by Calculated Risk on 2/23/2007 12:20:00 AM

"We're a little more disappointed than two weeks ago. For President's Day weekend we had good sales, but we didn't have anywhere near the bump up that we normally see. That's disappointing."
Robert Toll, Chief Executive, Toll Brothers

From AP: Toll Brothers 1Q Profit Falls 67 Percent

Alex Barron, an analyst with JMP Securities in San Francisco, said he wasn't surprised that Toll's comments have taken a more sober tone.

"Now, he's sounding a bit more concerned and depressed," he said. "You can't have five years of a good time and fix everything in a few quarters."

by Calculated Risk on 2/22/2007 08:42:00 PM

From Bloomberg: Subprime Mortgage Derivatives Extend Drop on Moody's Reviews

The perceived risk of owning low- rated subprime mortgage bonds rose to a record for a fifth day after Moody's Investors Service said it may cut the loan servicing ratings of five lenders.

An index of credit-default swaps linked to 20 securities rated BBB-, the lowest investment grade, and sold in the second half of 2006 today fell 5.6 percent to 74.2, according to Markit Group Ltd. It's down 24 percent since being introduced Jan. 18, meaning an investor would pay more than $1.12 million a year to protect $10 million of bonds against default, up from $389,000.

Graph from Markit:

The BBB- rated portions of ABX contracts are ``going to zero,'' said Peter Schiff, president of Euro Pacific Capital, a securities brokerage in Darien, Connecticut. ``It's a self- perpetuating spiral, where as subprime companies tighten lending standards they create even more defaults'' by removing demand from the housing market and hurting home prices, he said.

by Calculated Risk on 2/22/2007 10:43:00 AM

From the Department of Labor:

In the week ending Feb. 17, the advance figure for seasonally adjusted initial claims was 332,000, a decrease of 27,000 from the previous week's revised figure of 359,000. The 4-week moving average was 328,000, an increase of 1,250 from the previous week's revised average of 326,750.

Click on graph for larger image.

This graph shows the four moving average weekly unemployment claims since 1968. Although the four week moving average has recently been trending upwards, the level is still fairly low and not a concern.

Also, from the Conference Board today: Help-Wanted Advertising Index Dips Two Points

The Conference Board Help-Wanted Advertising Index — a key measure of job offerings in major newspapers across America — declined two points in January. The Index now stands at 32. It was 38 one year ago.

Although both claims and the help-wanted index were slightly weaker than expected, there is nothing indicating a significant slowing of the labor market.

by Calculated Risk on 2/21/2007 08:25:00 PM

"If there is one development to worry about the potential of recession it will be housing."
San Francisco Fed President Janet Yellen, 2/21/2007

San Francisco Fed President Janet Yellen spoke today in California: The U.S. Economy in 2007. Here are some excerpts on housing:

[T]he housing sector has been at the leading edge of the overall economic slowdown, and I’d like to turn my attention to that important sector now.
...
Despite the continued weakness in housing construction, which ... enters directly into the calculation of real GDP, there are some signs of stabilization in other aspects of housing markets, suggesting that construction activity may level out before too long. For example, home sales have steadied somewhat after falling sharply for a year or so. Considering this in combination with the continued drop in housing starts that I mentioned earlier, it is not surprising to find that inventories of unsold homes have begun to shrink. This development suggests that the process of resolving the imbalances between demand and supply in the housing market may be underway, and, as a result, we could very well see the drag on real GDP from housing construction wane later this year.

It's probably important to understand how "housing construction enters directly into the calculation of real GDP". Every month, the Census Bureau calculates construction spending, value put in place. The BEA uses this number to calculate Residential Investment (RI). This is essentially the amount of money homebuilders spend on construction each month. It doesn't matter if the home is sold, what matters for GDP is that a home is being built.

Since housing completions are still near record levels (even though starts have fallen off a cliff), construction spending hasn't fallen very much yet. And because starts have fallen significantly, we know that the RI component of GDP will continue to decline over the next few quarters. The question is if there will be another downturn in housing or, as Dr. Yellen suggests, the drag from housing will "wane".

However, since home completions are still near record levels, there has been very little impact yet on jobs and consumer spending - at least so far. Those impacts are in the future.

Of course, such a turn of events is by no means a given, because the improvements we’ve seen may just be temporary. ...

In addition to concerns about weakness in housing construction, there has been worry that difficulties related to housing markets could spread to consumer spending more generally. Since consumption expenditures represent two-thirds of real GDP, even a relatively modest impact from housing markets on this big sector could put a noticeable dent in overall economic activity.

