by Calculated Risk on 4/23/2008 06:27:00 PM

From the WSJ: Starbucks Blames Weak Economy In U.S. for Lower Outlook for Year

Citing "the sharp weakness in the U.S. consumer environment," ... Starbucks said U.S. comparable-store sales fell by the mid-single digits on a percentage basis amid lower traffic. ...

The company Wednesday highlighted California and Florida, which have been two of the hardest-hit states during the housing downturn ...

"The current economic environment is the weakest in our company's history, marked by lower home values, and rising costs for energy, food and other products that are directly impacting our customers," said Chairman and Chief Executive Howard Schultz.

Just another company reporting disappointing sales.

by Calculated Risk on 4/23/2008 05:04:00 PM

Video: Joseph Mason Says `Way Past Time' for Ambac Rating Cuts (click link for video)

Joseph Mason, an associate professor of finance at Drexel University, and Julia Coronado, a senior economist at Barclays Capital Inc., talk with Bloomberg's Kathleen Hays about Ambac Financial Group Inc.'s credit rating, economic and financial-market conditions, and the outlook for Federal Reserve monetary policy.

(Source: Bloomberg)

by Calculated Risk on 4/23/2008 01:55:00 PM

On the AMBAC conference call this morning, David Wallis, Ambac's chief risk officer noted that their 'losses are heavily concentrated in a small number of deals which they characterized as “striking” and essentially suspicious' (reader Brian's description). The also made some comments on their Alt-A deals - AMBAC has half a dozen deals now projecting cumulative losses of 20-25% vs initial expectations of approximately 6%.

According to Brian, AMBAC hinted that they might pursue legal action against Bear Stearns and First Franklin.

Here is a story from Dow Jones on the conference call: Ambac: Lawyers Scrutinizing Contracts On 17 Transactions

Bond insurer Ambac Financial Group Inc. (ABK) has hired legal and forensic experts to examine 17 of its financial guarantee transactions covering residential mortgage-backed securities as performance deteriorates.
...
[David Wallis, Ambac's chief risk officer] suggested that one prime candidate for legal scrutiny is a deal with Bear Stearns Co. (BSC) it closed in April 2007. ...

Ambac originally projected that losses on the underlying collateral of the Bear Stearns transaction would be between 10% and 12%, but now expects losses at 81.8% of underlying collateral, a transaction that has seen an unexpectedly "rapid escalation of losses," and represents an outsized percentage of the insurer's expected credit impairment, Wallis said.

by Anonymous on 4/23/2008 10:23:00 AM

The State Foreclosure Prevention Working Group released its second report on loss mitigation efforts yesterday, and frankly it is just as disappointing as the first one. I see our colleague PJ at Housing Wire has already blown his stack over it. Allow me to pile on; someone has to.

The report finds:

Seven out of ten seriously delinquent borrowers are still not on track for any loss mitigation outcome. While the number of borrowers in loss mitigation has increased, it has been matched by an increasing level of delinquent loans. The number of home retention solutions (forbearance, repayment plan, and modification) in process, as compared to the number of seriously-delinquent loans, is unchanged during the four month period. The absolute numbers of loss mitigation efforts and delinquent loans have increased, but the relative percentage between the two has remained the same. [Emphasis in the original.]

This "seven out of ten" statistic comes from measuring all 60+ day ("seriously") delinquent loans against the percentage that have been identified by the servicer as "in process." There is no definition of "in process" in the report; my best guess is that these are loans for which the servicer's loss mit department has made actual contact with a borrower. (That does not mean merely that the servicer has made contact; collections department contacts are not, as far as I know, considered "loss mit contacts.") Even more importantly, the report does not define "closed" in terms of loss mitigation efforts. I cannot tell from this report whether, for example, a loan that has a repayment plan instituted is counted as "closed" when the plan is agreed to, or only when the plan period ends and the loan is either brought current (successful repayment plan) or referred to foreclosure (unsuccessful). If the former is the case, then loans that are still delinquent would fall out of the "loss mit in process" category, but you would hardly say that they are "not on track for any effort." They would simply be part of a delinquent loan pipeline that is not referred to FC, because the repayment plan is still underway. It actually gets worse if "closed" cases for the purpose of this report really mean the latter--loans where the repayment plan ended either successfully or not. Let's go to the further "findings":

