by Calculated Risk on 3/27/2007 05:01:00 PM

From BusinessWeek: Feds Are Investigating Homebuilder Beazer

Amid the meltdown of the subprime housing sector, mortgage lenders and brokers have come under fire from state and federal officials for predatory lending practices with those risky borrowers. Now one national homebuilder is feeling the heat. BusinessWeek has learned that federal investigators have opened a broad criminal probe into lending practices, some financial transactions, and other dealings at Beazer Homes USA.

by Calculated Risk on 3/27/2007 04:46:00 PM

Emory W. Rushton, Senior Deputy Comptroller and Chief National Bank Examiner of the Office, of the Comptroller Of The Currency (OCC) provided testimony today to the House Committee on Financial Services. From Rushton's oral testimony:

OCC became concerned in 2002 with the growth of exotic mortgages that have the potential for a big payment shock, and we responded in an escalating fashion, both formally and informally, privately and publicly. By 2005, we were instructing our examiners to more aggressively address the risks of these products during examinations of national banks – at a time, I might add, when home prices were still rising – because we concluded that standards had slipped far enough. That intervention is one reason why you will find few payment-option ARMs in national banks today. Shortly after that, we initiated the interagency process that resulted in the nontraditional mortgage guidance that was issued last Fall.

And from Rushton's written testimony:

[T]he vast majority of subprime loans are not originated in the national banking system or supervised by the OCC. While some national banks and their subsidiaries help to serve the credit needs of the subprime market, their subprime lending last year amounted to less than 10% of the total of subprime mortgage originations by all lenders. ... National banks and their subsidiaries that engage in subprime lending are subject to extensive oversight by OCC examiners and must operate in close compliance with the OCC’s rigorous safety and soundness and consumer protection standards. ... Some have said, perhaps not surprisingly, that there is a direct connection between the rigor of the OCC’s supervision of subprime mortgage lending and the low level of this activity in national banks. Indeed, there have been recent instances in which banks have decided against converting to a national charter for this very reason.

In some ways this is comforting; apparently the national banks engaged in very limited option ARM and subprime lending.

by Calculated Risk on 3/27/2007 02:11:00 PM

From Reuters: Lennar says worst may not yet be over for inventory

Here is a real Time transcript of Lennar CEO Stuart Miller's comments (hat tip Brian):

“Let me begin by saying that these are difficult times for the home-building industry. We have recently completed our quarterly operation reviews with our division management team, and based on these extensive business plan and execution reviews, I can say first hand and with certainty that market conditions are very difficult across the country. As I listen to many of the leaders in the industry speak, that is our competitors and as I listen to economists and analyst and is investors, the message is becoming very unified and that is although we see some sporadic indications of firming in some markets, and we all look forward to seeing a firm foundation from which we can build forward, the reality is that market conditions are still challenging at best and in some markets continuing to deteriorate. Homes available for purchase has continued to climb while demand has been surely reduced. The market once driven by speculative build-up in demand and purchases that over the past years spurred more recent build up in inventory supply from speculators then put increased supply as they put homes back on the market and created the supply over hang and overall climate of customer caution.

On the demand side, the investor/purchaser part of demand has all but evaoprated. Primary purchasers on are on the side lines or demanding better pricing before purchasing. Because of the rapid deterioration of subprime lending market, an additional component of demand has now been sidelined because of the inability of a customer to qualify for a mortgage or because the purchaser of a customer's home needed for closing cannot qualify. What is clear is supply and demand have shifted and had are continuing to shift in some markets more rapidly than expected, and the inventory over hang will have to be absorbed before conditions normalize.

This is not new information. There remains a sizable amount of work to be done before our market finds any equilibrium. We have not seen evidence that the much anticipated winter/spring selling season has yet taken. Home pricing is continuing the process of being recalibrated in many markets through the use of incentives, brokers commission and price reduction, and the industry is continuing to be challenged to adjust home prices and land values as well. This recalibration process has not yet stabilized.

Further more, it is unclear today whether there is another shoe to drop. Questions remain as to whether our economy will weaken and the housing led recession or perhaps it is the supply and inventory over hang will be exacerbated by the resetting of mortgage rates on many adjustable rate mortgages that have fueled the market over the past years. Rate adjustments are creating payment stress concurrent with home prices falling and equity evaporating. On the other hand, the liquidity that exists in today's financial market is a real wild card and could be a critical mitigating factor alleviating negative market forces and restoring balance.