Up to this point, we haven’t seen signs of such spillovers. Consumption spending has been well maintained, showing a robust growth rate for all of 2006. However, going forward, there are at least a couple of ways that spillovers from weakness in housing could depress consumer spending, and these channels bear watching. First, housing makes up a significant fraction of many people’s wealth, so a significant change in house values can affect consumer wealth and therefore consumer spending. As you know, there have been fears about plummeting house prices. But so far, at least, house prices at the national level either have continued to appreciate, though at a much more moderate rate, or have fallen moderately, depending on the price index you look at. Looking ahead, futures markets are expecting small declines in a number of metropolitan areas this year. While these modest movements are undoubtedly imparting less impetus to consumer spending now than during the years of rapid run-ups, their effects are not likely to be dramatic.

... housing market developments also could spread to consumer spending if enough homeowners experienced financial distress. For example, rising variable mortgage rates could strain some consumers’ cash flow. What we find, however, is that, because of the rapid appreciation of home prices in prior years, most homeowners are sitting on a substantial amount of equity, a financial resource that they can fall back on. In particular, adjustable-rate borrowers with equity can avoid a rate reset by refinancing. Moreover, only a small fraction of outstanding variable rate mortgages are scheduled to be reset in each of the next few years.

Although Dr. Yellen mentions the housing wealth effect, I'm surprised she doesn't mention the possible impact of less Mortgage Equity Withdrawal (MEW). The wealth effect and MEW are related, but MEW probably shows up more directly in consumer spending. The wealth effect just means someone feels wealthier and therefore they are a little more willing to spend. However MEW is actual money burning a hole in the consumer's pocket.

Of course, financial distress could be a bigger problem for some borrowers who used so-called exotic financing—like interest-only loans, piggy-back loans, and loans with the possibility of negative amortization. These instruments are often designed to allow subprime borrowers into the market. In fact, there are signs of trouble for some households. Delinquencies on variable-rate mortgages to subprime borrowers have risen sharply since the middle of last year and now exceed 10 percent. But fortunately, delinquency rates for other types of mortgages—including all prime borrowers and even subprime borrowers with fixed-rate loans—have edged up only very modestly. I know that it’s common to see newspaper stories about homeowners who have run into trouble, and those situations are, indeed, regrettable. From a national perspective, however, the group with rising delinquencies still represents only a small fraction of the total market, with little impact on the behavior of overall consumption.

A forward-looking view of the credit risks associated with subprime mortgages can be obtained from a new financial instrument related to these mortgages. These instruments suggest a big increase in the risk associated with loans made to the lowest-rated borrowers, but little change in risk for other higher-rated borrowers. Based on these results, it appears that investors in these instruments expect the losses to be fairly well contained. Of course, a shift in market sentiment about the risk of some of these securities is always possible. Such a shift would have ramifications for mortgage financing and housing, likely through tighter credit standards and higher mortgage rates for certain borrowers. In fact, we already have seen some tightening among commercial banks in recent months.

The bottom line for housing is that the concerns we used to hear about the possibility of a devastating collapse—one that might be big enough to cause a recession in the U.S. economy—while not fully allayed have diminished. Moreover, while the future for housing activity remains uncertain, I think there is a reasonable chance that housing is in the process of stabilizing, which would mean that it would put a considerably smaller drag on the economy going forward.

I've never felt housing would experience (edit) "plummeting prices" or a "devastating collapse" (note: ac points out that Yellen defines a devastating collapse as one that takes the economy into recession, so I agree that is possible), and I think that is a bit of a strawman from Dr. Yellen. But what happens when credit standards are tightened as Yellen suggests is happening? Some potential buyers are removed from the market, and demand decreases. So we currently have record levels of supply and we will probably see less demand. Does that sounds like a market that is coming into balance?

I discussed the possible impact of tighter credit standards on the 2007 housing market before: Subprime: The impact on Existing Home Sales in 2007 Needless to say, I'm not as sanguine as Dr. Yellen.

by Calculated Risk on 2/21/2007 12:11:00 PM

Click on graph for larger image.

This graph shows the MBA Purchase Index since the inception of the index in 1990.

At the end of 2006 there appeared to be a surge in purchase applications. This might have been due to increased activity, or possibly favorable weather.

