by Calculated Risk on 7/25/2007 11:36:00 AM

From Bloomberg: KKR's Banks Fail to Sell $10 Billion of Alliance Boots LBO Debt

Kohlberg Kravis Roberts & Co.'s banks, led by Deutsche Bank AG, failed to sell 5 billion pounds ($10 billion) of senior loans to fund the leveraged buyout of Alliance Boots Plc, two people with direct knowledge of the deal said.

And from the WSJ: Bankers Postpone Chrysler Debt Sale

Bankers raising $20 billion in loans for Chrysler Group have postponed a sale of $12 billion in debt for the auto company and are planning to fund the bulk of that debt from their own pockets for the time being, according to a person familiar with the matter.

by Calculated Risk on 7/25/2007 09:56:00 AM

The National Association of Realtors (NAR) reports Prices Rise, Existing-Home Sales Decline in June

Total existing-home sales – including single-family, townhomes, condominiums and co-ops – declined 3.8 percent to a seasonally adjusted annual rate1 of 5.75 million units in June from a downwardly revised level of 5.98 million in May, and are 11.4 percent below the 6.49 million-unit pace in June 2006.
...
The national median existing-home price2 for all housing types was $230,100 in June, up 0.3 percent from June 2006 when the median was $229,300. The median is a typical market price where half of the homes sold for more and half sold for less.

Click on graph for larger image.

The first graph shows the NSA sales per month for the last 3 years.

The pattern of YoY declines in sales is continuing. For New home sales, March is usually the strongest sales month of the year. For existing homes, the Summer months are more critical.


The second graph shows the months of supply. With the months of supply now over 8 months, we should expect falling prices nationwide.


However, the NAR reports that YoY prices were up slightly in June.


The third graph shows nationwide inventory for existing homes. According to NAR, inventory declined from the record in May to a 4.196 million units in June.

Total housing inventory fell 4.2 percent at the end of June to 4.20 million existing homes available for sale, which represents an 8.8-month supply at the current sales pace, the same as a downwardly revised 8.8-month supply in May

Other sources have reported that inventory levels have increased, and I expect inventories to continue to rise through the summer. More on existing home sales later today.

by Tanta on 7/25/2007 09:05:00 AM

I would have posted this yesterday, but I got caught up in reading the actual Citi report on which it is based (and that's 58 pages of hard-core Nerdalytics). I am going to try to have something more to say about this today. Until then, Bloomberg:

July 24 (Bloomberg) -- Defaults on some so-called Alt A mortgages packaged into bonds last year are now outpacing those from subprime loans, according to Citigroup Inc.

The three-month constant default rate for 2006 Alt A hybrid adjustable-rate mortgages is 2.3 percent, compared with 2.2 percent for subprime ARMs, New York-based Citigroup analysts led by Rahul Parulekar wrote in a July 20 report. The figures represent the percentage of balances in a mortgage-bond pool expected to default in the next year based on 90-day trends.

The speed at which Alt A hybrid ARMs are being paid off due to home sales or refinancing has also fallen to about the same level as for subprime ARMs, which typically prepay more slowly, the analysts said. Slower prepayments can make the same rates of defaults more damaging by leaving more of the initial balances outstanding to eat into bond-investor protections.

The combination of challenges mean 2006 bonds backed by Alt A mortgages, a credit grade above subprime loans, may need ``lower loss severities to still come out with lower cumulative losses than subprimes,'' the Citigroup analysts wrote.

by Tanta on 7/25/2007 08:01:00 AM

Some of you may have noticed that LEND took quite a beating yesterday. Apparently there is some question of the viability of the Lone Star deal:

On June 29, Jean Wan filed an amended stockholder class action lawsuit against Accredited, Lone Star and several executives and directors involved in the deal.

Wan claimed Accredited would be better off remaining independent because many of the company's subprime mortgage rivals had already gone bankrupt. Once the market recovers, Accredited could thrive as one of the few remaining subprime specialists and shareholders shouldn't miss out on this opportunity, the suit argued.

The complaint is being called the "Forrest Gump" suit because it compares Accredited's situation with that of the two main characters in the 1994 film.

Forrest and Lieutenant Dan buy a shrimp boat and start the Bubba Gump shrimp company. But they struggle early on because there are so many other boats catching all the shrimp. Then a hurricane hits, destroying many boats and leaving Bubba Gump owning the last shrimp boat in the area. From then on, Forrest and Dan become rich, the suit explained.

Accredited, like Forrest and Dan, was able to weather the subprime mortgage storm that destroyed rivals like New Century Financial.

"Effectively, Accredited is now the 'Bubba Gump' of the subprime lending market," the suit said. "Currently, Accredited stands in the enviable position of being able to grab up the market share left by New Century and the other subprime lenders that have declared bankruptcy or left the market."

"This position will allow the holders of Accredited's equity to reap the lion's share of profits available in the subprime lending market," the complaint added. "The Individual Defendants, however, wish to keep these profits for themselves and freeze out Accredited's current shareholders."

