by Anonymous on 10/09/2007 11:52:00 AM

John Dugan, Mr. I Hate Stated Income and also Comptroller of our Currency, is on the warpath again:

San Diego, CA – Comptroller of the Currency John C. Dugan said today that banks need to strengthen their underwriting standards, particularly on loans sold to third party investors.

“I am here to say that bank underwriting standards for these products, in many cases, moved too far away from what they would have been if the bank had held those loans on its own books,” Mr. Dugan said in a speech to the American Bankers Association’s Annual Convention.

Mr. Dugan noted the many positive aspects of the “originate-to distribute” model, but said there can be negative effects on underwriting standards, including relaxing significantly the incentives to use caution and prudence in underwriting loans sold to third parties.

“When a bank makes a loan that it plans to hold, the fundamental standard it uses to underwrite the loan is that most basic of credit standards that I’ve already talked about: the underwriting must be strong enough to create a reasonable expectation that the loan will be repaid,” the Comptroller said. “But when a bank makes a loan that it plans to sell, then the credit evaluation shifts in an important way: the underwriting must be strong enough to create a reasonable expectation that the loan can be sold—or put another way, the bank will underwrite to whatever standard the market will bear.”

Comptroller Dugan outlined what needs to be done. “I am here to say that banks need to strengthen their underwriting standards so that they move back towards the fundamental principle of maintaining a reasonable expectation that loans will be repaid, even if the loans are to be sold to third parties – and that goes for mortgage loans, leveraged loans, or any other syndicated credit,” Mr. Dugan said.

What Dugan neglects to mention--or at least, what isn't in the reported summary of the speech--is the vicious feedback loop that goes on with this model. The problem is that for many years, banks often used a standard for determining an "investment quality loan" based on what secondary market investors--traditionally, Fannie and Freddie--would purchase. So when the GSEs and private investors relax standards for what counts as "capacity to repay," banks find themselves with a widening gulf between their own portfolio standards and "what the market will bear." This begins to suggest to portfolio managers that internal credit standards are "too tight," and so the banks don't just lower standards for loans they intend to sell, they lower standards for their own portfolio production.

(Hat tip FFDIC)

by Anonymous on 10/09/2007 10:04:00 AM

More stuff from the spreadsheet collection. This one looks at characteristics and some performance measures of securitized subprime loans from 2000-2006. Unfortunately, there is very little publically available data on unsecuritized subprime.

Comments:

1. Total MBS issued on this chart is mostly, but not exclusively, first liens. (It includes securities that have some second liens, but excludes securities that are exclusively second liens.)

2. The average loan amount is based on first liens.

3. WAC is weighted average coupon or "interest rate" in English.

4. "Reported" DTI simply means that's what was reported. While I have some doubts about the accuracy of that number when the full doc percentage is dropping, do notice that it is climbing even so. The historical maximum acceptable DTI for conforming agency-quality loans was 36%.

5. Historically, subprime was a refinance business, not a purchase money business. This chart shows that very clearly.

6. "Serious Delinquency" means 60 or more days delinquent, FC, REO, or BK. Because this is calculated on the current balance of these securities, this number will be much higher than what you see reported based on original balance. You should be aware that the remaining current balance of these older vintages is very low; the average "pool factor" or balance remaining for 2000, for instance, is around 5%, as opposed to 83% for 2006.

7. "Default" is a very specific technical measure here. A loan is reported as a default in a month when its balance is reported as zero and its last reported status was in foreclosure, REO, delinquent more than 150 days, or any other status and a loss of more than $1000 was recorded at payoff. In other words, "default" is the final disposition of a loan, and it includes things like short sales and short refis as well as foreclosures. It does not include active modifications or forbearances, since these loans still have a reported balance. It is a loss measure, and because it involves the final disposition of a loan, it is always much lower for new issues than for older issues, even if they are performing equally.

8. Cumulative loss is based on the original security balance, and is equal to default times severity.

Now, about that FICO average. On the one hand, the fact that the average FICO is rising can be filed under "I sure as hell hope so." When you look at the steadily rising risk factors of CLTV, documentation level, DTI, and so on, you would certainly expect that higher FICOs were being required as some kind of risk offset.

