by Calculated Risk on 10/19/2007 11:26:00 AM

Wachovia conference call comments (from Brian):

"Much of the increase in non-performing loans and the losses are on loans in certain California markets that have experienced fairly steep declines in prices. Our delinquency call centers report that the primary reasons for borrowers struggling to pay are three fold. First is reduction of income or underemployment. Second is the assumption of additional debt from lenders other than Wachovia and thereby changing the credit profile from the origination of the loan. And third unemployment. We have seen some uptick in unemployment in some of these markets. Let me also point out that while the average current estimate at the appraised value of non-performing loans is 77%, there is $380 million in balances out of the total $1.7 billion where the current estimate of value is over 90%. Actually on that pool, averages in the high 90s, again reflecting the dramatic decline of house prices in certain markets. These particular loans have a low loan to value of just under 80% at origination. It's interesting to note here that problems in these markets, really for all lenders seem to be across the board without originating FICO, the type of loan or the property. Given our outlook for continued weakness in the housing market and possibility for slow income consumer sector, we anticipate loans on consumer mortgage book continue to increase over the next few quarters and that losses will be up albeit fairly modest charge operates. To manage the increase in loans in foreclosure, we have significantly increased our staff responsible for handling Oreo properties and working with delinquent borrowers. Prepare the property to sell and sometimes choosing to maybe take a somewhat higher loss on that sale rather than risk holding out for a top dollar opportunity that may or may not come down the road.” emphasis added

Note that Wachovia is seeing rising unemployment - already - as a factor in delinquencies. But the most important comment is that the problem loans are: "across the board without originating FICO, the type of loan or the property".

Across the board!

On Commercial RE portfolio:

“The commercial real estate portfolio continues to perform very well overall. Loan secured with income producing property continues to enjoy solid underlying fundamentals with favorable vacancy rates and cash flows. As we have noted, probably on the last couple of calls, the portion of the commercial real estate portfolio connected to housing is experiencing an upward trend in criticized assets higher charge-offs and non-performs. While these loans have generally performed well overall and the charge-offs and total real estate financial services portfolio, we're only $3 million in the quarter, we do anticipate further softening and have recently undertaken a thorough review of commercial real estate loans. Nearly all of these loans are on a with-recourse basis. We are and will be moving aggressively to work with borrowers to shore up as best we can. We believe credit costs will be rising, we believe the deterioration will be manageable”

CRE sounds OK so far.

Here’s what they had to say about the marks in their CDO portfolio:

“Next line addresses other structured products [Total of $438MM]. Here we have the marks on warehouse positions and trading inventory, both of which we hold in trading portfolios. This includes the positioning Ken referred to in reference to sub prime mortgage exposure and AAA rated securities. $308 million is associated with sub prime securities [Their slides say $347 of the mark was related to subprime of which $308 was AAA subprime]. Basically there, we never would have expected that you see AAA securities trade so far so quickly from par.”emphasis added

They were later asked if they were happy with their risk management:

“And you know, we'll change the way we do some things. I would say that as we look at results, I think the biggest disappointment for me is that of those $1.3 billion end marks, we had about $300 million, in losses on AAA sub prime paper in trading desks and inventory. And the thing that disappoints me about that, we avoided it in our origination efforts and avoided it in, for the most part in our securitization efforts. So frankly, I think we had a little bit of a break down in having AAA sub prime in some of our portfolios we took losses on. I think it is amazing that we could take $300 million of losses on AAA paper. We didn't expect that that paper could degenerate that fast, with that kind of swiftness”emphasis added

Comments about the general credit environment:

Analyst:

As we talked to companies, September, I think you mentioned this too, was a particularly weak month for credit and is that trend, as you see it in October, about the same? Would you say it's slowed or accelerated?

Wachovia:

"Still kind of early in the month, but I would say that the trends we saw late August and September, you know, halfway through this month are about the same. I wouldn't say they've accelerated, but they haven't backed off either."

by Calculated Risk on 10/19/2007 10:52:00 AM

Yeah, another house price index, but this one has a cool map.

From First American: LoanPerformance Releases August House Price Index

Click on graph for larger image.

SAN FRANCISCO, Oct. 18, 2007–First American LoanPerformance ... today announced the release of its August 2007 LoanPerformance Home Price Index (HPI).

The LoanPerformance HPI provides a comprehensive set of monthly home price indices and median sales prices covering 7,376 ZIP codes, 956 Core Based Statistical Areas (CBSA) and 655 counties in all 50 states and the District of Columbia....