Data suggests that loss mitigation departments are severely strained in managing current workload. For example:
a. Almost two-thirds of all loss mitigations efforts started are not completed in the following month. Most loss mitigation efforts do not close quickly. This consistent trend over the last three months suggests that many proposed loss mitigations fail to close, rather than simply take longer than a month to work through the system. Based on anecdotal reports of lost paperwork and busy call centers, we are concerned that servicers overall are not able to manage the sheer numbers of delinquent loans.
b. Seriously delinquent loans are “stacking up” on the way to foreclosure. The primary increases in subprime delinquency rates are occurring in very seriously delinquent loans or in loans starting foreclosure. This suggests that the burgeoning numbers of delinquent loans that do not receive loss mitigation attention are clogging up the system on their way to foreclosure. We fear this will translate to increased levels of vacant foreclosed homes that will further depress property values and increase burdens on government services.

If the expectation is that loss mit cases would reasonably "close" in the month after they were "started," then it sounds as if in fact "closed" refers to the date an agreement was put in place, not the date of final resolution. If that is true, then one could expect closure to occur by the following month. However, that has to mean that there is a pipeline of "closed" but not yet "cured" loans out there, which makes hash of that claim that 7 of 10 are "not on track."

Furthermore, although this summary finding refers to loss mit efforts that are "started," in the remaining detail areas of this report I see no numbers that look clearly like "starts" to me. The tabular data all measures loss mit "in process," not "started." Again, "starts" can be usefully defined only if "completions" can be usefully defined; if there are thousands of loans on repayment plans or forbearance periods that have not yet finished or expired, and they are not counted as "closed," then the "in process" data would include workouts started many months previously that are still underway.

As far as seriously delinquent loans "stacking up," I simply note that nowhere does this report ever address things like a servicer's bankruptcy pipeline. How many delinquent loans are under a BK stay? Once the stay is in place, the servicer can neither initiate foreclosure nor unilaterally offer workouts without court approval; for that reason, all servicers I am familiar with handle those loans in a bankruptcy department that is separate from the loss mitigation group. If, in fact, these servicers reporting here are including BK loans in the loss mit pipeline, I for one would like to know that.

This is the part of the report that sent PJ over the edge:

New approaches are needed to prevent millions of unnecessary foreclosures. Without a substantial increase in loss mitigation staffing and resources, we do not believe that outreach and unsupervised case-by-case loan work-outs, as used by servicers now, will prevent a significant number of unnecessary foreclosures.

That phrase "unnecessary foreclosures" is not simply tendentious in the extreme; it totally misses the whole point of "loss mitigation." Unless you grant that foreclosure can at least in theory be "less loss" to an investor than a workout option--as the converse can be true--then you do not understand that "loss mit" is the process of deciding which action is less expensive to the investor and pursuing it. In such a context no foreclosure is "unnecessary"; it is simply the better or the worse choice in dealing with a severely delinquent loan.

But in the same breath, the report asserts that "case by case" analysis of each loan is a problem. How can anything other than a case by case analysis determine whether a foreclosure is "necessary" or not? Besides the fact, as PJ notes, that the Working Group is entirely ignoring fraudulent loans, what about those loans where the loss mit people discover, after reasonably diligent efforts of analysis, that there's just no way the borrower can afford modified loan terms that remain less expensive to the investor than foreclosure? Or that the borrower is not cooperating in good faith with the servicer? You do not have to assume that all servicers are expending the correct level of diligence to be able to see that they need to, if we are to determine whether foreclosure is necessary or not. This report simply assumes, prima facie, that foreclosures are unnecessary, and then advocates that servicers slap together "New Hope" style one-size-fits-all quickie workouts in order to decrease the "backlog." Dear heavens above, a subcommittee of a conference of state regulators is on record encouraging servicers to cynically reduce their delinquent loan backlogs by just inking some "standard" modification or repayment agreement with the borrower, and call it "closed" after that?

