by Calculated Risk on 5/14/2008 11:01:00 AM

A few notes (webcast here):

On house prices (added: map from Freddie of Year-over-year house price changes): Click on graph for larger image.

“Now previously we have said that we expect housing prices to fall at least 15% nationally, and today they [have fallen] about 9% through the measure we use which is relative to our market. We want to take a better look at the spring housing market to see whether or not the data is beginning to firm up. It is premature at this point from a data perspective to make a change in our formal estimate. However at this point we must say that the risk to the forecast are strongly weighted on the downside. Give the severity we have experienced, [we took] an increase in charge off in REO expenses associated with higher loan loss severities. As a result of this change, we raised our estimate for credit costs and increased our provision.”
Richard Syron, CEO, May 14, 2008 (emphasis added)

On increasing delinquencies and severity rates: (here are the slides)

"If you turn to slide six as dick noted earlier, as a result of the housing in the first quarter, increasing delinquencies and higher severity rates, in the first quarter [credit costs] moved to -- of 11.6 basis points compared to 5 basis points in the fourth quarter. These same factors drove [us to] raise our guidance for full year 2008 provision. On slide six you can see that our estimated credit losses for '08 have increased to 16 basis points with our 2009 estimate increasing to a rage of 20-25 basis points respectively. Our total credit losses now include the effect of our expected 2008 new business. Finally, slide seven, shows that despite the continued high level of charge offs we remain adequately reserved -- as of March our ratio of reserves was 1.6 times, consistent with where we were at year end. Another way to think about reserve coverage is a ratio to period losses [the ratio of] annualized first quarter charge off is about three times."

Fredde Mac moves entire ABS portfolio into level 3 given the “prices we were seeing in the market that didn’t make any sense.”:

Analyst: There is a headline out there that you have level 3 assets of $157 billion. I was just wondering is that true and is that related at all to the markups of the 1.2 billion gain?

Freddie Mac: No, it is not Paul. We made a determination in the first quarter that given how widely the pricing we were getting on the abs portfolio [varied] that it no longer made sense to leave that into level two. So we essentially moved the entire abs portfolio into level three. We were still using the mean pricing that we were getting from the dealers. So we're not using a model price. That is all that is. It has nothing to do with the trading portfolio.”

by Calculated Risk on 5/14/2008 09:51:00 AM

From Bloomberg: U.S. Foreclosures Rise 65 Percent as Vacated Homes Add to Glut

U.S. foreclosure filings climbed 65 percent and bank seizures more than doubled in April from a year earlier as rates on adjustable mortgages increased and vacated homes added to a glut of unsold homes, RealtyTrac Inc. said.
...
Bank repossessions jumped 145 percent in April from a year earlier to 54,574, according to Irvine, California-based RealtyTrac. The company has database of more than 1.5 million properties and monitors foreclosure filings including defaults notices, auction sale notices and bank seizures.

Banks will seize about 60,000 properties a month through December, when about 1 million U.S. homes, or a quarter of all homes for sale, may be bank-owned ...

The current pace of 1,000 foreclosures per day in California makes 60,000 per month nationally very likely.

by Anonymous on 5/14/2008 07:49:00 AM

I didn't think there was anything particularly earth-shattering in this report, but I did think some of you might be amused by this:

According to the FBI:

The above photos are from condos that were involved in a mortgage fraud. The appraisal described “recently renovated condominiums” to include Brazilian hardwood, granite countertops, and a value of $275,000.

It does make you wonder whether some of these reports of pre-foreclosure "trash outs" don't involve a few properties that were trashed from the get-go.

by Calculated Risk on 5/13/2008 11:36:00 PM

Occasionally I've read claims that the lack of refinery capacity was driving up the price of oil. As an example, here is an excerpt from an old Bloomberg article:

The shortage of refining capacity worldwide has contributed to the 57 percent rise in oil prices in the past year.

Of course the opposite would be true - a lack of refining capacity would keep down the price of oil (because refineries are the demand side of the equation for crude oil), but increase the price of gasoline (refineries are the supply side of the equation for gasoline).

Click on graph for larger image.

But now the demand for gasoline in the U.S. is falling, while world demand for oil is still strong. So the price of oil has risen sharply (because of global supply and demand, probably not speculation), while the price of gasoline in the U.S. hasn't kept pace as shown on the graph. (tell that to U.S. consumers!)

The graph compares the price of oil and gasoline in the U.S. Source: EIA for oil and gasoline. Note that oil prices (blue) have risen much faster recently than gasoline prices (red).

Jad Mouawad at the NY Times gets it right: Oil Refiners See Profits Sink as Consumption Falls

American refiners are going through a traumatic period. In a time of record gasoline prices, some of them actually lost money in the first quarter, and for virtually all refiners, profits are down sharply.

