by Calculated Risk on 2/15/2008 08:34:00 PM

From the WSJ: Bond Insurer Seeks to Split Itself, Roiling Some Banks

The beginning of a messy endgame to the bond-insurance crisis may be under way, and the industry that emerges could look very different from the one that bet big on subprime mortgages.

On Friday, Financial Guaranty Insurance Co., the nation's third-largest bond insurer, told the New York State Insurance Department that it will ask to be split into two separate companies. The idea would be for the new company to insure safe municipal bonds and for the existing one to keep responsibility for riskier debt securities already insured, such as those tied to the housing market.

The move may help regulators protect investors who have municipal bonds insured by the firm. But it could also force banks who are large holders of the other securities to take significant losses.
...
All of the banks have hired legal counsel and are prepared to go to court. The person familiar with the situation said FGIC's move could result in "instant litigation."
...
One plan the parties are discussing involves commuting, or effectively tearing up, the insurance contracts the banks entered into with FGIC ... In exchange, FGIC would pay the banks some amount to offset the drop in value of those securities, or give them equity stakes in the new municipal-bond insurance company.
...
"You're trying to unscramble the egg," said William Schwitter, chairman of the leveraged-finance practice at law firm Paul Hastings. "When you take a balance sheet that is supporting a variety of obligations and try to split it in two, it's difficult."
...
However, if a breakup is endorsed by the New York Department of insurance, that could limit the legal liability.

This really is unscrambling the egg. If the company is split in two, the muni bond insurer will probably be fine, and there is a strong possibility that the risky insurer would file bankruptcy. This would never work without some sort of agreement to limit the liability of the muni bond insurer. If the goal is to get the muni market functioning again - as it appears is the main goal of the NY Dept. of Insurance - then this makes sense. In that case, the banks will be revisiting the confessional soon.

by Calculated Risk on 2/15/2008 04:40:00 PM

Apartment Finance Today has an article in the February issue on lending standards for small "entrepreneurial" apartment developers: Putting the Squeeze On (not available online yet).

This article gives an idea on how much standards have been tightened.

Last year, developers were able to obtain 85% loan-to-cost financing, non-recourse (except standard completion guarantee) at 200 bps over LIBOR.

Today, the same developers can only obtain loans with a 70% to 75% loan-to-cost ratio and priced at 250 bps to 350 bps over LIBOR. In addition, lenders are looking for 25% of the loan to be recourse (secured with other assets of the developer).

Larger developers are seeing tighter standards too, but not to the extent of the entrepreneurial developers.

And perhaps the most daunting requirement:

"Construction lenders are limiting proceeds based on requirements from active permanent lenders that projected operating incomes exceed monthly debt-service obligations by at least 20 percent, compared with 10 percent (or even less) seen frequently in recent years."

Since the permanent lenders have tightened their requirements too, construction lenders have to carefully scrutinize the income projections to make sure the project will qualify for a permanent loan.

One contractor told me that apartment construction lending standards have been "fog a mirror, get a loan" for the last few years. That appears over.

by Calculated Risk on 2/15/2008 03:00:00 PM

From Michael Corkery at the WSJ: Commercial Builder Woes: What if There’s No Tenant at the End of the Rainbow?

... Knoxville builder [John Deatherage] ... was slated to break ground on six retail projects across the Southeastearn U.S., but his investors have put four developments on hold through the first quarter, at least.
...
“If the median home price drops from $400,000 to $350,000 that changes the whole neighborhood,’’ he says. “That directly impacts commercial retail.” For example, he says, it’s difficult to attract higher-end retail tenants to a neighborhood where home values are sinking or uncertain at best.

Some 145 million square feet of new retail space was built in the top 54 markets last year, with another 123 million square feet in the pipeline this year, according to Property & Portfolio Research. By comparison, the annual average between 2000 and 2006 was 118 million square feet.

“My guys are not going to break ground if there is no tenant at the end of the rainbow,’’ he says.