On the other hand, those average FICOs are getting awfully close to near-prime or even prime territory, depending on your definition (620-660 being the usual floor for prime). That means that a lot of these loans have FICOs clearly in prime range. In order to rule out the possibility of predatory steering, you have to trust that the subprime industry has been scrupulous about giving subprime loans to higher-FICO borrowers only when the other loan characteristics are clearly non-prime. This question cannot be solved by looking at averages or even really good stratifications; it takes loan-file-level reviews to really understand what's going on. As those loan-file-level reviews were, apparently, not done by aggregators and raters and investors, they are now being done by servicers and courts.

by Calculated Risk on 10/09/2007 02:08:00 AM

From the LA Times: Slipping imports reflect slowing economy

Cargo containers crammed with foreign-made goods that were supposed to set a record in August at major U.S. ports took an unexpected turn, with imports sinking 1.4% in another sign of the slowing of the economy.
...
The slump in oceangoing imports unloaded at the 10 largest U.S. container ports in August was the first drop since Global Insight began its monthly Port Tracker report in 2005. The number stunned some port watchers.

"When I first saw these numbers, I called the researchers and asked them if they had left a column out of the spreadsheet. I thought it was a typo," said Craig Shearman, vice president of the National Retail Federation, which pays Global Insight to conduct the trade research.

by Calculated Risk on 10/09/2007 12:25:00 AM

From the NY Times: A Bank Bet on Condos, but Buyers Want Out.

“We’re at the riskiest point of the condo lending cycle as these projects are being completed,” Jefferson L. Harralson, a bank analyst at Keefe, Bruyette & Woods, said. “In the coming weeks and months, we’re going to find out what the demand for these condos really is.”
...
Today, developers owe Corus $4 billion, $3.7 billion of which, or 92 percent, is in condominiums. Of that, about 25 percent of them are in projects in the Miami area and 9 percent are in Las Vegas, according to regulatory filings. More than $2.15 billion of its outstanding loans are due by the end of this year. Nationwide, the number of condos completed this year will be up 45 percent — 232,933 vs. 160,239 — from 2006, according to data tracked by Marcus & Millichap Real Estate Investment Services, a real estate investment brokerage based in Encino, Calif.

Note: Many of these are the kind of condo units that don't show up in the Census Bureau's New Home report. Some quotes from the article:

“I don’t want to take possession of it.”

“I can go a whole week without seeing a neighbor.”

Not only are there many unsold units, but some buyers are trying to break their contracts, or are thinking about walking away from their deposits.

by Calculated Risk on 10/08/2007 06:59:00 PM

The story this morning on distressed home sales in Orange County reminded me that all inventory isn't counted in either the Census Bureau's New Home, and the NAR's Existing Home, inventory reports.

Note: Distressed homes are usually homes that will sell for less than the amount owed (including tax liens). This includes properties in foreclosure and short sales. Some people also include 'must sell' properties (divorce) or seriously damaged properties. I prefer the first definition.

Let's start with New Homes. During periods of changing cancellation rates, the Census Bureau may overestimate or underestimate the actual changes to the inventory. Currently my estimate - based on an analysis of public builder's cancellations rates - is that the Census Bureau is underestimating New Home inventory by 77K units.

Another problem with the New Home data (both inventory and sales) is that some condos are not included. It appears town home style condos (with no neighbor above or below) are included in the New Home report, but high rise condos aren't included. Look at this marketing piece: First Condo Auction in D.C. Suburbs Offers Prices Not Seen in a Decade. The press release calls these "two story condos" and it appears from the picture that these are side by side type condos, so they are probably included in the New Home report as inventory. From the Press Release:

"There are currently about 19,000 unsold condominiums actively marketing in the Washington metropolitan area, with at least 16,000 new units coming on the market in the next 36 months," said William Rich, Vice President of Delta Associates.

Why a marketing piece would want to remind buyers of the excess inventory is a different issue, but some of these 35,000 units - if they are multiple story units - might not be included in the New Home report.

For existing homes, some distressed properties are not included in the Existing Home inventory report. Some bank REOs (Real Estate Owned) are not listed - and some REOs are. So it's difficult during periods of high foreclosure activity to accurately estimate the total inventory for existing homes.

The Census Bureau and NAR numbers are useful in comparing to prior periods, but this is just a reminder that the current reported inventory numbers are probably lower than actual.