Experts say the refiners are caught in a double bind. The price of their raw material, oil, is rising because of strong global demand. At the same time, consumption of gasoline in the United States is falling as a result of slower economic growth and consumer efforts to conserve.

Note: if you are wondering what could lead to a decline in oil prices, then global oil demand would have to slow or decline. One possibility is that growth in China could slow later this year as the world economy recouples:

In China ... oil imports have surged in recent weeks, a signal that the government is stockpiling oil and diesel in anticipation of the Olympic Games. Beijing, the International Energy Agency report said, is seeking to avoid a repeat of the embarrassing fuel shortages and power disruptions that plagued the country last year.

by Calculated Risk on 5/13/2008 08:04:00 PM

From Peter Viles at the LA Times: Foreclosure flood: 1,000 auctions per day in California

The April total of foreclosure sales at auction -- 22,838 for the state -- represents a jump of 44% over March totals and the highest level ever in California, ForeclosureRadar reports.
...
It appears the pipeline of potential foreclosures is jampacked, too: the ForeclosureRadar reported 44,101 new "Notices of Default" filings in April, a new record for California. Notices of Default are the first step in the foreclosure process.

I've been tracking the quarterly data from DataQuick, and this monthly data suggests the graph from this earlier post was very conservative! (graph repeated)

Click on graph for larger image.

For 2008, the number of NODs was estimated at 4 times the Q1 rate. Based on recent experience - with NODs increasing every quarter for the last 3 years - this is probably conservative.

As bad as 2007 was, 2008 will be much much worse.

by Calculated Risk on 5/13/2008 04:56:00 PM

From Bloomberg: MBIA, Ambac Losses Elevate Aaa Concern, Moody's Says

MBIA Inc. and Ambac Financial Group Inc. had ``meaningfully'' higher losses on home-equity loans and collateralized debt obligations than anticipated, raising concern about their Aaa status, Moody's Investors Service said.

The first-quarter losses reported by the companies in the past two weeks elevate ``existing concerns about capitalization levels relative to the Aaa benchmark,'' Moody's, unit of Moody's Corp., said in a statement today.

Moody's also issued a report today on second liens: U.S. Subprime Second Lien RMBS Rating Actions Update (no link). Moody's noted that losses to date have "greatly exceeded" their expectations, and Moody's increased their loss projections:

... Moody's has increased its loss projections on loan pools backing recent vintage subprime second lien RMBS in light of their continued poor performance. Moody's expects 2005 vintage subprime second lien pools to lose 17% on average, 2006 vintage pools to lose 42% on average, and 2007 pools to lose 45% on average.

Ouch!

by Calculated Risk on 5/13/2008 02:55:00 PM

Here is a graph that is clogging up all those internet tubes:

Click on graph for larger image.

This graph, from the St. Louis Federal Reserve, shows the non-borrowed reserves of financial institutions. Looks like some serious cliff diving, but with a little research, we discover this graph is misleading.

The explanation is pretty simple. The Federal Reserve decided to classify the TAF and the primary dealer credit facility as borrowed reserves (see this table). If we back out these collateralized borrowings, you get the total reserves, and that has been very steady. False alarm.

A more interesting chart was present by Dr. Janet Yellen this morning showing the Fed's balance sheet.

This graph shows that about half the Fed's U.S. Treasuries have been committed to fight the liquidity crisis.

by Calculated Risk on 5/13/2008 02:43:00 PM

Update: here is an article from Dow Jones: Toll Bros. CEO: Customer Traffic 'Worst We've Ever Seen'

Click on graph for larger image.

A few headlines from Toll Conference call. So much for the 2008 Spring selling season. Well, there is always next year!

by Calculated Risk on 5/13/2008 01:30:00 PM

From San Francisco Fed President Janet Yellen: Credit, Housing, Commodities, and the Economy. (here is a PDF with graphs)

On housing:

Now let me turn to the second of the three main factors behind the current economic weakness—namely, the housing cycle. I have mentioned that earlier in this decade when financial markets were “awash in liquidity,” bubble-like conditions emerged in many areas of the economy, including housing. During this period, housing construction was very strong and housing prices soared. In fact, the ratio of house prices to rents—a kind of price-dividend ratio for housing—reached historical highs by early 2006, suggesting that house prices might be well above those that could be justified by fundamentals.

Since then, housing markets have “hit the skids.” In inflation-adjusted terms, residential construction fell by 13 percent in 2006 and by 14 percent in the first half of last year. Of course, once the financial shock hit last summer, things got even worse, with real residential construction dropping at a 24 percent rate on average since then. And, indicators of conditions in housing markets are pointing lower for the future. Housing starts and permits as well as sales are trending down, and inventories of unsold homes remain at very high levels. These inventories will need to be worked off before construction can begin to rebound.