"This latest home price index confirms that property values in key mortgage markets like California, Nevada, Florida, and Arizona continue to exhibit on-going declines,” said Damien Weldon, vice president of collateral and prepayment analytics for First American LoanPerformance.

“Within these States, cities like Los Angeles, Las Vegas, Miami and Phoenix are leading the market downwards. At the ZIP code level, the picture is often much bleaker because there are individual ZIP codes that are down nearly 20 percent compared to last year,” added Weldon.

I doubt any states have really seen price increases over the last 12 months.

by Tanta on 10/19/2007 09:30:00 AM

Given the questions in the comments to yesterday's post on seller-funded down payment assistance (DAP), I thought I'd offer a very simplified example of what the issue is. Yes, this is simplified; FHA loan calculations are pretty complex, even though they aren't as complex these days as they used to be.

Currently, FHA requires a minimum cash investment from borrowers equal to 3.00% of the contract sales price. The effective LTV can still exceed 97% even with a 3.00% investment, because borrowers can finance a portion of allowable closing costs, including their up-front mortgage insurance premium (UFMIP), in the loan amount. (FHA borrowers with a base LTV of more than 90% also pay an additional mortgage insurance premium in the monthly payment of 0.50% annually.) The current UFMIP with 3.00% down is 1.50% of the loan amount.

The administration's proposed zero-down program would have UFMIP of at least 2.25% and a monthly premium of at least 0.55%.

FHA does allow the borrower's down payment to come from gift funds provided by relatives, employers, governmental agencies or true charitable organizations. The point here is that 1) these are supposed to be true gifts with no expectation of repayment, not disguised loans, and 2) they may come only from parties who do not have an interest in the transaction.

Property sellers may contribute up to 6.00% of the sales price to an FHA borrower without affecting the appraised value of the property, but this contribution may be applied only to closing costs and points, repairs, etc., not to the minimum investment (i.e., the down payment). If the seller contributions exceed 6.00%, the excess amount is subtracted from the sales price of the property (as a "sales inducement"), which lowers the maximum loan amount accordingly. HUD has never allowed property sellers to directly provide funds for the minimum 3.00% down payment.

The seller-funded DAP programs get around this problem by having the property seller contribute the down payment funds to a "nonprofit" company which then "gifts" the funds to the borrower. Sellers are generally charged a fee of at least $400 for "processing" their contributions. Every reputable study (non-industry-sponsored) of the resulting loans (like this one) shows that 1) the sales prices of the properties are inflated by the amount of the "assistance" and that 2) the loans default at least twice as often as those with bona-fide gifts from a disinterested party. Even worse, because they are processed with the standard UFMIP charged to loans with a 3.00% down payment, this additional risk is not offset by a higher premium.

Here's how it works. First, here's a "typical" FHA loan with a 3.00% down payment (we'll assume that the seller pays closing costs other than UFMIP in cash, just to keep things simple):

• Original list price: $100,000
• Contract sales price: $100,000
• Appraised value: $100,000
• Required borrower down payment: $3,000
• Base Loan Amount: $97,000
• UFMIP: 1.50% or $1,455
• Total loan amount: $98,455
• Effective LTV (based on original list price): 98%

Here's how it works with a typical seller-funded down payment:

• Original list price: $100,000
• Contract sales price: $103,505 (list price plus $400 processing fee, divided by 0.97)
• Appraised value: $103,505 (or any amount above that, as LTV is calculated on the lower of appraised value or contract sales price)
• Required borrower down payment: $3,105 (provided by the seller via the DAP)
• Base loan amount: $100,400
• UFMIP: 1.50% or $1,506
• Total loan amount: $101,906
• Effective LTV (based on original list price): 102%

If the DAP loan were treated as the same risk as the proposed zero down program, you would get UFMIP of 2.25% or $2,259, resulting in a total loan amount of $102,659 and effective LTV of 103%. That would actually produce a higher loan amount than a true zero down program would, because of that $400 "processing fee" to the "nonprofit" (zero down base loan amount of $100,000, UFMIP of $2,250, total loan amount of $102,250, or $409 less than the "assistance" loan).

What happens if the appraiser refuses to play along with this scheme? Well, that would create a problem: the maximum loan amount is calculated on the lesser of the sales price or appraised value, and so the borrower could not borrow enough to pay the inflated sales price if it were greater than the appraised value.