I am not a knee-jerk defender of the mortgage servicing industry by any measure. These are the last people I would encourage to behave any worse than they already do. But even I am troubled by the gross naivete about delinquent loan servicing implied by this report:

Loss mitigation proposals do not close for a variety of reasons; one reason is the level of paperwork required to close a loan modification. Servicers have told us that borrowers simply do not return the required documentation to complete the modification, and borrowers and counselors have reported that servicers lose paperwork they have sent in to the servicer. Regardless of where the problem arises, it appears that the level of paperwork required is a barrier to preventing unnecessary foreclosures.

I am willing to believe that servicers do lose or misplace paperwork, although I'd really like someone to look into these claims rather than just engaging in he said-she said. On the other hand, this is default servicing we're talking about. I mean, the phrase "the check is in the mail" is a culture-wide joke of long lineage; you don't have to have ever worked for a servicer to know that people claim to have sent stuff they never in fact sent all the time. People are given explicit instructions to send things via trackable mail to the Loss Mit department, and they send them via regular mail to the payment address (which is usually just a lockbox, often located ten states away from the loss mit people). And sometimes borrowers do return only some of the paperwork, somehow "forgetting" the items like tax returns, pay stubs, or bank statements requested by the servicer to assure that the borrower qualifies for the deal offered. You know. I am not "blaming the borrower" here; I am pointing out that different stories between servicer and borrower are just like different stories between the two parties to a divorce: it is not wise to take only one version at face value without checking out the other, if for no other reason than this is a situation in which people are not exactly at their best, emotionally, psychologically, or indeed morally. That is a fact of life in default mortgage servicing. Any group affiliated with a state regulator who seems to want to pretend that this is not a fact is not, frankly, competent.

Beyond that, to conclude that "paperwork is the barrier" should strike fear in the hearts of everyone. It isn't just investors and servicers who are put at risk when we decide--you know this is coming--to just skip the part about executing formal agreements and start servicing these loans to "informal" relaxation of terms. It's the borrowers who are at risk as well. I've heard enough lately to last my lifetime about borrowers in FC and BK courts objecting to servicers unable or unwilling to produce the exact mortgage note executed by the borrower, which determines not just "standing" for the servicer, but the exact terms of the indebtedness. What defense does a borrower have if he or she is foreclosed against after failure to perform under an undocumented, unsigned agreement? What defense does the servicer have if it cannot prove failure to perform? What god-awful horrible mess are the courts going to inherit down the road a ways if we just dismiss formal agreements as "barriers" that servicers should dispense with?

The lesson of the "stated" disaster--stated income, stated assets, stated appraised values, oral "promises" of loan originators rather than clear written disclosures, the whole cluster of practices that removed the "barrier" of "paperwork"--is apparently still lost on the Working Group. We started this by being "efficient" about the documentation and casual about the borrower's own statements; we aren't going to get out of it that way. This report just reeks of political grandstanding. I'm sure I know at least one journalist who will love it.

by Calculated Risk on 4/23/2008 09:28:00 AM

From the UPS conference call: (hat tip Brian)

Chief Executive Scott Davis:

UPS's first quarter results illustrate the dramatic slowing in the U.S. economy. At our investor conference on March 12th, we told you that volume growth in January had been up 3%. But in the six weeks prior to the conference, it had been negative. We also said if these trends persisted through March, we would not achieve the earnings guidance we had provided for the quarter. [The] trends did continue. Many have become sharply more negative in the last two months. ... The great unknowns are the severity and the duration of the current economic slowdown. Many of our customers have tightened their belts resulting in a shift away from our premium air products to ground shipments.
emphasis added

Chief Financial Officer Kurt Kuehn:

These results reflected a noticeable tradedown in service levels from express to saver, saver to deferred, and deferred to ground. As customers worked hard to reduce their costs. Tradedown was evident across all customer sectors but was most prevalent in retail. This is a tell tale sign of a progressively worsening economic environment. In addition, the timing of Easter had a negative impact on average daily volume.