Click on graph for larger image.

I’ve already discussed the precipitous fall in house prices nationally, so it’s striking to note that, even with these declines, the ratio of house prices to rents remains quite high by historical standards. That, of course, suggests 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. In particular, the Case-Shiller composite index for home prices shows a 15 to 20 percent year-over-year decline in the second half of this year.

The bottom line is that construction spending and house prices seem likely to continue to decline well into 2009.

by Calculated Risk on 5/13/2008 01:00:00 PM

Here is an overview of non-residential investment and commercial real estate (CRE) from our most recent newsletter.

Recently many companies have announced plans to cut capital spending in 2008. This probably means non-residential fixed investments will decline in 2008, as compared to 2007.

This decline in investment is an important indicator for the economy, since changes in fixed investment correlate very well with GDP. The first graph shows the change in real GDP and Private Fixed Investment over the preceding four quarters through Q1 2008.

Click on graph for larger image.

The red line is the year-over-year change in fixed investment, and the blue line (scale on left axis) is the year-over-year change in GDP. Correlation is 79%.

A decline in residential investment is one of the best indicators of a future recession, and that has been flashing a recession warning for some time. Now some of the focus is on non-residential investment, especially on commercial real estate, to determine if a recession has started.

The second graph shows two components of private fixed investment: residential (shifted 5 quarters into the future) and nonresidential structures.

This graph shows something very interesting: in general, residential investment leads nonresidential structure investment. There are periods when this observation doesn't hold - like '95 when residential investment fell and the growth of nonresidential structure investment remained strong.

Another interesting period was in 2001 when nonresidential structure investment fell significantly more than residential investment. Obviously the fall in nonresidential structure investment was related to the bursting of the stock market bubble.

However, the typical pattern is that residential investment leads non-residential structure investment. The normal pattern would be for investment in non-residential structures to have turned negative now.

There is plenty of evidence of an imminent slump in non-residential structure investment. Research firm Reis recently reported that the strip mall vacancy rate have risen to 7.7%, the highest level since 1996. For offices, the vacancy rate has risen to 13.6% nationally according to Grub & Ellis, and they expect the vacancy rate to rise sharply:

“With demand turning negative at the same time that the construction pipeline will deliver the 94 million square feet still underway, [office] vacancy is expected to peak at 18% by the end of 2009.”
Grubb & Ellis economist Robert Bach, April 2008

The Fed survey in April of Senior Loan officers provides further evidence of an imminent slump. The April survey showed an increase in tighter lending standards for Commercial Real Estate (CRE) loans. This graph compares investment in non-residential structure with the Fed's loan survey results for lending standards (inverted) and CRE loan demand. This suggests investment in non-residential structures should decline soon since lending has tightened considerably.

Another indicator is the architectural billing index from the American Institute of Architects. From the AIA (emphasis added):

“[T]he Architecture Billings Index (ABI) dropped two points in March and fell to its lowest level since the survey’s inception in 1995. As a leading economic indicator of construction activity, the ABI shows an approximate nine to twelve month lag time between architecture billings and construction spending.”

Clearly the CRE slump is here. Now the question is how deep and how fast CRE investment will decline. One way to think about this is to look at previous declines in non-residential investment.

The following graph shows non-residential investment in structures as a percent of GDP since 1960. Over time there has been a decline in spending (as a percent of GDP), probably related to globalization (more factories were being built overseas).

The non-residential investment boom related to the S&L crisis (and energy investment) is obvious on the graph, and we should probably ignore that period when looking at a typical CRE bust.

The two light red circles show the investment busts during the '90/'91 and '01 recessions.

The decline in non-residential investment was fairly rapid during the previous two recessions (a decline in non-residential investment is usually more rapid than a decline in residential investment). In fact most of the decline in investment happened within four quarters.

During the '90/'91 investment slowdown, non-residential investment declined 17% in total, and about 14% in the first year. For the '01 investment slowdown, non-residential investment declined almost 20%, and 19% in the first four quarters.

It is very possible - based on tighter lending standards that the decline in non-residential investment will be greater (on a percentage basis) than the previous two busts. However, based on commercial vacancy rates, it doesn't appear that some segments of commercial are as overbuilt as in the '90/'91 and '01 periods.

These two factors somewhat balance out, and my guess - based on these two previous busts - is that non-residential investment will decline about 15% to 20% over the next four quarters, from a $501 billion seasonally adjusted annual rate (SAAR) in Q4 2007, to about $400 billion to $425 billion in Q4 2008 - and that most of the bust will happen during 2008.
Read on ... there is MUCH more!