Lennar's strategy has been certain and consistent as we have seen these market conditions unfold over the past year. We have consistently focused primarily on protecting our balance sheet first and foremost. We have maintained day by day focus on our business operations. We have continued to refine our business model in each of our markets. We've mapped out a strategy to regain our margin in this new market environment, and we are determined to be possible positioned for recovered market conditions. Our overriding strategy is defined by our focus on our balance sheet. Our company has intensified the focus on generating strong cash flow at the expense of maintaining margins.”

by Anonymous on 3/27/2007 10:19:00 AM

Fitch has a new publicly available Special Report, Impact of Financial Condition on U.S. Residential Mortgage Servicer Ratings. It identifies a high-risk class of servicers and points to some of the sources of increased risk:

To date, the financial difficulties of the various parties have been caused mainly by liquidity, overcapacity, margin pressure and poor asset quality, all of which are directly origination/ seller focused. However, for servicers who are captive to an origination shop and/or issuer, and who do not have either a diversified product mix or a financially strong parent or partner, difficulties experienced at a corporate level will undoubtedly impact the servicing operation, eventually if not immediately. For third-party subprime servicers, this impact is less. However, these servicers could also experience a loss of new loan volume, as well as the potential for higher default levels in current portfolios. Much of this increase could be caused by the defaulting subprime borrowers being unable to obtain refinancing, both due to flat or decreasing home price appreciation and the tightening of credit standards on new originations. Any servicer, whether captive or third party, which has predominantly subprime credit quality loans in portfolio, could find its timelines and overall cost to service facing increased levels not seen in recent history.
. . .
The major areas of concern for some originators/issuers of subprime products, and therefore their captive servicers, are liquidity, overcapacity, margin pressure and asset quality. Although in recent periods some reduction in liquidity capacity could be managed, based on declining volumes, current liquidity trends are primarily a result of tripped covenants and liquidity providers’ rapidly declining risk appetite. To date, when covenants have been tripped, the profitability covenants are frequently the first to be triggered. Previously, the liquidity providers were more willing to extend maturities for a short period in order to provide a company an opportunity to repair the breach. It now appears that these banks’ flexibility is declining, and margin calls have begun in earnest. Margin calls, combined with early payment defaults (EPDs), have eroded some firms’ financial position to the point that several are on the brink of bankruptcy, necessitating them to stop funding new originations and/or seek potential sale or partnership arrangements.

In recent years the industry has seen new participants enter the market, which has led to overcapacity. This overcapacity has begun to ease, with several players exiting the market, or at a minimum tightening underwriting guidelines and eliminating certain products. More consolidation is expected before the industry will be appropriately sized for expected ongoing mortgage market dynamics. In addition, extremely aggressive competition, rising funding costs and slowing origination volume have pressured profitability. Margins on whole loan sales have sharply deteriorated due to supply/demand imbalances, as well as the declining risk appetite among investors. Aggressive competition has also been a contributor to the deterioration of asset quality as evidenced by EPDs and rising default rates on subprime loans. . . .

Currently servicers are challenged with rising expenses, shrinking margins and fluctuating origination, and therefore portfolio, volumes. In addition, servicers are dealing with the complexities of natural disasters, compliance to varying federal and state regulations, as well as servicing a number of new and unique products. Further, the increasing delinquency environment may stress those servicers that are not adequately staffed or prepared to manage seriously delinquent loans with flexible default management solutions.

The entire report is fairly brief—five pages—and certainly worth a read. Bear in mind that the “historical” experience in the mortgage industry is that servicing income is counter-cyclical: you make more on servicing in those periods in which you make less on originations. History may be refusing to repeat itself for some people right when that would be convenient.

by Calculated Risk on 3/26/2007 05:30:00 PM

Some people are wondering why existing home sales were up and new home sales were down. In the long run these two series correlate very well.

Click on graph for larger image.

This graph shows the annual new and existing home sales since 1969. Use the left scale for existing home sales and the right scale for new home sales. Clearly, using annual data, the two series move together.

Note: Rsquare is 0.87.

However there are some timing differences as to when the data is reported. From the Census Bureau:

New home sales and existing home sales are released each month at about the same time. Many comparisons are made between the two series, but before doing any comparisons, one must be aware of some definition differences that affect the timing of the statistics.

The Census Bureau collects new home sales based upon the following definition: "A sale of the new house occurs with the signing of a sales contract or the acceptance of a deposit." The house can be in any stage of construction: not yet started, under construction, or already completed. Typically about 25% of the houses are sold at the time of completion. The remaining 75% are evenly split between those not yet started and those under construction.

Existing home sales data are provided by the National Association of Realtors®. According to them, "the majority of transactions are reported when the sales contract is closed." Most transactions usually involve a mortgage which takes 30-60 days to close. Therefore an existing home sale (closing) most likely involves a sales contract that was signed a month or two prior.

Given the difference in definition, new home sales usually lead existing home sales regarding changes in the residential sales market by a month or two. For example, an existing home sale in January, was probably signed 30 to 45 days earlier which would have been in November or December. This is based on the usual time it takes to obtain and close a mortgage.

The shorter answer: new home sales have been crushed, existing home sales are about to be crushed.

For the general economy, new home sales are far more important, because of the related employment and spending on materials. However, for those directly impacted by existing home sales (real estate agents, appraisers, mortgage brokers, home inspectors, etc.), the coming slump in existing home sales will have a larger impact.