What if the seller simply reduced the contract price by $3,505 (the cost of assistance plus processing fee)?

• Original list price: $100,000
• Contract sales price: $96,495
• Appraised value: $100,000
• Required borrower down payment: $2,895
• Base Loan Amount: $93,600
• UFMIP: 1.50% or $1,404
• Total loan amount: $95,004
• Effective LTV (based on original list price): 95%

The problem with that last scenario, of course, is that the borrower still has to come up with a down payment. The whole purpose of seller-funded DAPs is to get borrowers with no funds into loans, not merely to facilitate legitimate seller concessions.

Does it really matter whether gift funds come from an interested party? Yes, it does. A party without an interest in the transaction has no incentive to induce or persuade the borrower to pay more than the fair market value of the property; in fact, a distinterested party has an incentive to assure otherwise, since the lower the appraised value and contract sales price, the less the third party has to contribute. Government agencies and true nonprofits who provide such assistance are known for being mean and skeptical reviewers of appraisals and sales contracts, you see. (They also generally have income limits and other rules designed to keep speculators and other non-needy folks out of their programs.) Seller-funded DAPs avoid all that "red tape" and "excessive processing time."

I personally have never had any enthusiasm for the proposed zero down FHA program. But even it is better than the DAP scam. Those who claim that DAP loans provide a benefit to borrowers without funds are making no sense even if you grant that making loans to people without even minimal skin in the game is a good idea: the DAP programs simply keep contract sales prices inflated, channel fees into the pockets of "nonprofits" who provide no other service than laundering money, and result in lower insurance premiums than FHA should be getting for loans with riskier profiles. If you care at all about the long-term survival of the FHA program, you would be doing everything you can to protect it from this kind of damage.

By their own logic, the Congressional defenders of DAPs should be pursuing the zero down program, and/or funding for true nonprofits and local governments who provide forms of down payment assistance that don't inflate sales prices and that offer real, useful homebuyer counseling services. One of the arguments for DAP is that it is available for borrowers who aren't lucky enough to have family, an employer, or a local agency or true nonprofit who can provide gift funds. That's right: if you aren't lucky enough to receive a true gift that enables you to buy a market-priced property, you can be thrown to a bunch of sharks who will provide you with a "gift" with a hidden price tag. This is a good thing, since owning an overpriced home and making the higher payments is, I guess, a major blessing.

Supporting DAPs means supporting property sellers--particularly but not limited to builders and developers--and the "entrepreneurs" who form "nonprofits" to extract fees from naive homebuyers, not to mention loan originators who pocket higher commissions, with the risk being carried by government insurance. It is, precisely, the kind of sleazy, conflict-ridden, self-serving "initiative," overtly "faith-based" or its sort-of secular equivalent "dream-based," that thrives in an environment where regulation is dismantled or unenforced and "government" is bashed with one hand and milked with the other. It is an "innovation" just like plainer, older-fashioned forms of money-laundering are "innovations." It takes a profound ideological blindness to march behind the DAP banner in the name of "helping first time homebuyers."

by Calculated Risk on 10/19/2007 08:34:00 AM

From the WSJ: Wachovia's Net Falls 10% On Loan-Loss Provisions

Wachovia Corp.'s third-quarter net income dropped 10% as loan-loss provisions quadrupled and the company recorded $1.3 billion in losses and write-downs. Wachovia also signaled increasing credit troubles ahead.
...
Loan-loss provisions surged to $408 million from $108 million amid growth in auto, commercial and consumer real estate lending. Net charge-offs were 0.19% of average net loans, compared with 0.16% a year earlier. Nonperforming assets, troubled loans that could turn into charge-offs, more than doubled to 0.63% of loans from 0.26%.

by Calculated Risk on 10/19/2007 02:08:00 AM

From the WaPo: Capital One Reports Loss From Closing Mortgage Unit

Capital One Financial of McLean posted its first quarterly loss ever, from the expense of shutting down its mortgage lender, and warned of additional challenges in the credit card and auto finance businesses.
...
Yesterday's announcement offered a glimpse into how the credit crunch might affect other areas of lending.