Another possibility is that because many smaller lenders have closed shop, more potential buyers are applying for loans from the lenders covered by the MBA survey. From the MBA:

The survey covers approximately 50 percent of all U.S. retail residential mortgage originations, and has been conducted weekly since 1990. Respondents include mortgage bankers, commercial banks and thrifts. Base period and value for all indexes is March 16, 1990=100

As an example, suppose 1000 people applied for loans in a given week from 10 lenders.

Lender 1: 250
Lender 2: 150
Lender 3: 100
Lender 4-10: remaining 500 applications.

The MBA survey covers "approximately 50 percent of all U.S. retail residential mortgage originations", so in this example the MBA would only need to survey the top 3 lenders. Now if lender 10 closed shop (with 50 applicants), and the applicants all applied in equal proportions to the other lenders, the MBA index would increase 5% without any increase in overall activity.

My suspicion is this is what happened in late 2006, especially since the increased activity didn't show up in New or Existing home sales.

by Calculated Risk on 2/21/2007 10:28:00 AM

The Mortgage Bankers Association (MBA) reports: Mortgage Applications Decrease

Click on graph for larger image.

The Market Composite Index, a measure of mortgage loan application volume, was 606.6, a decrease of 5.2 percent on a seasonally adjusted basis from 639.8 one week earlier. On an unadjusted basis, the Index decreased 2.9 percent compared with the previous week and was up 4.1 percent compared with the same week one year earlier.

The Refinance Index decreased 5.4 percent to 1921.1 from 2031.7 the previous week and the seasonally adjusted Purchase Index decreased 4.8 percent to 381.4 from 400.7 one week earlier.

Mortgage rates were mixed:

The average contract interest rate for 30-year fixed-rate mortgages decreased to 6.19 percent from 6.24 percent ...

The average contract interest rate for one-year ARMs increased to 5.81 from 5.8 percent ...

The second graph shows the Purchase Index and the 4 and 12 week moving averages since January 2002. The four week moving average is down 1.3 percent to 398.7 from 404 for the Purchase Index.

The refinance share of mortgage activity decreased to 44.9 percent of total applications from 46.1 percent the previous week. The adjustable-rate mortgage (ARM) share of activity remained unchanged at 21.2 percent of total applications from the previous week.

by Calculated Risk on 2/20/2007 05:22:00 PM

From MarketWatch:

NovaStar mulls change to REIT status NovaStar Financial said late Tuesday that it's considering whether to change its Real Estate Investment Trust status after the subprime mortgage lender reported a fourth-quarter net loss.
...
Problems with mortgages originated in 2006 knocked $17.4 million, or 47 cents a share, off fourth-quarter earnings. Provisions for losses on loans NovaStar has been forced to repurchase cut $13.4 million, or 36 cents a share, off results. More provisions for losses on a package of early 2006 mortgages the company securitized cost it another $10.3 million, or 28 cents a share, NovaStar said.
...
REITs have to distribute at least 90% of their taxable income as dividends. NovaStar Chief Financial Officer Greg Metz said the company expects to recognize little, if any, taxable income in 2007 through 2011, so "management is currently evaluating whether it is in shareholders' best interest to retain the company's REIT status beyond 2007 given the asset, income and other REIT-related restrictions the company must operate within."
emphasis added

NovaStar conference call (hat tip max):

by Calculated Risk on 2/20/2007 04:16:00 PM

From Charlotte Observer: Wells Fargo cuts 250 jobs in Fort Mill

The cuts are the latest fallout from problems in the business of subprime lending -- lending at high interest rates. Demand for new high-rate loans is shrinking even as defaults on existing loans are rising, leaving lenders with less revenue and more expenses.

Wells Fargo, like other large mortgage lenders, has responded to the defaults by tightening the requirements for new loans, further shrinking the volume. The Fort Mill office, which is part of the company's subprime operation, will have less work to do.

"We tightened our credit policy," Wells Fargo said in a statement. "This decision directly impacts our nonprime loan volume, which in turn impacts staffing levels in the areas devoted to managing these loans."

by Calculated Risk on 2/20/2007 12:26:00 PM

StillLearning asked in the comments about mortgage servicing, and since y’all are nerds, not dummies, here’s my highly-selective occasionally-oversimplified summary for you that skips the boring parts like how your check gets out of the “lockbox” and that stuff. We can discuss extra-credit issues like “excess servicing” and “subservicing” and “SFAS 144 meets MSR” and “negative convexity” and other kinds of inside baseball in the comments. There is a lot that can be said about loan servicing, but let’s start with the basics:

Servicers have two major types of servicing portfolio: loans they service for themselves and loans they service for other investors. In accounting terms, the “compensation” is the same, meaning that even if you are the noteholder, you pay yourself to service the loans in the same way that an outside investor would pay you, and it shows on the books that way. The differences in compensation stem from the basic fact that one is generally more motivated to do a good job servicing (particularly collecting and efficiently liquidating REO) for one’s own investment than for someone else’s.