Stupid is as stupid does.

by Calculated Risk on 7/25/2007 01:50:00 AM

From the WSJ: Chrysler's Bankers May Take On Debt

Chrysler's attempt to tap debt markets for $20 billion hit a critical juncture as bankers began discussing the likelihood that they will have to step up with a large part of the money because investor demand hasn't been strong enough.
...
The struggle to raise money from investors was the latest sign of how inhospitable debt markets have become recently. ... Chrysler's bankers -- including J.P. Morgan Chase & Co., Goldman Sachs Group Inc., Citigroup Inc., Bear Stearns Cos. and Morgan Stanley ... were yesterday discussing plans to take a half or more of a $10 billion piece of the Chrysler auto loan, people familiar with the matter said.

The debt to be held by the banks would bear the first losses if Chrysler has problems repaying. ... The $8 billion loan sale for Chrysler Financial, meanwhile, is still on track to be completed this week, though the company has had to increase the amount of interest it would pay on the debt.

It also needs to raise $42 billion, much of it to compensate Daimler for existing Chrysler debt it still holds. That sale isn't expected to be as difficult, because much of it will be backed by healthy Chrysler auto loans.

by Calculated Risk on 7/24/2007 07:41:00 PM

From the WSJ: Fed Official Sees No Signs Of Subprime Woes Spreading

A Fed policy maker said rising delinquencies on prime mortgages would be one reason to worry that problems in subprime mortgages are affecting the broader economy, but there's no sign of that yet.

"If I started to see some of the spillovers occur in some of the prime mortgages, I'd get more nervous," Federal Reserve Bank of Philadelphia president Charles Plosser said in an interview with The Wall Street Journal Tuesday. Worrisome signals, he said, would be "things like serious, substantial falls in consumer spending, or employment really begin to tail off" or signs that the negative impact on consumer wealth of falling housing prices is "showing up in consumption in one form or another, or employment. And we don't see that much."

I guess Plosser will be "more nervous" tonight when he reads the CFC press release and the summary of their conference call.

by Calculated Risk on 7/24/2007 05:03:00 PM

Later this week I'll post an update on my 2007 housing forecast. I've been waiting for the foreclosure data for Q2, and the existing and new home sales data for June, scheduled to be released tomorrow and Thursday respectively.

On Friday I pulled out the old Supply and Demand drawings to compare the housing market to an efficient market. In this post I'd like to discuss two recent shifts in demand for housing, and how I expect them to unwind.

First, here are the new and existing home sales, since 1969, normalized by the number of owner occupied units (OOU).

Click on graph for larger image.

For the recent housing boom (in sales, not price), I marked three periods on the graph. There may be some disagreement on the dates and the causes of the boom for each period, but a simply explanation is:

Period 1: This was mostly due to fundamentals of real wage growth, employment growth and demographics.

Period 2: This was primarily due to an interest rate shock (lower rates) that moved renters to home ownership.

Period 3: This was primarily due to speculation, especially home buyers using excessive leverage for speculation.

NOTE: The following models of demand shifts assume an efficient market and no shifts in supply.

Period 2: Interest Rate Shock

This diagram depicts how I'd expect an interest rate shock to impact housing demand. After interest rates decrease sharply, there would be a temporary increase in demand - perhaps for a couple of years - as renters migrate to home ownership.

According to the Census Bureau, the number of American households renting decreased by 1.4 million from 2001 to early 2004. These households probably migrated to home ownership because the "rent or buy" decision favored buying due to lower interest rates.

This increase in demand was temporary, and according to the Census Bureau, the migration from renting to buying ended by early 2004.

Looking at a Supply and Demand diagram, the interest rate shock temporarily shifted demand from D0 to D1.

This moved the quantity demanded from Q0 to Q1, and the price from P0 to P1.

When the demand shifts back (above model of temporary demand shift), the quantity demanded falls back to Q0 - but housing suffers from sticky prices, so price only declines slowly to P0.

However, we can look at the graph of actual sales (first graph), and we can see that sales didn't decline in 2004 and 2005; instead sales increased.

Period 3: Excessive Leverage as Speculation

Speculation frequently chases appreciation, and the earlier price increases, based at least somewhat on fundamentals and an interest rate shock, probably spurred many buyers to only considered their monthly costs when buying a home (during period 3). Many of these buyers used excessive leverage, speculating that the price would continue to increase into the future.

This type of leveraged activity pulls demand from future periods as shown in this diagram. The rampant speculation (with innovative mortgage products) pushed demand from D1 to D2, with associated increases in price and the quantity demanded. However, when the speculation ends, demand will eventually fall back to D3; below the level of demand (D1) when the speculation started.

These models are just a guide, and are intended for efficient markets. But this suggests to me that sales, especially of existing homes, will eventually decline to below the levels of 1998 to 2001.

