risk throughout the economy. This development may be positive for the long run, but it will be contractionary in the short run.

by Calculated Risk on 10/09/2007 01:49:00 PM

From William Poole, President, Federal Reserve Bank of St. Louis: Real Estate in the U.S. Economy. On housing (emphasis added):

"... recent events suggest that housing will remain weak for several more quarters; stabilization may not begin until well into 2008. Probably the most important statistics in this regard are the number of unsold new homes still on the market relative to their current sales rate and the recent trends in house prices. Figure 7 shows that the inventory-to-sales ratio of unsold new and existing single-family homes has risen sharply since early 2005. The current level of inventories relative to sales is about double the average levels from 1999 to 2005.

Some potential homebuyers are no doubt delaying purchase because they expect house prices to fall. As seen in Figure 8, prices have decelerated sharply nationwide. According to the price index published by the Office of Federal Housing Enterprise Oversight (OFHEO), through the second quarter of 2007 prices are still a bit above year earlier levels.(11) However, another measure of national house prices—the S&P/Case-Shiller price index (SPCSI)—actually declined 3 percent in the second quarter from a year earlier. A subset of this measure, indexes based on house prices in the 10- and 20-largest U.S. markets, suggests that prices have declined even more in the third quarter. In July 2007, the 10-city composite has declined 4.5 percent from 12 months earlier and the 20-city composite has declined about 4 percent.

A decline in home prices on a national average basis is relatively rare. In fact, using OFHEO data, there has been no such decline over four quarters since the inception of the purchases only OFHEO index in 1991 or since 1975 using OFHEO’s total index, which includes refinancings. It appears that we are in uncharted territory, and, given that fact, a forecast of house prices must be regarded as highly uncertain."

And concluding remarks:

"The financial market turmoil that began in August hit hard an already struggling housing market. Financial markets appear to be stabilizing, but they have not returned to normal and are still fragile. Most forecasters have reduced their expectations for GDP growth and believe that downside risks have risen. However, the employment report for September, the latest available at this time, does not suggest that the downside risk is occurring. As an aside, the substantial upward revisions to data released in the August report remind us that it is a mistake to place too much weight on any one report.

Although this episode of financial turmoil is still unfolding, my preliminary judgment is that there are no new lessons. Weak underwriting practices put far too many borrowers into unsuitable mortgages. As borrowers default, they suffer the consequences of foreclosure and loss of whatever equity they had in their homes. It is painful to have to move, especially under such forced circumstances. Investors are suffering heavy losses. There is no new lesson here: Sound mortgage underwriting should always be based on analysis of the borrower’s capacity to repay and not on the assumption that a bad loan can be recovered through foreclosure without loss because of rising property values.

The other aspect of the current financial turmoil that reaffirms an old lesson is that it is risky to finance long-term assets with short-term liabilities. Consider a portfolio of any sort of long-term assets or assets carrying substantial credit risk, such as securities collateralized with subprime mortgages. Financing such a portfolio with commercial paper makes the firm vulnerable to the risk that holders of the commercial paper will refuse to roll over maturing issues. Over the past few months, firms that structured their portfolios this way found themselves faced with exactly this problem. No manufacturing firm would ever finance a portfolio of fixed assets with commercial paper; once market sentiment became distrustful of subprime assets, these assets lost value and became no more marketable than investments in factory buildings.

The Federal Reserve has neither the power nor the desire to bail out bad investments. We do have the responsibility to do what we can to maintain normal financial market processes. What that means, in my view, is that we want to see restoration of active trading in assets of all sorts and in all risk classes. It is for the market to judge whether securities backed by subprime mortgages are worth 20 cents on the dollar, or 50 cents, or 100 cents. Obviously, the market will judge different subprime assets differently, based on careful analysis of the underlying mortgages. That process will take time, as it is expensive to conduct the analysis that good mortgage underwriting would have conducted in the first place. Although there is a substantial distance to go, restoration of normal spreads and trading activity appears to be under way, and we can be confident that in time the market will straighten out the problems. We do not know, however, how much time will be required for us to be able to say that the current episode is over."