So major investors like the GSEs have all sorts of supplemental compensation structures in place for their servicers: everyone may start out being paid just the basic servicing fee, but if you meet the GSE goals for loss mitigation and general performance standards, you get “bonuses.” Private label security servicing agreements are huge and complex, and the terms can vary. Often the way those deals provide the “extra” incentive for the servicer to do a good job is the fact that the servicer is the issuer, and the issuer retains the residual or equity tranche of the deal—so the servicer does have skin in the game when it comes to mitigating losses.

The basic economics of servicing compensation is that the servicer gets what is called a “servicing fee” on each loan equal to a slice of the interest paid. The usual servicing fee for prime loans is .25% for fixed rate and .375% for ARMs; FHA/VA loans are .44%. What you get in subprime varies widely; generally, the worse the credit quality, the more you have to pay the servicer, because the more work the servicer will do (i.e., making collection calls to get the payment in each month). ARMs are more servicing work than FRMs because the rate and payment adjustments have to be processed, notices sent, loan balances recast, etc. Servicers generally get to keep part or all of late fees (those don’t get passed on to the investor), which can create a perverse incentive: it compensates the servicer for the additional expenses of handling a delinquent loan, but it can tempt the servicer to post payments in a tardy fashion or to not bother with collection calls until after the point where a late fee is assessed to assure the fee income. The real bottom-feeder servicers make a fortune on this kind of crap. (Hence the GSEs’ “bonus” program for loss mitigation efforts: it’s a way to “reincentivize” the process so that the servicer “wins” when a troubled loan becomes current again and those late fees go away.)

The general fact about servicing fees is that they are always paid first: technically, of course, the servicer gets the payment, so the servicer gets to take its 25 or 37.5 bps off the top before passing the rest through to the investor. (There’s also non-negligible “float” income here for the servicer, as payments get collected on and around the first of the month but the “cutoff” for passing them through to the investor generally isn’t until the 25th or so.) But it’s more than just a technical fact; it’s a risk management thing, like the airline drill where passengers are advised to adjust their own oxygen mask first before assisting their children. No investor ass will be covered unless there’s a servicer to cover it, so you pay the servicer first. On the other hand, the servicer is the very first party to incur any expense in the case of delinquency or default, and the servicer’s expenses just “rack up” until final liquidation (payoff if the loan is refinanced or the property sold voluntarily, liquidation of the REO if the loan is foreclosed). Once again, though, servicer expenses come “off the top” of the liquidation proceeds, and the investor gets what’s left over.

Hence there’s always a balancing act going on between servicer and investor: if, as an investor, you want to micromanage your servicer, to make sure that it isn’t going hog wild with expenses or dragging things out until there are no proceeds left for you, you can find yourself spending too much money “redundantly servicing” loans to have any worthwhile yield left. On the other hand, if you don’t force the servicer to get your permission to take certain steps, you won’t have any yield left because the servicer eats it in expenses or throws away the property for a sweetheart price just to get the problem off the expense-o-meter.

We were talking the other day about Wells Fargo’s servicer rating being “used” to improve the rating of co-issued securities. WF is a good example of a good, conservative servicer (at least from an investor’s perspective) who doesn’t have to be babysat or argued with all the time. You very frequently do get what you pay for in this industry, and an investor might pay WF more for servicing loans, but still come out ahead of someone using some bottom-feeder servicer whose contract looks like a deal until you find out how it is going to be managed.

In any case, the other side of “float” for the servicer is the usual requirement that the servicer advance interest (and possibly principal, although that’s less common) to the investor when it is “scheduled” to be due but wasn’t actually paid by the borrower. You’ll see, for instance, the term “scheduled/actual” used to refer to a servicing arrangement. That means that the servicer must pass through all scheduled interest each month, whether collected from the borrower or not, but only actually collected principal. Most deals these days are S/A or S/S. (A/A exists, but it’s like “with recourse,” which we talked about on a prior thread. It takes a very well-capitalized, high-risk tolerance investor to accept an A/A deal; most of the ones I see these days are old Freddie Mac MBS that are down to six loans each and just won’t die until the last payment is made.)