Flippers and Supply Shifts

Some people may be thinking about the impact of investors (or flippers) on the demand curve. Note: This type of speculation was probably only rampant in the coastal regions. Instead of viewing investor activity as a demand shift, it might be better way to view this type of speculation is as storage - or a supply shift; when the investor buys, they remove the asset from the supply. This means that investor speculation shifted the supply curve (not shown) to the left during the period of speculative activity. When the speculator sells, the supply curve shifts to the right, as the stored units come back on the market. So the news is bad for housing: not only is the demand curve shifting left, but the supply curve is shifting right (especially in some coastal regions).

Credit: template for diagram was from Wikipedia.

by Calculated Risk on 7/24/2007 01:15:00 PM

From Bill Gross at PIMCO: Enough is Enough

Over the past few weeks much ... has changed. The mistrust of rating service ratings, the constipation of the new issue market and the liquidity to hedge the obvious in CDX markets has led to current high yield CDX spreads of 400 basis points or more and bank loan spreads of nearly 300. The market in the U.S. seems to be looking towards this week’s large and significant placing/pricing of the Chrysler Finance and Chrysler auto deals to determine what the new level for debt should be. In the U.K., a similarly large deal for BOOTS promises to be the bell cow for European buyers. But the tide appears to be going out for levered equity financiers and in for the passive owl money managers of the debt market. And because it has been a Nova Scotia tide, rising in increments of ten in a matter of hours, it promises to have severe ramifications for those caught in its wake. No longer will double-digit LBO returns be supported by cheap financing and shameless covenants. No longer therefore will stocks be supported so effortlessly by the double-barreled impact of LBOs and company buybacks. The U.S. economy in turn will not benefit from this tidal shift and increasing cost of financing. The Fed tightens credit by raising short-term rates but rarely, if ever, have they raised yields by 150 basis points in a month and a half’s time as has occurred in the high yield market. Those that assert that this is merely an isolated subprime crisis should observe very closely the price and terms that lenders are willing to accept with Chrysler finance this week. That more than anything else may wake them, shake them, and tell them that their world has suddenly changed.
emphasis added

The Chrysler deal will be interesting, and Chrysler finance is probably the best part of the deal (and most easily financed). Back in '89, the failure of the UAL LBO marked the peak of the LBO cycle, however that deal was very different from today since UAL was contingent on obtaining debt financing (if I remember correctly). Now very few deals have contingencies, and we are seeing more and more bridge loans become "pier loans" that end up on the investment banks' balance sheets. See Citi May Be Stuck With Bridge Loans and JPMorgan Marks Down "Hung" Bridge Loan. This probably means the consequences of a failed major deal could be much uglier than in '89.

by Calculated Risk on 7/24/2007 11:34:00 AM

From Mathew Padilla at the O.C. Register reporting on DataQuick numbers:

There were 17,408 foreclosures in the Golden State in the second quarter — that’s the highest quarterly total since DataQuick began tracking them in 1988. It surpassed the previous high point of 15,418 foreclosures in the third quarter of 1996.
...
Notices of default, the first stage of foreclosure, totaled 53,943 in the second quarter, the highest since late 1996.

DataQuick reported 46,670 Notice of Defaults (NODs) in Q1.

Click on graph for larger image.

This graph shows the NODs filed in California since 1988. For 2007, the number is estimated at twice the NODs for the first half of 2007. This estimate is probably low, since the housing market appears to be deteriorating rapidly in California.

UPDATE: Here is the DataQuick press release: California Foreclosure Activity Continues to Rise

by Tanta on 7/24/2007 08:28:00 AM

This ought to calm the markets:

Management anticipates that the second half of 2007 will be increasingly challenging for the industry and Countrywide. Absent a reduction in mortgage interest rates, production volumes are expected to fall and competitive pricing pressures are expected to increase. In addition, volatility in the secondary markets has increased significantly early in the third quarter and liquidity for mortgage securities has been reduced as a result. These conditions are expected to adversely impact secondary market execution and further pressure gain on sale margins. Furthermore, additional deterioration in the housing market may further impact credit costs.

Management has taken, and is continuing to take, a number of actions in response to changing market conditions. These include tightening of credit guidelines, particularly related to subprime and prime home equity loans; further curtailment of subprime product offerings, including the recent elimination of certain adjustable-rate products; risk-based pricing adjustments; use of mortgage insurance for credit enhancement; and expense reduction initiatives. . . .

Credit-related costs in the second quarter included:

-- Impairment on credit-sensitive retained interests. Impairment charges of $417 million were taken during the quarter on the Company's investments in credit-sensitive retained interests. This included $388 million, or approximately $0.40 in earnings per diluted share based on a normalized tax rate, of impairment on residual securities collateralized by prime home equity loans. The impairment charges on these residuals were attributable to accelerated increases in delinquency levels and increases in the estimates of future defaults and loss severities on the underlying loans.

-- Held-for-investment (HFI) portfolio. The provision for losses on HFI loans incurred in the second quarter was $293 million, driven primarily by a loan loss provision of $181 million on prime home equity HFI loans in the Banking segment.

Guidance hereby reduced to $2.70 to $3.30/diluted EPS from April's $3.50 to $4.30.

I could be snarky about this, but since it's the first thing I've read today that didn't blame the rating agencies for all the problems, I'm giving extra credit.