CFO: UPS Cutting investment and spending:

As Scott mentioned, we have put an action plan in place to address the impact of economic slowing on our U.S. business. We will, one, use the expansiveness of our service portfolio to help our customers navigate through these challenging times. Two, exercise discipline with respect to investment, supporting only those projects that are essential. And three, remain diligent in managing variable and semi-variable costs. With regard to the last point, we have a number of initiatives in place. We are restricting hiring, except in the sales arena. We are stopping all non-critical projects. And limiting discretionary spending including business travel, relocations and consulting services.

Outlook:

Turning now to our outlook for the second quarter and the rest of the year. At this point, we see no immediate signs of economic improvement. ... On the international front, cross border trade remains robust, despite pockets of economic slowing.

Q&A on internation shipments:

Analyst: Soes the 12 to 15% goal for international, does that suggest that we're not going to see a slowdown in that arena or is that consistent with kind of a decoupling where the brunt of recession is felt here in the U.S. and not beyond.

UPS: We're seeing certainly changing trade flows and U.S. imports are slowing, but at the same time, U.S. exports are increasing. Asia to the U.S. is perhaps not as robust as it was but Asia to Europe remains robust.

by Calculated Risk on 4/23/2008 09:17:00 AM

From the WSJ: Credit Crunch Weighs On Ambac Results

Ambac Financial Group Inc. swung into the red in the first quarter on a further $1.73 billion in collateralized-debt-obligation losses and $1.04 billion in loss provisions ...

That pretty much wipes on the $1.5 billion raised last month.

by Calculated Risk on 4/22/2008 10:15:00 PM

From Bloomberg: Target Writes Off 8.1% of March Credit-Card Loans

Target Corp., the second-largest U.S. discount chain, said it wrote off 8.1 percent of its credit-card loans in March as consumers grappled with job losses and the biggest housing slump in a quarter century.

Defaults during the month totaled $55.5 million, the Minneapolis-based retailer said in a regulatory filing today. The charge-off rate was 6.8 percent in February.

This is pretty ugly - especially the increase in the charge-off rate from 6.8% to 8.1% over one month (this is another company pointing to significant problems in March).

Note: Target didn't write off 8.1 percent in March - that is the annual charge-off rate.

by Calculated Risk on 4/22/2008 07:26:00 PM

Roger Lowenstein writes in the New York Times Magazine: Triple-A Failure (hat tip Jasper and others). This is an excellent overview of how the rating agencies failed. Here is an excerpt:

Moody’s recently was willing to walk me through an actual mortgage-backed security step by step. I was led down a carpeted hallway to a well-appointed conference room to meet with three specialists in mortgage-backed paper. Moody’s was fair-minded in choosing an example; the case they showed me, which they masked with the name “Subprime XYZ,” was a pool of 2,393 mortgages with a total face value of $430 million.

Subprime XYZ typified the exuberance of the age. All the mortgages in the pool were subprime — that is, they had been extended to borrowers with checkered credit histories. In an earlier era, such people would have been restricted from borrowing more than 75 percent or so of the value of their homes, but during the great bubble, no such limits applied.

Moody’s did not have access to the individual loan files, much less did it communicate with the borrowers or try to verify the information they provided in their loan applications. “We aren’t loan officers,” Claire Robinson, a 20-year veteran who is in charge of asset-backed finance for Moody’s, told me. “Our expertise is as statisticians on an aggregate basis. We want to know, of 1,000 individuals, based on historical performance, what percent will pay their loans?”