Having to advance scheduled interest offsets the float; it’s another way to balance the incentives. It really starts to matter when we get to this thing called “nonaccrual.” Basically, a usual servicing contract will require the servicer to advance interest until the loan is more than 90 days delinquent, after which it is placed in “nonaccrual” status, meaning it is deemed uncollectable and no more interest has to be advanced. (Note: this doesn’t mean that past-due interest is “forgiven” for the borrower; it means that the investor can no longer “count” past-due interest as noncash income, because the odds of ever getting it are getting ugly.)

Even if the servicer no longer has to keep advancing scheduled interest, though, it has to keep paying property taxes and insurance, if the borrower isn’t paying it, until the property is sold. It also has to cover the other expenses in a foreclosure (unless the contract specifies that the investor or mortgage insurer will advance for certain costs) until the final payday. In practical real-world terms (not the pretty stuff you see in contracts), when recovery values in a foreclosure are high (in an RE boom), servicers can noodle along and rack up expenses you didn’t know existed—i.e., shove as much of your “overhead” into FC expenses as you can get away with, since someone else will eventually pay the tab. That’s what we mean when we say that you used to be able to make money off a foreclosure. When the liquidation value starts to approach or drop under the loan amount, on the other hand, investors and insurers start going over those expense reports with a fine-toothed comb, and it can end up in the same kind of “war” we’re seeing with repurchases.

There are two important things to know about loan servicing income in the normal (non-delinquent) side of things. One, loan balance matters to servicers in a way it doesn’t matter to investors. If you are buying, say, a $1MM interest in a $500MM pool of loans, you get the WAC (weighted average coupon or interest rate) on your million, regardless of whether that million is made up of 20 $50,000 loans or 2 $500,000 loans. Of course, if your yield is really coming from 2 $500,000 loans, you’re at much higher risk of losing yield due to refinance or principal due to default, since one-out-of-two isn’t great odds. But that’s why you’re buying a small piece of a huge pool, so you don’t have that kind of risk (the whole-loan investor has that kind of risk).

The servicer, on the other hand, gets its 25 bps for the $50,000 loan and the $500,000 loan, while its fixed costs are the same for each loan. Not only that, the fixed costs are “front-loaded” (for performing loans, remember). The big expense is getting the loan “boarded” on the servicing system, getting the initial notices out, doing the initial escrow analysis and tax setups and so on; after that (until the annual tax bills or annual ARM adjustments come into play), a performing loan is a cheap deal: payment comes in each month, gets posted, it drives itself at this point. But this means that the $50,000 loan has to stay on your books a lot longer than the $500,000 loan does for you to get past break-even, because the servicing fee/float income is a little bit a month, not an upfront lump sum. Loan officers and brokers get paid upfront lump sums for loans, so they like big loans too. Underwriters get nervous about big loans, because with loan balance increase comes credit risk increase.

So there are competing pressures—costs, risk, efficiency—in the industry regarding loan balance. In a “normal” environment, these competing pressures (servicers want the bigger loans, investors want the smaller loans) keep risks reasonably mitigated. But next time you see some statistics showing a much lower average loan balance for subprime pools, bear in mind that this isn’t just because subprime borrowers often can’t afford to borrow more. It’s because small loans have to have large servicing fees, in order to make them worthwhile for the servicer, so they have “subprime” interest rates. FHA pays 44 bps in servicing not just because their loans don’t perform as well as Fannie/Freddie loans; they also do this so that servicers will service those smaller, therefore less profitable, loans and not cut low-to-mod home-price borrowers out of the market.

The other thing is that, in direct terms, the interest rate on the loan doesn’t matter to the servicer (loan balance being equal). If I’m servicing an 8.50% loan for you, I take .25% off the top and pass through 8.25% to you. On a 4.50% loan, I take .25% off the top and pass through 4.25% to you. The servicer gets paid first, and I get my quarter and you get the rest. Indirectly, though, the servicer’s income is rate-dependent because of refinances. High-rate loans prepay faster than low-rate loans, when prevailing market prices change and the “booms” happen, so a high-rate loan is less likely to stay on the books long enough to cover costs and start generating actual profit. When market rates go up, the investor who is getting 4.25% on loans that will not refinance is losing money, because it could buy a new loan and get 8.25%. However, the servicer’s income is best in that situation, since its profitability is time-dependent, not actual yield-dependent.