Capital One reported an increasing number of delinquencies and defaults in both the credit card and auto finance sectors. As a result, the company said its expenses associated with covering bad loans have increased.
...
There are signs that the collapse in the mortgage markets has taken a toll on consumer spending, said Scott Hoyt, director of consumer economics at Moody's Economy.com.
...
"If [credit card issuers] were to cut back significantly, that would have the potential to be a blow to spending," he said.

by Calculated Risk on 10/19/2007 12:06:00 AM

From the WSJ: Citi's SIVs: Staving Off a Fire Sale

Executives of Citigroup Inc. say the giant bank has secured funding through year end for the $80 billion in structured investment vehicles it manages after selling $20 billion in assets since the midsummer credit crunch.

The steps taken by the bank's alternative-asset management unit ... mean the Citigroup SIVs can avoid the kind of forced selling at distressed prices begun by some other European SIV managers ...
...
Mr. Havens of Citigroup said in an interview the Citi SIVs have in the past week or so been able to sell "many billions of dollars" of short-term debt known as commercial paper "to top-tier-name institutions."

And the following article on SIVs is excellent: How London Created a Snarl In Global Markets

The ... bankers hatched the idea of setting up a fund that would issue short-term commercial paper and medium-term notes to investors, then use the money to buy higher-yielding assets, typically longer-term ones. The bank would profit by collecting fees for operating the fund. The fund's assets would belong to its investors, so they would stay off the bank's balance sheet. SIVs had an advantage over conduits, a similar structure that was already gaining popularity: They didn't require banks to cover fully the fund's debts if the commercial-paper market dried up.

by Calculated Risk on 10/18/2007 05:58:00 PM

Click on graph for larger image.

Source: Cleveland Fed, Fed Funds Rate Predictions

The market now expects a 25bps rate cut to 4.5% at the upcoming meeting.

by Calculated Risk on 10/18/2007 03:36:00 PM

From Bloomberg: Rhinebridge Commercial Paper SIV Says May Be Unable to Pay Debt (hat tip julian)

Rhinebridge Plc, a structured investment vehicle run by IKB Deutsche Industriebank AG, said it may not be able to pay back debt related to $23 billion in commercial paper programs.

Rhinebridge suffered a ``mandatory acceleration event'' after IKB's asset management arm determined the SIV may be unable to repay debt coming due, the Dublin-based fund said in a Regulatory News Service release. A mandatory acceleration event means all of the SIV's debt is now due...

Just yesterday, the Cheyne Finance receiver said: "In our view people should not take this as a precedent for other SIVs." Uh, nevermind.

by Calculated Risk on 10/18/2007 03:01:00 PM

From DataQuick: Bay Area home sales plummet amid mortgage woes

Bay Area home sales sank to their lowest level in more than two decades in September, the result of a continuing market slowdown and borrowers' increased difficulties in obtaining "jumbo" mortgages, a real estate information service reported.

A total of 5,014 new and resale houses and condos were sold in the nine-county Bay Area in September. That was down 31.3 percent from 7,299 in August, and down 40.1 percent from 8,374 for September a year ago, DataQuick Information Systems reported.

Sales have decreased on a year-over-year basis the last 32 months. Last month was the slowest September in DataQuick's statistics, which go back to 1988. Until last month, the slowest September was in 1991 when 5,735 homes were sold. The strongest September was in 2004 when sales totaled 12,868. The average for the month is 8,961.

"A lot of escrows just didn't close in September because the buyers couldn't get financing. Some of those sales might close this month or next, but many of the deals are going to be put on hold or die on the vine. Jumbo financing has become more available the last few weeks, but lenders are being more cautious than before, and the loans cost more," said Marshall Prentice, DataQuick president.

The number of Bay Area homes purchased with jumbo mortgages dropped from 3,762 in August to 1,935 in September, a decline of 48.6 percent. A jumbo mortgage is a home loan for $417,000 or more. For loans below that threshold, the sales decline was 14.0 percent, from 2,675 in August to 2,301 in September. Historically, sales drop by about 10 percent from August to September.

The median price paid for a Bay Area home was $625,000 last month, down 4.6 percent from $655,000 in August, and up 0.8 percent from $620,000 for September last year.
...
Foreclosure activity is at record levels.

by Calculated Risk on 10/18/2007 11:48:00 AM

Quotes of the day from WaMu (via Seattle Times):

"This is perhaps the most challenging cycle for housing that we've seen in many decades," WaMu Chief Executive Kerry Killinger said in an interview. He and other WaMu executives said they don't see any improvement in the near term.

And from the WaMu CFO:

"I have never seen housing credit conditions change so significantly over such a short period of time, nor can I remember a period when there was less clarity about near-term housing and credit trends," [Chief Financial Officer Tom] Casey said