The loans in Subprime XYZ were issued in early spring 2006 — what would turn out to be the peak of the boom.

Lowenstein follows XYZ through the rating process, and through the eventual downgrades.

Almost immediately, the team noticed a problem. Usually, people who finance a home stay current on their payments for at least a while. But a sliver of folks in XYZ fell behind within 90 days of signing their papers. After six months, an alarming 6 percent of the mortgages were seriously delinquent. (Historically, it is rare for more than 1 percent of mortgages at that stage to be delinquent.)

Moody’s monitors began to make inquiries with the lender and were shocked by what they heard. Some properties lacked sod or landscaping, and keys remained in the mailbox; the buyers had never moved in. The implication was that people had bought homes on spec: as the housing market turned, the buyers walked.

By the spring of 2007, 13 percent of Subprime XYZ was delinquent — and it was worsening by the month.

Shocked? Homebuyer's were speculating with no money down. Mortgage brokers didn't care because they would sell the loans immediately and collect their fees. Wall Street didn't care because they could package the loans and sell them to investors. Investors would have cared, except they trusted the rating agencies. And as this article describes, the rating agencies weren't evaluating the underlying loans - they were performing statistical analysis using models based on lenders that cared if the borrower would repay the loan.

At the same time, regulators - despite numerous warnings - mostly ignored the problem, apparently for ideological reasons ("let the free market work"). What a mess.

by Calculated Risk on 4/22/2008 04:58:00 PM

From Paul Jackson at Housing Wire: Stick a Fork in It: Moody’s Downgrades 1,923 Subprime RMBS Classes — In Just Two Days

Between Monday and Tuesday, calculations by Housing Wire show that the rating agency has slashed ratings on 1,923 tranches from 232 seperate subprime RMBS deals from 2005-2007 vintages.

That total includes hundreds of formerly Aaa-rated securities ...

The downgrades surely tally into the multiple of billions worth of subprime debt, and portend additional earnings pain for many market participants — write-downs on the value of RMBS in a portfolio usually aren’t marked up until a downgrade takes place.

Is it Friday yet?

by Calculated Risk on 4/22/2008 04:41:00 PM

From the WSJ: Yale’s Shiller: U.S. Housing Slump May Exceed Great Depression (hat tip hopeinsd)

Yale University economist Robert Shiller ... said there’s a good chance housing prices will fall further than the 30% drop in the historic depression of the 1930s. Home prices nationwide already have dropped 15% since their peak in 2006, he said.

“I think there is a scenario that they could be down substantially more,” Mr. Shiller said during a speech at the New Haven Lawn Club.

Mr. Shiller, who admitted he has a reputation for being bearish, said real estate cycles typically take years to correct.

Historically housing busts take about 5 to 7 years from price peak to trough. If we date the current bust as starting in early 2006, the price bust for existing homes will probably last until 2012 or so. I suspect 2008 will see the steepest price decline, followed by a few years of smaller percentage declines in the bubble areas.

As of the end of 2007, the Case-Shiller house price index showed national prices were off 10.2%. I suppose this means Shiller is estimating prices fell 5% nationally in Q1. Very possible.

Of course according to OFHEO, house prices rose in February, and are only off 3.1% from the peak!

U.S. home prices rose approximately 0.6 percent on a seasonally adjusted basis between January and February, according to OFHEO’s new monthly House Price Index. For the 12 months ending in February, U.S. prices fell 2.4 percent. Since its peak in April 2007, the index is down 3.1 percent.

The OFHEO prices don't seem to fit with the price declines being observed in most markets.

Also, Shiller's forecast is in nominal terms; a 30% price decline in real terms (inflation adjusted) is very likely. Three years of flat nominal prices would be close to a 10% decline in real terms.