This means several things. Servicing income is “counter-cyclical,” so a bank that has both a mortgage investment portfolio and a servicing platform can make money either way, if not always at the same time. Also, servicers have a built-in incentive to keep the loan going, where the investor might like to see it foreclosed. The whole uproar over servicers doing “modifications” as if it were only a way to “hide” losses misses the point that the servicer’s financial incentive is to keep getting its quarter every month. Sure, you can originate a new loan to replace the old loan, but you have those front-loaded fixed costs that don’t go away. Finally, the name of the game in servicing is “economy of scale.” The consolidation of the servicing industry from the days of Tanta’s youth to the present has been nothing short of extraordinary. The servicing market is dominated by the 800-pound gorillas, and will stay that way unless and until market incentives change or risk concentrations get so out of hand that someone has to create some “Baby Bells” out of this.

The end of the long story is that “normal” mortgage environments have lots of opposing forces in more or less equilibrium: the originator, the investor, the servicer. When the environment is not normal, distortions come in and risk levels can appear that are not “historically” usual (and everybody acts surprised). There is going to be some major whining, moaning, and gnashing of teeth by mortgage originators, should we have a real-live credit crunch, that you won’t necessarily hear from mortgage servicers, who have been taking it the shorts all these boom-years and are about to start getting profitable, assuming that delinquent-servicing costs don’t explode on them. If they have the staff to handle the FCs and BKs and REOs, it’s gravy because the investor and insurer are going to end up covering those costs as long as they’re justifiable. If you’re an inefficient servicer whose expense reports don’t pass the investor’s smell test, you’ll lose money if the REO doesn’t sell fast enough. If you’ve been puzzled about what motivates the “nuclear waste” buyers, now you know—they aren’t looking for yield on a note, they’re looking for profit on distressed-loan servicing. The reason they’re offering such crap bids is that the REO isn’t moving fast enough, which increases their expenses and thus eats into their profits. (That and the fact that the loan documents are such a giant mess in so many of these deals that it will take the Olympic Lawyer Relay Team to sort it out.)

That said, what you want to watch if you’re looking at a servicer is the category of loans that are 90+ days delinquent but not yet REO. That may not be anyone’s largest pile of delinquent loans (out of the total of 30-60-90-120-FC-REO), but it’s the one that is the expense-hole. Anyone who is letting that bucket get bigger at a faster rate than it is racking up 60-day delinquencies has a problem. Every loan that is 90 days down this month was 60 days down last month, so out-of-proportion increases in the 90+ category means that the trouble is on the liquidation (escape) side, not just the credit deterioration (entry) side: BKs or legal-document troubles are delaying foreclosure, or nobody really wants to foreclose right now because the bids are going to suck so badly. Dragging it out, though, just makes the servicer wait that much longer to get paid and eats away at what the investor will recover. It’s expensive to carry REO and market it, but you can’t list it until you own it and you can’t sell it until you list it. There are ways to win at the servicing game, but there are also many ways to lose.

by Calculated Risk on 2/20/2007 02:57:00 AM

From Justin Lahart at the WSJ: After Subprime: Lax Lending Lurks Elsewhere

Investors who dabbled in subprime mortgages have learned that risk is a four-letter word. The lesson might need to be applied elsewhere before too long.
...
When housing was hot, subprime mortgages seemed like a sure thing. ... The default rate has since soared.

Could this happen to other borrowers? Mortgage lenders rely on FICO scores for conventional mortgages, too. And easy money hasn't been limited to mortgages. Yields on junk bonds -- the debt of the least creditworthy companies -- have never been as low against comparable Treasury yields as now. The same is true of emerging-market debt. Defaults on these bonds are low, as they were in subprime a few years ago. But how comforting should that be?
...
The downturn has been marked by an unexpectedly large number of "early defaults," for which borrowers stop paying shortly after getting their mortgages. [Asset-backed securities research Thomas] Zimmerman sees "soft fraud" in the mix of defaults. Someone might take out a mortgage, buy a home, avoid payments and live rent-free until the marshals come.

Nobody seemed to realize the risks inherent in extending mortgages with loose standards that left borrowers with little skin in the game. The question worth asking now: Where else has lax lending been going on?

If the answer is far and wide, things could get uglier.

My suggestion: take a hard look at CRE and C&D. When "things get ugly", defaults in CRE and C&D really increase (see early '90s on this Fed chart for commercial real estate).