And for a visual, here is a photolog of empty retail space in the Sacramento area from Sacramento Real Estate Statistics (hat tip Atrios)

by Calculated Risk on 2/15/2008 12:04:00 PM

From the Downey Financial 8-K released today.

Click on graph for larger image. This would be a nice looking chart, except those are the percent non-performing assets by month. Yes, by month!

Update: Tanta wrote about DSL's mods-as-NPA issue in the comments to this post: Downey Restates NPAs

by Calculated Risk on 2/15/2008 11:11:00 AM

Here are three interesting graphs on Countrywide Lending: January 2008 Operational Results

Click on Graph for larger image.

The first graph shows that delinquencies and foreclosures pending continue to rise.

Delinquencies rose to 7.47% in January (as a percent of unpaid principal balance) from 7.2% in December.

Foreclosure pending rose to 1.48% from 1.44% in December.


The second graphs shows Countrywide funding for nonprime loans and HELOCs (Home Equity Lines of Credit). Nonprime funding is now zero (this includes subprime and Alt-A).

The collapse in HELOCs probably means that MEW (Mortgage equity withdrawal) is declining rapidly - probably impacting consumer spending in 2008.

And the third graph shows CRE (Commercial Real Estate) funding. This has all but dried up.

Part of this is probably company specific, but this is further evidence of the coming slowdown in CRE investment.

by Anonymous on 2/15/2008 10:43:00 AM

This was a pretty amazing article in the Financial Times:

Homeowners are being advised that it would be cheaper to walk away from big mortgages than incur further losses on their household budgets, increasing the chances that more high-end real estate transactions will collapse.

This advice from lawyers contrasts with the conventional wisdom that homeowners would risk serious damage to their credit scores if they were to default on their loans.

But legal advisers argue that the future credit costs homeowners would incur in such cases would be far lower than the cash they would have to bring to closing if they sold their homes, given the current cataclysmic conditions in the housing markets.

“It is the tipping point argument,” said a senior partner at one of the biggest mortgage firms, who asked not to be named. “The borrowers have so many issues with their balance sheets that they are considering a new policy.”

Wow, that's pretty brazen. Of course it is. I made it up. This is what the FT actually says:

Leading banks are being advised that it would be cheaper to walk away from big buy-out deals than incur further losses on their funding commitments, increasing the chances that more high-profile private equity transactions will collapse.

This advice from lawyers contrasts with the conventional wisdom that banks would risk serious damage to their reputations if they were to drop out of deals.

But legal advisers argue that the break-up fees banks would owe in such cases would be far lower than the write-downs they would have to make on their loans, given the current cataclysmic conditions in the capital markets.

“It is the tipping point argument,” said a senior partner at one of the biggest private equity firms, who asked not to be named. “The banks have so many issues with their balance sheets that they are considering a new policy.”

(Thanks, e!)

by Calculated Risk on 2/15/2008 10:03:00 AM

From the WSJ: FGIC Will Request Break-Up

Financial Guaranty Insurance Co., a major bond insurer, has notified the New York State Insurance Department that it will request to be split into two companies.

One of the firms would likely retain much of the business of insuring structured finance bonds such as those backed by mortgages, which have come under severe pressure due to the housing market slowdown, according to a person familiar with the matter.

The other company would likely retain most of the municipal bond insurance business, which is stronger....

by Anonymous on 2/15/2008 07:39:00 AM

Washington Post sends a reporter to a home builders' trade show.

ORLANDO -- The cavernous convention center, the site of this week's International Builders Show, is lined row after row with slick display booths and polished sales reps peddling retro-style ovens, state-of-the-art foam insulation and a vegetable-oil-based product that plugs leaky ponds.

But the crowd is a bit thinner than in the past, and the mood among the gathered home builders is noticeably different as their industry drags through the worst market in years.

"A few years ago, everyone was very happy and smiley," said Douglas Jones of Keystone Builders in Richmond. "Last year it was a touch off. This year it's a little more serious. It's perceptible."

With housing sales foundering, inventory way up and the future of the industry hazy, the show, with 1,900 exhibitors and nearly 100,000 attendees, is more angst-ridden as builders look for ways to stay afloat until there's a turnaround. Attendance is expected to be down about 5 percent.

"There's a deep sense of concern about the market right now," said David Seiders, chief economist for the National Association of Home Builders, after sitting on a panel of experts who delivered a sobering talk on the state of the industry.

"This time last year, it looked like the demand side of the market was stabilizing. Our forecasts were that, yeah, 2007 will be a down year but it won't be that bad," he said.

"Then the entire subprime debacle hit, other shocks to the financial system hit. A lot of builders are frankly bewildered as to what in the world has happened. I can't go 15 feet without being grabbed by somebody trying to talk about it."

Seiders now predicts a turnaround in the latter half of this year, but other less-optimistic economists see no improvement until 2009 or later.

Frankly bewildered, huh? Wait til they're stunned and surprised. It'll be perceptible.

by Calculated Risk on 2/14/2008 09:59:00 PM

For a little evening reading, here is the 9 page Cerberus letter to investors (via the WSJ Deal Journal)

After sketching the grim state of affairs with references to the “liquidity crisis,” a “market panic” and a “widespread decline across all sectors,” Cerberus boss Steve Feinberg (pictured) and his co-founder William Richter addressed its highest-profile deals.

The bigger concern of the two: GMAC, the former lending arm of General Motors that finances billions of dollars worth of homes and cars. “We have significant concerns,” they write in this nine-page letter to their investors, which was first reported on by Bloomberg. “If the credit markets continue to decline and we find ourselves in a prolonged environment of capital market shutdown, GMAC could run into substantial difficulty.”

by Calculated Risk on 2/14/2008 05:57:00 PM

Patrick M. Parkinson, Deputy Director, Division of Research and Statistics testified today to Congress on Bond Insurance. Here are a few excerpts:

... downgrades [of bond insurers] might adversely affect financial stability through several channels. These include: (1) the potential for disruptions to municipal bond markets, (2) potential losses and liquidity pressures on banks and securities firms that have exposures to the guarantors, and (3) the potential for further erosion of investor confidence in financial markets generally.

Parkinson provides a discussion of what is happening in the muni bond market:

If guarantors are downgraded to below AA-, many money funds will be required to put tender option bonds and variable demand obligations back to the liquidity providers. Investors may also choose to put securities back in advance of potential downgrades. Indeed, some money market funds reportedly have already exercised this option with respect to securities insured by those guarantors with significant exposure to CDOs of subprime RMBS.

And on the banks:

Of greater concern is the potential for losses at banks that have hedged their holdings of super senior tranches of CDOs of ABS with credit protection purchased from the guarantors. These hedges lose value when the financial condition of the guarantors deteriorates. In fact, many banks already have written down the value of their hedges significantly to reflect the market view that some guarantors may not meet their obligations on the protection they sold to the banks. Thus, further downgrades of the guarantors may not necessarily require those banks to write down the value of their hedges significantly further. However, as long as the concerns about the ability of some guarantors to meet their obligations persist, any further declines in the value of the banks' holdings of CDOs of ABS will not be fully offset by increases in the value of their hedges.

Even if banks' losses from exposures to the guarantors are moderate relative to capital, banks could experience significant balance sheet and liquidity pressures if they take significant volumes of tender option bonds, variable-rate demand obligations, or ARS onto their balance sheets. The banks that have these exposures are currently well capitalized. However, if these banks take on significant-enough volumes of such securities, the resulting downward pressure on capital ratios might prompt some of them to raise additional capital or constrain somewhat the growth of their balance sheets to ensure that they remain well capitalized. Efforts to constrain the growth of their balance sheets could be reflected in somewhat tighter credit standards and terms for a variety of bank borrowers, including households and businesses. Many banks already have tightened lending standards and terms, likely in part because of balance sheet pressures associated with recent turmoil in financial markets. Further tightening would add to the financial headwinds that the economy already is encountering.

Part of the problem is no one knows how large the losses will be. As Parkinson notes, even moderate losses for the banks can result in further tightening and exacerbate the credit crunch.